Advisers concerned about gold exposure with Credit Suisse’s $20 million review notes on stocks

By Emma Trincal

New York, Nov. 23 – Credit Suisse AG, London Branch’s $20 million of 0% review notes due Nov. 25, 2024 linked to the least performing of the common stocks of Amazon.com, Inc., Morgan Stanley and Barrick Gold Corp. offer a compelling structure and payout, advisers said. But one of the three underlying stocks was a concern.

The notes will be called at par plus an annualized call premium of 16% if each stock closes at or above its applicable call level on any annual review date, according to a 424B2 filing with the Securities and Exchange Commission. For each stock, the call level will be 100% of the initial price for the first three review dates and 60% of the initial price for the final review date.

If the notes are not called, investors will be fully exposed to any losses of the worst performing stock.

Correlations

Carl Kunhardt, wealth manager of Quest Capital Management, said he was not overly alarmed by potential performance divergences between the underlying stocks belonging to three different sectors.

“The correlations aren’t strong, but they’re not negative either,” he said.

The coefficient of correlation between Amazon and Morgan Stanley is 0.356; it is 0.27 between Amazon and Barrick and 0.03 between Morgan Stanley and Barrick, based on the average of the three- and five-year coefficients of correlation.

Growth and hedge

“In a strong economic environment financial stocks are going to do well,” he said.

“Amazon is more of a retail stock than anything else now. So, if the economy is strong the stock will be moving up too.”

Only Barrick was different as a gold miner stock, he noted.

“People tend to use gold as a hedge when the economy is weak. So, you could see it rising when the other two are dropping.”

Still, Kunhardt was not too concerned about the possible dispersion risk.

“As long as the correlations are not negative, I’m fine with that.”

One-year duration

Kunhardt said he liked the annual call dates.

“I like that you’re not going to get called in three months,” he said.

“You don’t want to be called early with something that’s aggregating. But it may be the most likely scenario.

“At least you get a one-year premium.”

The “decision tree” for investors consisted of assessing the value of the barrier and the call premium.

Risk-reward

“It’s about your comfort level of staying above 40%. After four years I would say the odds are pretty high. It’s not likely that either one of these stocks will breach the 40% level in my opinion,” he said.

“My guess is you’ll have two of the stocks that will be up and a third one lagging. For instance, Morgan Stanley and Amazon could be strong and Barrick lagging or the other way around: Barrick strong and the other two, lower.

“But it doesn’t mean that any of them is going to be down 40% at maturity.”

The more likely outcome for investors is an automatic call on the first date, after one year.

“That makes your decision tree a little bit easier,” he said.

“I would be happy to be called in one year with 16%. If you want better returns, go to Vegas, but you’re going to get way lower odds.”

Underlying problem

Usually, Kunhardt said he would not consider a longer-dated note such as this one.

“The tenor doesn’t bother me so much because I don’t think you’re going to reach the four year. I’d be surprised if you passed the first year,” he said.

However, Kunhardt pointed to two drawbacks which would lead him to reject the notes.

“It’s not a note I would avoid based on the tenor. It’s not a note I would avoid based on the structure, and I wouldn’t necessarily avoid it simply because of the low correlations. I’m OK with all that,” he said.

“I would avoid it because I just don’t like using single names, and I don’t like worst-of. These are two big issues.”

Interesting deal

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, also expressed a mixed view on the note. Almost every aspect of the product seemed right except one.

“While I don’t love four-year notes, this one is quite unusual and honestly interesting,” he said.

“You’re not giving up much. Combined, the three stocks don’t have a huge amount of dividend yield,” he said.

The highest-paying dividend stock is Morgan Stanley yielding 2.35%. Barrick Gold yields 1.32% and Amazon doesn’t pay dividends.

“The 16% annual coupon in this environment is very attractive,” he said.

However, investors are paid for the risk as the three stocks are expensive, he noted.

Sweet maturity

Amazon is up by 68% this year. Barrick Gold and Morgan Stanley have gained 25% and 18%, respectively.

“The stocks have to be positive in order to earn the very substantial coupon.

“In normal circumstances, I wouldn’t be interested even though the payments are cumulative.

“But what’s really intriguing is what happens at maturity. If all three stocks are above the 60% barrier, you get paid 64%.

“That’s a very favorable outcome.

Foldes said he expects stocks like Morgan Stanley and Amazon to continue to grow.

“Just look at Amazon. It’s been incredibly convenient for people during Covid to do their shopping online. It’s now a new way of life.”

Morgan Stanley, he added, is a “solid company” with a strong brokerage and banking franchise.

“You would expect those two companies to continue to grow. And since they only need to be above 60%, the odds are in your favor,” he said.

Wildcard

“The only one that’s really challenging is Barrick. The stock of a gold mining company is obviously going to be impacted by gold prices and we know that gold is very volatile.”

Gold breached the $2,000 per ounce threshold in August, closing at $2,089.20. Its current price is 12% lower at $1,835. For the year, the precious metal is up about 21%.

“Gold is still very high,” he said.

“The wildcard to me is the gold stock.

“You have exposure to the worst-of, and if Barrick drops more than 40%, you have a terrible loss. You have not collected anything during the four years. If the barrier is breached at maturity, you can lose close to half of your principal or even more...”

Barrier, commodity exposure

Foldes explained that the tail risk associated with the barrier and the uncertainty about the future price of gold would prevent him from buying the notes.

“But I might inquire with the issuer and see what kind of yield I could get if I replaced Barrick with another company not necessarily correlated to a commodity price but a company that can generate strong earnings and whose stock is likely to appreciate,” he said.

Foldes conceded that he probably would not keep the 16% coupon doing this.

“But it would give me much more comfort to eliminate something that’s too closely driven by the price of gold and to replace it with a solid growth stock.”

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the placement agents.

The notes priced on Nov. 18 and settled on Nov. 23.

The Cusip number is 22552WTW5.

The fee is 0.6%.

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