Credit Suisse’s 7.1%-9.1% airbag autocall tied to Royal Caribbean seen as too risky

By Emma Trincal

New York, May 19 – Credit Suisse AG, London Branch plans to offer a fixed coupon payable monthly linked to the common stock of Royal Caribbean Cruises Ltd., a type of product advisers said has become less common than before. Despite this one’s fixed and high coupon, advisers remained guarded.

The upcoming 7.1% to 9.1% airbag autocallable yield optimization notes due May 26, 2017 is part of a group of reverse convertibles with a fixed income, according to data compiled by Prospect News and interviews with financial advisers. As investors continue to search for yield, many have switched to contingency as a way to elevate the coupon while moving away from single-stock exposure to mitigate market risk, according to buysiders.

A total of $2.66 billion reverse convertible products have priced this year as of May 13, according to data compiled by Prospect News. About 80% of it, or $2.11 billion, consists in notes that pay a contingent coupon when the underlying is above a specific barrier on a given observation date. The other 20%, or $553 million, pay a guaranteed income.

During the same time last year, the split between contingency and guarantee of the coupon was two-third versus one-third, respectively.

The Credit Suisse airbag autocallables will pay the 7.1% to 9.1% interest monthly with the interest rate set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

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

The payout at maturity will be par unless the final share price is less than the conversion price, in which case the payout will be a number of Royal Caribbean shares equal to $1,000 divided by the conversion price. The conversion price will be 80% of the initial share price.

Company risk

“I don’t like these kinds of deals,” said Steve Doucette, financial adviser at Proctor Financial.

“You’re trading an 8% coupon for an unlimited downside on a single stock.”

Royal Caribbean is a volatile stock, he noted. The share price has already dropped 24.12% for the year.

“This is obviously a highly volatile stock,” he added.

The implied volatility is about 30% or twice that of the S&P 500 index.

Doucette said he avoids investing in single-stock deals in general as investors are directly exposed to company risk.

He cited an example of such risk, linked to a company’s operations.

“I don’t know about this stock in particular but the Norovirus has grown rampant in the cruise industry, which leads me to think that it’s not the best time to buy one of those stocks,” he said.

“You don’t want to be sick on a boat all the time.”

Several Royal Caribbean ships have experienced outbreaks of gastrointestinal sickness such as the Norovirus. Three such cases were reported last year and one in March, according to the company’s blog.

Benchmarks preferred

Doucette said that he invests in structured notes for income replacement. But he strongly prefers notes linked to one or even several equity indexes, such as worst-of notes and autocallables with a contingent coupon.

“That’s the important thing. You’re taking market risk. You’re not taking company risk.”

Because indexes tend to be less volatile than the stocks used in reverse convertibles, issuers have priced reverse convertibles that deliver a contingent, rather than a fixed coupon when there is index exposure.

But Doucette said he’d rather have contingency risk of the coupon than market exposure to a single stock.

“Besides, some of those contingent coupon deals are almost guaranteed coupon based on how they’re structured. If you get a coupon barrier of 40% – and you can –you get to collect your coupon over and over,” he said.

High P/E ratio

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the decision of investing in these income products linked to stocks required a thorough analysis of the sector and of the underlying security itself.

“It’s an interesting concept. A dividend of 8% is very good by anybody’s account,” he said.

“However, Royal Caribbean is in a relatively volatile sector of the market. The economy is in a very sluggish period. Consumers are going to pull back and start saving more and perhaps postpone some trips,” he said.

A 25% decline in the share price for the year would be a strong buy signal for some; for others it would only represent a “falling knife,” he said. He took a cautious stance pointing to the stock’s price to earnings of 23.5.

The S&P 500 index, which is considered overvalued, is approximately at the same level at 23.82.

“It’s still trading at a high P/E. I would be concerned that the stock could continue to fall another 20%,” he said in reference to the barrier observed at maturity.

Risk mitigation

Medeiros said that the investment is “interesting” for the coupon. The fact that investors may be put the stock at maturity rather than realizing a loss may be a positive, he added, as they get a chance to recoup their principal.

“If your shares are under water, depending on the price of the option, you can hedge the downside. For instance be long a put,” he said.

In his view though, the stock carried too much risk.

“It’s up to you if you want to see in the 25% decline a risk or an opportunity. It depends on the stock and on your view I guess,” he said.

“For me, I would be more inclined to see more risk in this case.

“If it’s down 25% and still trading at 25 times earnings, I’m probably going to stay away from the trade.”

UBS Financial Services Inc. is acting as distributor.

The notes are expected to price Friday and settle May 25.

The Cusip number is 22549H609.

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