Credit Suisse’s 11%-13% reverse convertibles on gold ETF require conviction, risk tolerance

By Emma Trincal

New York, Jan. 13 – Credit Suisse AG, London Branch’s 11% to 13% autocallable reverse convertible securities due Jan. 25, 2018 linked to the VanEck Vectors Gold Miners exchange-traded fund received lower-than-average scores as a result of two factors, said Tim Mortimer, managing director of Future Value Consultants.

“It’s all about volatility and the barrier. Nothing else matters,” he said.

The coupon will be set at pricing, and interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if the fund closes at or above the initial share price on July 20, 2017 or Oct. 20, 2017.

The payout at maturity will be par unless the fund closes at or below the 65% knock-in level on any day during the life of the notes and finishes below its initial 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, the cash equivalent.

Volatility

“It’s quite a highly volatile ETF, as you would expect with gold stocks,” Mortimer said.

The implied volatility for this ETF is in the mid-40s, compared to near 11 for the S&P 500 index.

“The coupon looks high, but you have this autocall. With the autocall, you may come out half way through with 6.5%.”

American option

The American barrier is also an important risk factor.

American barriers are observed during the life of the notes and not just once at maturity, a feature designed to boost the premium.

In this case, the barrier is observed on a daily basis, which increases the risk that it may be breached, he said.

“The market hits the barrier any day and you lose the protection. Yes, it’s 65%, but if it hits once, which is likely with this type of fund, there isn’t much protection,” he said.

While the 11% to 13% coupon appears attractive, the combination of a risky barrier and high volatility shed a different light on the upside.

“The coupon isn’t that high based on the risk,” he said.

“You get called if the market is doing well, but you are exposed to a daily American barrier which for a fund with such volatility is not that deep.”

Conviction trade

The notes, however, could be appealing for the right type of investor.

“It’s for someone who wants some yield, more yield than you could get on an index. If you’re confident that you’re not going to hit that barrier in that space of time, then you’d be happy,” he said.

“It’s all about your view on the stock.”

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others, including its peers and all products.

In the firm’s methodology, the product type for these notes is designated as “review reverse convertible,” which represents fixed-rate reverse convertibles with an autocallable feature.

Risk

The risk is broken down into two components: market risk and credit risk. The firm adds them to calculate its riskmap, which measures the risk associated with a product on a scale of zero to 10.

The notes have a 6.56 market riskmap versus an average of 3.27 for the product type and 2.63 for all products, according to Future Value Consultants’ research report on the product.

“Obviously, the risk here is the result of the high volatility combined with the American barrier,” he said.

The tenor does not help either.

“If you hit the barrier and then recover, you’re OK. But in one year, if the fund drops 35%, you have very little time and a low probability to come back up,” he said.

The credit riskmap is 0.23, which is less than the 0.30 average for the product type.

“This one is easy. You have a good credit and a short maturity, which is what you want to get a low credit risk,” he said.

Adding the two risk components gives a 6.79 riskmap. This risk level is much higher than the 3.57 average score for similar products. It is also more elevated than the 3.01 average riskmap for all products.

Price score

Future Value Consultants uses its price score to calculate the value of each product 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 report showed a 2.79 price score, which is significantly less than the 6.15 average score for the same product type.

“Because of the risk we see on this product and because it’s a short maturity, the price score doesn’t come out very well,” he said.

Risk-adjusted return

The return score, calculated on the same scale, is Future Value Consultants’ measure of the risk-adjusted return of a note.

The return score is 4.50 for this product versus an average of 6.06 for similar products and 6.53 for all products.

“It’s not so bad because on a forward-looking basis with our typical growth assumptions, the chance of hitting the barrier is not quite as high as it would be with the [issuer’s] pricing model,” he said.

“The return score is our estimate of how it might perform looking forward. We calculate the risk premium. We assume the assets are going to go up over time.

“This is why long-dated products based on our model show more growth potential, which usually helps the return score.”

Overall

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

The notes have a 3.64 overall score while the average for the product type is 6.10, according to the report.

“This is for someone who has a very strong and particular view on the underlying ETF,” he said.

“If you believe it’s going to double in one year, this is not for you. But it’s true with any reverse convertible.

“What you want is to collect the coupon and not breach the barrier.

“That’s why your view is so important. Those products look best when the market goes sideways.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Jan. 20 and settle on Jan. 25.

The Cusip number is 22549JDW7.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.