Credit Suisse's Bares linked to Euro Stoxx offer 25% buffer, but giving up dividend is costly

By Emma Trincal

New York, May 7 - Credit Suisse AG, Nassau Branch's 0% Buffered Accelerated Return Equity Securities due June 3, 2019 linked to the Euro Stoxx 50 index offer an appealing risk reward with a large buffer and an uncapped, leveraged upside, sources said.

However, investors need to decide whether giving up the high-yielding dividend on the underlying index is worth those benefits, especially on a six-year term.

The payout at maturity will be par plus 150% to 160% of any index gain, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 25% and will be exposed to any losses beyond 25%.

No cap, 25% buffer

Don McCoy, financial adviser with Planners Financial Services, said that he liked the notes, especially due to the unusually large buffer.

"It does sound pretty good. You have 1.5 times whatever the index is with no cap. You're not going to get the dividend, but on the other hand, you get this 25% downside protection. It's not so easy to find a 25% buffer lately," he said.

"It definitely sounds pretty good to me, especially for people who want to have exposure to the European stock market but want to get some downside protection. A lot of people are nervous about the situation in Europe. This note would be your way to get them invested in this market while giving them some protection to hold on to."

The Euro Stoxx 50, the eurozone equity benchmark for large-cap equity, has incurred wide moves since 2009. It is up 5% for the year, and it has risen 24% in the past 12 months. But its performance over the past five years is negative, down 28% while the S&P has gained 14.6% during the same time.

"You do have to park your money for six years. But you get the upside leverage. A one-and-a-half times leverage is not a lot, but your return is not capped, so that's actually pretty attractive, especially for bullish investors. It definitely enhances the offer. If I'm fairly optimistic and not capped, it's a good thing for me," he said.

"This deal would work for a variety of clients. If you're bullish, you have the enhanced exposure with no cap. If you're risk-averse, at least you get the 25% downside protection."

McCoy said that European stocks have seen their price trade at significant discounts as the eurozone continues to struggle with its sovereign debt crisis. The potential reward of this volatile asset class may be appealing to investors with a great tolerance for risk but not to everyone.

"A lot of clients may want to consider the European market, but the headline fear is there and everyone worries about the next crisis. These are valid short-term fears. Investors know that it's not impossible to get another Cyprus within the next 12 months. And yet, in two or three years, you might see a significant upswing in European equity. This note would be attractive to people who recognize the value of European stocks but are too afraid to jump in. The 25% buffer would address a lot of the concerns about market risk.

"I like this product. It offers benefits to many different types of investors," he said.

Hidden return

Jim Delaney, portfolio manager at Market Strategies Management, was more cautious, saying that the cost of giving up the 3.75% dividend yield on the index may be too high in some cases.

"If you take the index and compare its total return with its simple price appreciation, you get a sense of the gap between investing in the index directly and investing in the notes," Delaney said.

"Over the past six years, the total return index has lost 22.7%. At the same time though, the price-only index has declined by 40%. That's a big difference. You can see that not getting dividends puts you at a disadvantage."

After six years, the total return performance - which would be that of an equity investment - is 28% higher than price-only performance, he explained.

"You get a 25% buffer on the downside. But you could have generated a 28% cushion just with the dividends," he said.

On the upside, getting leverage with no cap is appealing, he noted. But investors would have to compare that payout with a direct investment in the index, including price and dividend.

"A 3.75% dividend for six years would represent 22.5% without compounding. Give or take, that's your 28% gap if you compound," he said.

"Whether you look at the buffer or the upside potential, you're giving up 28%. That's a lot."

Delaney said that the Euro Stoxx has "gone sideways" since 2009 in comparison to the S&P 500. Investors in the notes need to be bullish if they expect a strong performance after six years, he added.

"If you want to invest in the notes rather than in the index, you have to think that you'll be better off with the product. We're not sure that's the case with the downside protection, since you can actually generate a better buffer with the dividends. Looking at the upside, your notes would have to perform better. That's what you would expect from the leverage," he said.

"But the Euro Stoxx dividend and the resulting compounding power are so valuable that it's far from proven that you're going to outperform on the upside as a noteholder just because you have the leverage.

"You'll need a lot of growth in the index to break even and make up for the loss of dividends even if you factor in the leverage component.

"With a 3.75% dividend yield per year that you're not getting and the 1.5 times leverage that you benefit from, the Euro Stoxx has to go up 3.1% a year just to break even and you would still be flat compared to the index.

"This 3.1% minimum return you need to get each year is the relative value of the dividend payout. Even with the leverage, if you don't get this return, you're better off going with the index.

"I only need to be moderately bullish if I want to break even with the performance of the index, just to tie it. But if I want to beat it, I've got to be very bullish because the dividend I'm not getting represents a lot of money. It is a big contributor to the index return, and I have to do without it."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes will price May 24 and settle June 3.

The Cusip number is 22547Q2K1.

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