Credit Suisse’s contingent coupon notes on oil stocks cut some of the risk with tenor, picks

By Emma Trincal

New York, Jan. 9 – Credit Suisse AG, London Branch’s contingent coupon autocallable yield notes due Jan. 16, 2025 linked to the worst performing of the American Depositary Shares of BP plc and the common stocks of Chevron Corp. and ConocoPhillips may show less risk than it appears despite the use of single stocks and three names in a worst-of structure, according to sources.

The notes will pay a contingent quarterly coupon at an expected annual rate of 8.25% if each underlying share closes at or above its coupon barrier level, expected to be about 60% of the initial level, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission. The exact coupon rate and barrier level will be set at pricing.

The notes will be called at par if each underlying closes at or above its initial level on any quarterly trigger observation date from Jan. 10, 2019 through Oct. 10, 2024.

The payout at maturity will be par unless any underlying finishes below its knock-in level, expected to be about 60% of the initial level, in which case investors will lose 1% for each 1% decline of the worst performing underlying from its initial level. The exact knock-in level will be set at pricing.

Sector recovering

“It’s interesting. I just sold oil today,” said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, who has been bullish on the commodity when it was an “unloved” asset class.

“Last summer, people were really scared of oil stocks. Prices were low. But now the oil sector is up so much. I sold some today,” he said.

The important risk to consider was whether any of the three oil stocks could fall by more than 40%.

“I would say yes; a big drop is likely. But the real risk is not that oil stocks are overpriced. They’re not. The risk is that the overall market falls into bear territory,” he said.

Bearish across the board

“I don’t expect the oil sector to collapse. But if we have a bear market – and we’re going to have one – it would be very unusual for energy shares to go up when the rest of the market goes down.”

In fact, stock prices correlated with oil may even drop more.

In a bear market scenario, which he expects to unfold and end within the next two years, a 40% to 70% price decline in the oil sector was a very possible outcome, he said.

Seven years

The tenor of the notes however offered some risk mitigation.

“I wish they would have come out with this this at the end of 2015 or beginning of 2016 when we were at much lower prices. Even July or August last year would have been better,” he said.

“The timing is not perfect. But the length is reasonable because seven years gives you a lot of time to recover from a bear market.

Kaplan is bearish on equities. He anticipates a bear market this year followed by a recession next year.

“The stock market is going to go down. After that, prices will go up again,” he said. “Commodities may recover even faster if we feel inflationary pressures. And since nothing happens to your principal when there is a 40% price drop during the period other than not getting paid, I think your risk of losing money at the end is pretty limited.

“You may not collect your coupon for a couple of years. But you will collect some.

“The wording to this note is not bad. At least the seven-year window is very favorable.”

Good stock picks

Tom Balcom, founder of 1650 Wealth Management, liked the trade due to the choice of the stocks and the barrier level.

“These are household names, companies people like and stocks with pretty stable prices,” he said.

“Also, those stocks are fairly correlated, which is a good thing.”

When underlyings are correlated in a worst-of, there is less of a chance that only one security would perform negatively, compromising the return of the noteholder, according to the prospectus.

Barrier

Compared to investing in the stock outright, the barrier gave the noteholder the advantage.

“Sure you’re going to give up dividends and some of those stocks pay high dividends,” he said, pointing to BP, the highest-yielding of the three underlyings paying a 5.57% dividend.

“But the note gives you protection from a pullback, which you wouldn’t have if you invested in the stocks.”

Balcom said that a barrier breach was unlikely due to the size of the barrier.

“A 40% drop is severe. You would need more than a bear market to go down that much. People have to buy oil. These are things people need. You would need a serious shock to oil prices,” he said.

Such a scenario could happen of course, but Balcom said no one can forecast a “catastrophe.”

“There are risks involved. But you’re getting compensated,” he said.

“For someone who wants income, this trade offers more benefits than you would think.”

Credit Suisse Securities (USA) LLC is the agent.

The notes (Cusip: 22550W5J2) will settle on Jan. 16.

© 2015 Prospect News.
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