Credit Suisse’s autocall reverse convertibles on homebuilder ETF offer less common sector

By Emma Trincal

New York, June 2 – Credit Suisse AG, London Branch plans to price an income-generating product tied to an exchange-traded fund not very often seen as the underlying of a structured note.

The issuer will price contingent coupon autocallable reverse convertible securities due June 3, 2021 linked to the SPDR S&P Homebuilders ETF, according to a 424B2 filing with the Securities and Exchange Commission.

Interest is payable quarterly at an annual rate of 12% if the ETF closes at or above its 75% knock-in level on a quarterly observation date.

The notes will be called at par plus the coupon if the shares close at or above the initial share price on any quarterly trigger observation date.

The payout at maturity will be par unless the shares finish below the knock-in level, in which case investors will receive a number of shares equal to $1,000 divided by the initial share price or, at the issuer’s option, an amount in cash equal to the value of those shares.

Not so common

Only 22 notes offerings totaling $50 million have used the SPDR S&P Homebuilders ETF as their sole underlying since the fund’s inception on Jan. 31, 2006, according to data compiled by Prospect News.

The last one to price was UBS AG, London Branch’s $280,000 of one-year leveraged notes in January 2016, according to the data, which compiles registered structured notes.

Sharp moves

The SPDR S&P Homebuilders ETF tracks the stocks of companies involved in home building activities such as lighting fixture, plumbing, kitchen cabinets. The two top holdings of the fund are Home Depot Inc. and Lowe's Cos. Inc.

The lockdowns have generated a slowdown in construction, which negatively impacted the fund’s returns, said Tom Balcom, founder of 1650 Wealth Management.

Between the beginning of the year and the March 23 lows, the ETF dropped significantly more than the S&P 500 index. Its price fell by 46% versus 33% for the equity benchmark. On the other hand, the fund has recovered much faster since then, up 73% versus 40% for the S&P 500 index. Overall, the year-to-date performance is negative for both and nearly the same with the S&P 500 down 5.2% and the ETF 6.55% lower.

Bullish

“You had a sharp sell-off when people were forced to stay at home. People were afraid,” said Balcom.

“At the same time, people moving out of the city and relocating to the suburbs is a new trend and that should help the sector.

“This note is a bet on the recovering economy, on people returning to normalcy. I like the asset class.”

Balcom said he liked the structure as well.

“25% is very good from these levels unless we have another wave of coronavirus,” he said.

“12% is a nice coupon. When you think of the 10-year Treasury yielding 0.7%, that’s a nice spread over that.”

Downside risk

Donald McCoy, financial adviser at Planners Financial Services, was not sure the notes offered a satisfying tradeoff for investors, especially those seeking income.

“It’s another one of these things I’m not sure why I would offer this to a client,” he said.

He pointed to the volatility of both the fund and the market.

“Much like the S&P, the ETF had a significant V-shape this year. The S&P has outperformed because of the big names – Apple, Microsoft – that have done well.

“Every time you pick a sector, you get more volatility.”

The ETF has a 35% implied volatility compared to 22% for the S&P 500 index.

“If the market tanks again and we get hit with another 30% drop, I basically stay in limbo. I haven’t lost anything yet. I’m just not getting my coupon,” he said.

He expressed other concerns, pointing to market risk with losses of at least 25% if the barrier is breached at maturity.

“You’re not investing in this note for the return; otherwise, you would buy the shares outright,” he said.

“You’re investing in it for the income. Given the fragility of the market and the fact that we have recovered so much from the March lows, the potential is there for retesting those lows and going down 25%.”

The return is not worth the risk, especially for income investors, he said.

“At the end of the year, you get 12%. It’s something, but you can be hit with significant losses. For an income play, it seems inappropriately dangerous on the downside,” he said.

Autocall

Finally, McCoy said the automatic call feature defeated the purpose of finding a steady stream of income for investors who rely on it.

“If the ETF is up 1% at the end of the quarter, you’re out and you get 3%.

“You go through the nuts and bolts of finding an investment for a client who wants income and now you have to start all over again. I don’t think it’s a very efficient income strategy.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will settle on Wednesday.

The Cusip number is 22550MFE4.

© 2015 Prospect News.
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