Credit Suisse’s 6%-8% contingent coupon autocalls on S&P, Nasdaq show reasonable risk profile

By Emma Trincal

New York, June 8 – Credit Suisse AG, London branch’s contingent coupon autocallable yield notes due Sept. 30, 2019 linked to the worst performing of the S&P 500 index and the Nasdaq-100 index are geared toward income investors who seek a balanced risk-return profile, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will pay a contingent quarterly coupon at an annual rate of 6% to 8% if each underlying index closes at or above its 70% coupon barrier on each trading day for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are called at par if each index closes at or above its initial level on any determination date other than the final date.

The payout at maturity will be par unless any underlying index ever closes below its 70% knock-in level during the life of the notes, in which case investors will be fully exposed to any losses of the worse performing index.

“This is an income product even though you’re not getting a fixed interest rate. Unlike a pure autocall you have a chance to receive one or several coupons without being called. This makes the product attractive to income investors,” said Hampson.

Volatility

Several aspects of the structure contributed to reduce the risk.

“You have a barrier of 70%, which for a 15-month note does seem quite low, so that’s a good thing,” she said.

“You’re looking at two indices, not two or three single-stocks.

“The Nasdaq is slightly more volatile but these are quite stable indices.”

The implied volatility of the Nasdaq-100 index and the S&P 500 index is 15.7% and 14.5%, respectively, she said.

“We’re not talking about tech stocks with a volatility of 30%, 40% or even 50%.”

Dispersion

The use of a worst-of payout increases the odds of breaching a barrier.

The return is tied to the performance of each index, which adds risk compared to a single underlier, she said.

“Anytime you add an index and link your return to the worst-of, you increase the risk,” she said.

But the issuer picked two significantly correlated underliers, which decreased the probability of one moving down in price while the other goes up, she added.

“The correlation between these two indices is high, which gives you a little bit less premium but also less risk.”

The Nasdaq-100 and the S&P 500 show a correlation coefficient of 0.93. It means that both indexes have a nearly perfect positive relationship.

The correlation may reduce the premium. But the mere addition of a second index to the mix helped make the economics work, she said.

Hampson estimated that the same structure based solely on the S&P 500 index would probably lower the coupon rate by two percentage points.

Risk mitigation

Finally, the automatic call feature itself can be seen as a risk mitigation element.

“On the first call point after six months, the chances of kicking out are extremely high. You get paid your first coupon and you’re out. There is no risk once the notes are redeemed obviously,” she said.

Overall the product presents a relatively “balanced” structure with a “decent” premium without excessive risk-taking, she said.

“It’s a worst-of, so naturally it’s at risk. It’s not a conservative product. The American barrier at maturity adds a bit more risk as well,” she said.

American barriers have a periodic observation – and in this case daily – through the life of the notes. They differ from the less risky and more typical European barrier, which is observed at maturity.

“Yet it’s got an autocall. The barrier is quite generous, which makes it easier to collect the coupon and your principal back.”

First call first

Future Value Consultants offers stress testing reports on structured notes. Those determine the probabilities of occurrence of outcomes pertaining to a specific product and structure type.

Each report contains a total of 29 sections or tests, which encompass simulation tables as well as back testing analysis.

The Monte Carlo simulation uses market and implied data to run the tests, including risk-free rate, issuer credit spread, deposit rate, dividend yield and volatility as well as correlation matrix.

The first key observation illustrated by the report is common to all autocallable notes: the occurrence of an autocall on the first call date is the most likely outcome by far.

One table (“product specific tests”) reveals that the notes will be called more than 53% of the time in a neutral market scenario.

A neutral scenario is the basis of the simulation. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying. The model is also run on four other market scenarios, which are: bull, bear, less volatile, more volatile.

In the bull scenario, the call on the first call date occurs 63% of the time. Even in the bear assumption, the probability is 48%.

Short duration

“These are high probabilities. It’s obviously the most likely scenario,” she said.

Future Value Consultants also runs the same tests from a back testing analysis.

It shows that the frequency of a “first call” was 66% over the past 10 years.

“That’s very similar to the results of our bull simulation. It makes sense given the bull market of the past decade,” she said.

Investors should not downplay the highly probable early redemption.

“As an income investor you need to know that half or two-thirds of the time, your notes will be called after six months,” she said.

“As long as you’re aware that you’re most likely to kick out with half of your annual income and that you need to reinvest it elsewhere, that’s fine.”

Call, no call

When the notes are not called on the first observation date, the chances of a call drop significantly.

There is less than a 16% chance of an automatic call on the second and third call dates combined, according to the table.

In nearly a third of the time (a probability of 31%), the notes mature, which means that at least one index ended lower than its initial level. This is the “no call occurred” outcome.

At the end

When this happens, several scenarios are possible.

In 12% of the time, investors will lose principal and finish with less money than they started with as a result of the barrier breach. A very small probability (less than 1%) points to situations in which noteholders still finish above water as the one or several coupons they collected offset the losses of principal. This is possible because the American barrier can be triggered during the life and a small price decline at maturity could be offset by the income payments.

The real negative scenario, the one in which investors will get at maturity less than what they initially invested shows an 18% probability.

“It’s not huge,” she said.

“This product is somewhere in the middle.

“It’s got elements that are high risk, such as the worst-of and the American barrier. But there are also plenty of items that limit all those negatives. So it’s hard to say that it’s a highly aggressive structure. It’s not. It’s not conservative but it’s not high risk either.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on June 26 and settle on June 29.

The Cusip number is 22550WUT2.

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