Credit Suisse to price two deals linked to S&P 500 that are aimed at distinct types of bulls

By Emma Trincal

New York, July 1 - Credit Suisse AG, Nassau Branch announced two uncapped barrier notes linked to the S&P 500 index, both designed for bullish investors but with different outlooks on the market.

One deal using a digital payout targets mildly bullish investors, while the other may appeal to more bullish players through the use of leverage, according to sources' comments.

Credit Suisse plans to price 0% digital-plus barrier notes due July 31, 2017 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus the greater of the index return and the fixed payment percentage if the final index level is greater than or equal to the initial index level. The fixed payment percentage is expected to be 15% to 20% and will be set at pricing.

If the final index level is more than 70% of the initial index level but less than the initial level, the payout will be par. Investors will be fully exposed to the index's decline from the initial level if the final index level is 70% or less of the initial level.

The second deal, an issue of 0% Accelerated Return Notes, has a three-and-a-half-year term and provides 120% of any index gain on the upside and a 75% barrier on the downside. Investors become fully exposed to losses from the initial level if the index falls more than 25%.

Digital preference

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that the leveraged note may offer a better risk/reward, but most of his clients would opt for the digital payout.

"The digital is nice from the perspective of compensating you for not getting the dividends. The digital [notes] offer 15% to 20% over a four-year period. That's about 4%, maybe 4.5% compounded return each year," he said.

"You have uncapped participation in the upside, some protection on the downside, but if the market is lackluster, at least you have a little bit of return. With these 4% to 4.5% annualized, you're not losing out to inflation.

"This is not for a roaring market. It's not for a down market either because you have the barrier issue.

"But in a lackluster market, at least you're getting something, especially from the point of view of not getting dividends."

Kalscheur said that both deals are comparable in various ways.

"They're both issued by Credit Suisse, tied to the same index. A four-year and a three-and-a-half year ... that's close enough for argument's sake," he said.

"Credit rating-wise, Credit Suisse is not my first pick, but it's definitely a bank I wouldn't mind having exposure to. It's at the bottom of the top tier echelon, so that's encouraging."

The payout, however, makes the products very different from one another as they represent two different forms of market views.

"The levered one is a more bullish call on where the S&P is going over the next three-and-a-half years," he said.

"If the market is going to move to its historical levels, anywhere in the 6%, 7% to 10% annualized levels, the levered one is better. If the market is going to be uninspiring, the digital would be best."

Kalscheur said that although the two notes are different in structure and represent distinct market views, most of his clients would choose the digital product over the leveraged note.

"This comes down to the difference between statistics and investors' psychology," he said.

"From a statistical standpoint, the risk-adjusted return of the leverage product is going to be superior to the other one.

"But when you sit in front of a client and explain the deal, in my experience, they'll pick up the digital three times as much.

"It may be because of the clientele we have. Our investors are business owners who have already made their money and are more worried about losing it.

"You give them the choice between making 120% of the market or getting at least 4% to 4.5% a year if the market is not up a lot so they're ahead of inflation, eight out of 10 of them would take the digital.

"Another firm might have a completely different experience.

"Rather than participating in the market and trying to outperform the benchmark, our investors want to think that if the market does absolutely nothing in four years, at least they'll get something.

"It's better for them to get a kicker if the market is up only 5% or 10% over the period rather than trying to maximize the upside. That's why we tend to lean toward these deals."

Decent barriers

Kalscheur explained that the downside protection levels are not the reason behind this preference.

"It's not the barrier that plays a role here. Both notes have a barrier. A bigger barrier is always better. I'd much rather have 30% than 25%. However, with the S&P 500 as underlying, the odds of breaching the barrier are small, even with a 75% barrier," he said.

"With a back-of-the-envelope calculation, investors have a 95% chance of never hitting the 75% barrier in three years," he added, pointing to the 18% standard deviation for the S&P 500 over the past three years and assuming a "normalized equity return" of 10% a year.

"Our clients feel comfortable with that. What people worry the most with those deals is to stay invested for a while and get zero return at maturity. The barriers are not the main issue. Both notes have unlimited upside, and the barriers are both pretty decent. It's more the upside risk that would lead our clients to prefer the digital one."

SPDR alternatives

Marc Gerstein, research consultant at Portfolio 123, said that both notes should be viewed as alternatives to the SPDR S&P 500 ETF Trust.

"I see both deals as alternatives to the SPDR. You're forfeiting the dividends while you're getting some downside protection," he said.

"I think I would prefer the digital one with the 30% downside protection. If the market is flat, you get at least something regardless of how small the gain is. I'm not extremely bullish, so I would lean toward the digital.

"Also, there are plenty of leveraged deals out there. If I wanted to play with leverage, I would want to do it myself and have more control over it."

But both notes, in his view, are better choices than a direct investment in the SPDR based on the 2% dividend offered by the fund, which tracks the S&P 500 index.

"The dividend advantage is minor if you compare it with the SPDR. It's worth giving it up in order to get 30% or 25% downside protection," Gerstein said.

"You'd have to get your head examined if you were to choose the SPDR over those two deals. Dividends are not high enough to justify not taking advantage of the downside protection."

Investors, however, are subject to the credit risk of Credit Suisse during the life of the notes, according to the prospectus.

"That may be true, and you're in for three or four years. But even if you're locked in, it's still worth it. People who buy the SPDR are not going to trade anyway. Chances are they will put it away and forget about it anyway," he said.

The digital notes (Cusip: 22547Q5H5) are expected to price July 26 and settle July 31. Credit Suisse Securities (USA) LLC is the agent.

The leveraged notes (Cusip: 22547Q5N2) are expected to price in July. Barclays is the placement agent.

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