Credit Suisse’s digital plus notes tied to Euro Stoxx to offer buffer, uncapped gains

By Emma Trincal

New York, Aug. 21 – Credit Suisse AG, London Branch’s 0% digital plus buffered notes due Aug. 28, 2023 linked to the Euro Stoxx 50 index make it more likely for investors to outperform the underlying index in most scenarios, said a financial adviser. However, investors are giving up a high dividend yield, noted another one, which could be detrimental in a bullish environment.

If the index finishes at or above its initial level, the payout at maturity will be par plus the greater of the index gain and a fixed payment percentage, which is expected to be 42% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls by up to 20%, the payout will be par.

Otherwise, investors will lose 1% for every 1% beyond the 20% buffer.

Creditworthiness

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he liked the notes a lot. He pointed to the weakest aspects of the product first.

“Credit Suisse is a good credit but not my favorite. A lot of European banks have issues going on, in particular with Turkey. But this issuer’s credit is not a deal killer,” he said.

European banks have wider credit default spreads than their U.S. counterparts, according to Markit. For instance, Credit Suisse’s five-year CDS spreads are at 70 basis points, which is wider than any large U.S. bank. Levels among domestic banks range from 43 bps for JPMorgan to 63 bps for Goldman Sachs, according to Markit.

Underlying

Kalscheur was also “not a big fan” of the Euro Stoxx 50 index, arguing that the 9% allocation to the technology sector in this index was too small compared to U.S. benchmarks.

“Some complain that the S&P is too tech-heavy. But this is just the opposite ... not enough tech, which is a high-performing sector,” he said.

Length

Besides those two points, Kalscheur said he was impressed by the structure.

“The terms are absolutely fantastic,” he said.

“We want long-term notes. We like it, in part because that’s how you get these kinds of terms.

“Even if you only get the digital, over a five-year period, it’s about 7.5% compounded. That’s not a bad return.

“In a mediocre market, you outperform the index handsomely.”

Foregoing the yield

Kalscheur noted that investors must forgo a high dividend yield of over 3%.

“You’re giving up a lot of income. But having this combination – digital plus uncapped upside – gives you a solid appreciation potential,” he said.

“If in five years this index shoots the lights out, if it’s up 100%, you’ll be up 85%. No client is going to fire me for that. It’s when people expect a return and you don’t come even close that your clients are unhappy.

“I trail the index by 3% a year. It’s not insignificant. But it’s not all that much considering what you get,” he said pointing to the 20% buffer as an additional benefit to investors.

Two out of three times

When assessing a structured note this adviser uses back testing analysis based on available historical statistics on a given underlying. For the Euro Stoxx 50 index, his data dates back from 2002.

“It’s not a long track record but it gives me an idea,” he said.

The frequency of the index finishing between zero and 42% for any five-year trailing period in the past 16 years is 45.7%, according to his compilation.

“Almost half of the time you’ll be in that window of flat to mediocre return, which is exactly the window where the note will outperform the index,” he said.

On the downside the frequency of a decline in the index after five years was 28.6%.

“Almost 50% of the time you’ll outperform with the digital. Nearly 30% of the time, you’ll outperform with the buffer.

“I want to set myself up where I can win two out of three times. That’s my goal in general.

“Here the market is down, I win.

“The market is mediocre or flat, I win.

“The market is up a lot, it’s up 115%...my client is up 100%. That’s respectable.”

Fee

Another positive in his view was the fee amount of 0.75%, according to the prospectus.

“At first, I thought it was a typo. The fees are ridiculously low.

“Anytime you have low fees plus a high-dividend yield underlier, you can have terms like that.

“This is a textbook 101 of what we want to see in a structured note,” he said.

Being picky

Kalscheur said the note is not for everyone.

“Some people may not like the five-year, and that’s fine. Or it may match your market outlook. That’s OK too.”

But he said he liked the notes as is. If pressed to make a change in the structure, he brought the following two ideas. First, he would introduce a geared buffer to improve the tax treatment of the notes. This would enable investors to be subject to long-term capital gains as opposed to ordinary income tax as it is the case with straight buffers.

“But that’s not even the main reason. You can always put that type of note in a tax-free account,” he said.

“I may use the geared buffer as a negotiation tool to try and get a little bit of leverage like 1.1 or 1.15 times above the digital.

“But I’m being picky. It’s almost like I’m looking for problems.

“For this index and Credit Suisse, you can’t get any better than this.”

Long tenor

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, had a very different view.

“There are things we like and things we don’t like,” said Foldes.

The things he did not like prevailed partly due to his strongly bullish outlook on Europe.

“A five-year maturity is too long for us. It also makes the 20% buffer totally unneeded because it’s extremely unlikely that a major index like the Euro Stoxx will be down over an extended period of time like five years,” he said.

Opportunity cost

The long holding period also increased the opportunity cost of giving up the dividends.

The Euro Stoxx 50 index yields 3.1%.

While investors receive a minimum return of 42% at maturity if the index is flat or positive, they are also missing about 16% in dividends over the term, he noted.

Mean reversion

This difference is negligible if the index is flat or up only slightly, he said, because the digital accelerates the return.

But it is not the case in a bullish scenario.

“We just don’t believe the performance of the Euro Stoxx is going to be moderate. We think at the contrary that there is a lot of upside potential,” he said.

“The Euro Stoxx has been lagging the U.S. markets for a long time. It is very attractively valued right now, which is another reason why it is unnecessary to spend money on a 20% buffer.”

From 2008 to 2017, the S&P 500 index has outperformed the euro zone benchmark seven out of 10 times, according to Morningstar. This year is no exception with the Euro Stoxx showing less than 1% in positive return while the S&P 500 index is up 6.32%.

Some tweaks

“This is a note for someone who is not bullish, someone who thinks the Euro Stoxx is going nowhere. That’s not our view. We are bullish on the asset class,” he said.

If Foldes was to remodel the note, he would try and shorten the maturity while agreeing to have a more modest buffer. His objective would be to increase the digital payout while keeping the upside uncapped.

“Ideally and if possible, I’d want to add some leverage in order to offset some of what I’m losing in dividends,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes (Cusip: 22551L4W7) will price on Aug. 23 and settle on Aug. 28.

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