Credit Suisse's cert plus notes linked to Euro Stoxx, EAFE offer attractive upside for bulls

By Emma Trincal

New York, Jan. 16 - Credit Suisse AG's 0% cert plus securities due Feb. 5, 2018 linked to the Euro Stoxx 50 index and the iShares MSCI EAFE exchange-traded fund offer significant upside leverage with no cap, a set of features likely to appeal to investors bullish on Europe, sources said.

The payout at maturity will be par plus the underlying return of the worse-performing component, according to a 424B2 filing with the Securities and Exchange Commission.

If an underlying component's final level is greater than or equal to its initial level, its underlying return will be 220% to 230% of its return. The exact upside participation rate will be set at pricing.

If a component's final level is less than its initial level and a knock-in event has occurred, its underlying return will be equal to its return. A knock-in event occurs if either component finishes at or below its knock-in level, 70% of its initial level.

If a component's final level is less than its initial level and a knock-in event has not occurred, its underlying return will be zero.

Expanding the parameters

Steve Doucette, financial adviser at Proctor Financial, said that the worst-of structure employed in the product is one that allows investors to increase the upside or incorporate more downside protection in products in a low-volatility environment.

That's because the payout is tied to the worse-performing underlying components, which gives structurers higher premiums when selling the embedded put options.

"Back six months or a year ago, we couldn't get good terms on products, so we went to the worst-of because by adding two underlying assets that are not much correlated, you can expand your parameters. We really didn't like the caps we were seeing. The cap was the issue. The worst-of can really raise the cap. You can get a decent upside, and that's what we wanted: an upside that was reasonable," he said.

"If there's only one underlying, the terms won't be as attractive. You might get less leverage or less of a barrier protection.

"And that's been the problem in this market. Notes are not sold because volatility is low. So they add the worst-of to increase the return or improve the downside protection."

Correlation

Doucette explained that the less correlated the underlying components in a worst-of are, the more the issuer can "expand the boundaries" of the notes, which means increase the upside, improve the downside protection or both.

On the other hand, when the two underliers are highly correlated, the premium may be reduced.

In the notes, the Euro Stoxx 50 index and the iShares MSCI EAFE ETF have a correlation coefficient of 0.95 as they both give investors exposure to European equity.

The iShares MSCI EAFE ETF, which is tied to a benchmark tracking developed countries in Europe, Australia, Asia and the Far East, currently allocates at least 60% to European stocks, according to BlackRock's website.

Getting good terms with such high correlation is a little bit of a "surprise," according to Doucette.

"With such high correlation, you wonder to which extent they can improve the parameters. I suspect you may have very little if any change compared to a note tied to one single index," he said.

"If you put together the Russell and the S&P, how much of a worst-of structure do you get? Those two are correlated. In a bear market, one may go down, that's the real risk. But the other may not go down by much more.

"That's the same thing here. So I am surprised they're able to give you the uncapped return with this amazing level of leverage using two correlated components. I guess that's a question to ask the issuer."

Doable

A structurer, who is not with Credit Suisse, offered an answer.

"It's doable even with the high correlation. It's a four-year play, so you have some time," he said.

"We're pricing right now an SPX, EAFE worst-of, four-year also, no cap and two-times leverage with a 15% geared buffer. The two underlying indexes are a bit less correlated, but it's a hard buffer.

"It's doable when investors are willing to go longer, like four years. Also, it depends a lot on people's view on the market. If the view is somewhat negative, it cheapens the option, which is a big help."

Attractive play

The four-year maturity is acceptable for Doucette.

"It's not a bad note," he said.

"You're capturing the return on Europe, and investors feel more optimistic about Europe. It's a four-year. We like to stick to three-year. But if there's a pullback, there's a pullback, and it may pay off as you get close to maturity.

"There is phenomenal leverage with no cap on the upside and very decent downside protection."

Matt Medeiros, president and chief executive of the Institute for Wealth Management, also liked the terms of the notes.

"It's an interesting offer for the European sector. The two indices have a relatively high correlation. It shouldn't be too much of a difference between the two," he said.

"I like the enhancement without the cap on the underlying.

"The barrier on a point-to-point basis is sufficient for those two markets.

"In general, it seems to be a pretty attractive play for somebody who wants to participate in the euro zone, and it's a good issuer, which obviously is a concern when you go out four years.

"I haven't seen too many of these types of structures before. I'm more focused on the underlying asset class.

"What I've seen is a lot of notes on the euro zone. It's a growth opportunity for a lot of people."

Credit Suisse Securities (USA) LLC is the agent.

The notes are expected to price Jan. 30 and settle Feb. 4.

The Cusip number is 22547QG75.

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