Credit Suisse’s 15% autocall reverse convertibles tied to 3D require conviction, sources say

By Emma Trincal

New York, Sept. 9 – Credit Suisse AG’s 15% autocallable reverse convertible securities due Sept. 18, 2015 linked to 3D Systems Corp. shares offer an enticing headline rate, but the risk associated with 3D Systems shares makes the deal only suitable for investors familiar with the company and knowledgeable about the stock, sources said.

Interest will be payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

A knock-in event will occur if the stock closes at or below the knock-in level, 65% of the initial share price, on any trading day during the life of the notes.

The notes will be called at par plus accrued interest if the stock closes at or above the initial share price on March 13, 2015 or June 15, 2015.

If the notes are not called and a knock-in event does not occur, or if it does but the final share price is greater than or equal to the initial price, the payout at maturity will be par.

If a knock-in event occurs and the final share price is less than the initial price, investors will receive a number of shares of 3D Systems stock equal to $1,000 divided by the initial price or, at the issuer’s option, the cash value of those shares.

“You really have to look at the risk-reward profile, not just the coupon,” said Tom Balcom, founder of 1650 Wealth Management.

“Fifteen percent a year is great, but anybody buying this note has to have a view on the company. It’s a nice juicy yield, but that’s only part of the story.

“Someone who understands the company, someone who has a strong feeling about the stock might be interested in the notes, but for the average layperson, I wouldn’t touch this because of the high volatility and uncertainty of the underlying.”

3D Systems, based in Rock Hill, S.C., is a provider of three-dimensional printers.

Huge swing

“The 52-week range is $43.37 to $97.28. There’s a huge swing in the stock. The share price is down 45% for the year,” he said.

“It’s been down so much some traders may think it’s time to get back in, but you never know unless you know how healthy the company really is, and you can still have the surprise of negative earnings. It’s a possible play only for someone who knows the stock inside out.”

The contingent protection allows for a stock price drop of up to 35%. But the probability of breaching the barrier level is increased by the volatility of the stock, which is high, he said.

The implied volatility of 3D Systems is 55%.

“Having a 35% barrier is certainly nice. It looks decent. But it’s true to a point. The stock has been going down so much it may be a falling knife,” he said.

“If you’re bullish, you can either buy the stock outright or buy the note. The advantage of the note is the protection.

“But I would still not recommend this product unless the client has a good knowledge of the stock. There is just too much potential for losses.

“Even if you can use the 15% coupon as some sort of a cushion, look at this year’s performance so far. The stock drops by 45%. You take a 30% hit.

“The stock trades at $52 per share right now. Unless you’re a technical analyst and have the belief that the floor is at $50 or $45, then in that case, the trade makes sense.”

Assuming an initial share price of $52, the knock-in event would be triggered if the share price fell below about $34 on any day, he said.

Stock vs. reverse convertible

A distributor said that autocallable reverse convertibles are not without risk. However, these notes are competitively priced compared to similar products. Investors, in particular registered investment advisers, have expressed a strong demand for these products, he said.

“This stock shows a huge volatility, but we see reverse inquiries for high-volatility stocks like that from the advisory groups we work with,” this distributor said.

Autocallable reverse convertibles have been the second fastest-growing structure this year after delta one notes, according to data compiled by Prospect News. The volume of these products is $5.7 billion this year as of the end of August, a 37% increase from the $4.15 billion volume recorded during the same period of 2013.

“These notes are extremely common. Clients see many of them in the monthly offerings,” this distributor said.

“This one has a 15% headline coupon, but they didn’t have to force it. The structure allows for that given the volatility of the stock.

“If you had a 15% coupon with an 85% barrier, I’d say that’s a mismatch. But in this case, a 15% coupon with a 65% barrier for one year is a fairly balanced structure.”

The risk associated with these products is when the knock-in event occurs, which can happen any day, and when the share price finishes negative, according to the prospectus.

But the distributor said that the downside risk may be lower with the notes than with the stock.

“If you compare this with a long-only position in the stock, in every instance, when you receive the shares of the stock, you’re better off having owned the reverse convertible because you had at least the guaranteed 15%. It’s your downside cushion. Every single time you get put the shares, you’re better off than having owned the shares,” he said.

“There are a lot of benefits in a reverse convertible versus owning the stock, but you can’t have everything, and you’re not going to have liquidity.”

Adding to a position

Michael Iver, chief executive of iVerit Consultancy and a former structurer, said that investors in the notes would have to be very comfortable about the stock. In many cases, they may even be shareholders.

“I’ve seen reverse convertibles on headline stocks that are widely held, like Apple. But a company that only focuses on 3D systems is a niche company in the technology industry. You’d better really know the stock before you participate in the deal,” Iver said.

“We’re not talking about a bellwether of the tech sector that may even correlate well to the broader market. This is a highly specific play in a niche industry. This is not Apple.

“To me, this deal would be for people who already have a position. They don’t own a full position. They may just want to add to their existing exposure. They’re looking to buy on the dip and get paid for waiting, which is what they get through the coupon.

“If the stock falls enough, you get your exposure. If not, you get a nice coupon. You’re selling a put; you’re buying on the dip.

“Those investors may have a strategic position on the stock. They have a belief in the company’s story. They’re willing to take on some risk because they have a strong conviction.”

Credit Suisse Securities (USA) LLC is the agent.

The exact terms will be set at pricing.

The notes will price Sept. 15 and settle Sept. 18.

The Cusip number is 22547QTC0.

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