Credit Suisse’s 7% reverse convertible autocall tied to VeriFone show low risk-adjusted return

By Emma Trincal

Chicago, Aug. 14 – Credit Suisse AG, London Branch’s 7% autocallable reverse convertible notes due Aug. 22, 2016 linked to VeriFone Systems, Inc. shares offer a fixed coupon and 30% contingent protection but the volatility of the underlying stock and the American-type barrier used in the structure increase the risk profile, said Tim Vile, structured products analyst at Future Value Consultants.

The result is a risk-adjusted return below than average.

The notes will be called at par if VeriFone stock closes at or above the initial share price on either of two trigger observation dates, according to a 424B2 filing with the Securities and Exchange Commission.

The observation dates will be Feb. 17, 2016 and May 18, 2016.

Interest on the notes, which will price Tuesday and settle on Aug. 21, will be payable monthly.

American

The payout at maturity will be par unless the stock ever closes below the 70% knock-in level during the life of the notes and the stock finishes below its initial level, in which case investors will receive a number of VeriFone shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

A barrier is called “American” when it can be observed periodically before the expiration of the product.

“It’s a 70% barrier. It’s not bad really. But with an implied volatility in the mid-30%, the barrier could be easily breached,” Vile said.

As of Friday, the stock last hit the barrier in October 2013, he noted.

“The stock has not dropped to such levels in 22 months. Of course investors can always interpret this in two ways. But the stock has actually been pretty stable last year.”

Investors in the notes are betting that volatility will decline. As a result, the best market environment for this type of product is one with low volatility, he explained.

“You don’t want the stock to move much. It’s a fixed-income note that gives you 7% for the year,” he said.

Six-month no call

The notes cannot be called automatically during the first six months, he noted, pointing to this as a particularity for a product with quarterly observation call dates.

“There is no call at the end of the next quarter so you know that you will stay invested at least for the first six months,” he said.

“Without the chance of getting out earlier, your exposure to market risk is slightly higher which is why the issuer was able to price this type of fixed coupon.

Some investors may appreciate the postponement of the call by one quarter as it reduces reinvestment risk.

“They know that if they get called on the first call date, they’ll get at least six months’ worth of income.”

Future Value Consultants in its research assesses risk, return and price using a variety of proprietary scores in order to compare a product with others.

The firm measures each product against two different averages – for the same product type and for all products recently issued.

The product type for this note is called “review.” This category of Future Value Consultants comprises all reverse convertibles with a fixed coupon regardless of whether an automatic call feature is included or not.

Risk

Future Value Consultants assesses the risk associated with a product by adding two risk components--market risk and credit risk. The resulting riskmap measures risk on a scale of zero to 10 with 10 the highest level of risk.

The market riskmap of 3.97 is “only slightly lower” than the average of the same product type of 4.08, he said, commenting on the firm’s research report for these notes.

“It’s pretty much in line with the average review note,” he said.

“The 7% coupon gives some protection over a one-year period.

“The 30% contingent protection is decent.

“The volatility is pretty average.

“But the American barrier adds more risk since the barrier can be breached any time.”

The 0.25 credit riskmap is “neutral,” he said.

“It’s exactly the same as the average for this structure type. “Review products tend to be short-term, which reduces credit risk exposure quite significantly,” he said.

Return score

The return score measures the risk-adjusted return of a product on a scale of zero to 10. It is calculated based on five hypothetical market scenarios and using the best among the five, or a low volatility market in this case.

The return score is 5.69 versus an average of 6 for similar products and 7.70 for all products, according to the report.

“It’s below the average for the same product type. But it’s especially lower than the average of all products,” he said.

“Having a cap and an American barrier doesn’t help when you compare this product with longer-dated enhanced return notes, which may be buffered or uncapped,” he said.

Value

For each product, Future Value computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The price score is 4.95 versus an average of 5.96 for the same product type, according to the report.

“It’s short term. That’s not good in terms of price score because you have less time to amortize the fees, which we compute annually,” he explained.

“Also the issuer probably did not spend enough on the options.”

Overall

The overall score measures Future Value Consultants’ general opinion of the quality of a deal. The score is the average of the price score and the return score.

The notes have a 5.32 overall score while the average for the product type is 5.98.

“It’s a little bit different. The barrier is 30%, which is not bad for one year but it’s an American barrier. You get a fixed coupon, which is good. You know you’ll have at least 7% in protection. But this is a volatile stock. Any investor in the notes should be familiar with it and willing to take on some significant risk,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The Cusip number is 22546VJZ0.

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