Credit Suisse's Bares linked to Euro Stoxx 50 index are designed to offer alternative to ETF

By Emma Trincal

New York, May 30 - Credit Suisse AG's 0% Buffered Accelerated Return Equity Securities due June 28, 2018 linked to the Euro Stoxx 50 index may be used as a substitute for a long-only position, said Tim Mortimer, managing director at Future Value Consultants.

"In some return scenarios, the advantage of using the notes versus the fund may be greater," he said.

"Even though you forego the dividends, you have some leverage, no cap and a buffer, which is good."

If the index finishes above the initial level, the payout at maturity will be par plus 125% to 130% of the gain. Investors will receive par if the index falls by up to 15% and will lose 1% for every 1% that the index declines beyond 15%, according to an FWP filing with the Securities and Exchange Commission.

"The participation is not double or triple, but it's still reasonable, and you have no cap, which seems to be the trend. People don't want to miss out on the bull market. They want to stay long equity," he said.

"The buffer is good at 15%. It's a valuable downside protection."

Euro trend

Mortimer said that the Euro Stoxx 50 is one of the most popular underlying indexes at the moment.

"The S&P had a very strong performance, especially over the past five years. People believe European stocks have a lot more to go," he said.

Even though the two indexes are more correlated this year - the U.S. benchmark is up nearly 4%, and the Euro Stoxx has increased by close to 5% - people use this note "as a play to diversify out of the S&P," he said.

"These notes offer quite good value in price and return. The credit risk is reasonable with Credit Suisse," he noted.

The five-year credit default swap spread for Credit Suisse is 59 basis points, according to Markit. In comparison, the CDS spreads for Bank of America and Goldman Sachs are 68 bps and 80 bps, respectively.

"The leverage gives you something extra to compensate for the loss of dividends and the credit risk," he added.

Dividend, credit risk

The Euro Stoxx 50 index offers a 2.7% dividend yield.

The credit spread an investor gets as compensation for taking on the credit risk of Credit Suisse is 1%, he said.

Adding the two, an investor in the notes is "missing on" 3.7% compared to an equity investor who benefits from the dividends and the absence of credit risk.

"So if you compare the structured notes with a long equity position that pays dividends net of fees you get a certain breakeven threshold above which you are better off with the notes," he said.

"Compared to an ETF, the notes need to earn 3.7% a year to compensate you for the non-payment of dividends and credit risk. The ETF has a 50 basis points fee. With a leverage factor of 1.3, the breakeven over the four-year period is 42%.

"If the index return is above 42%, investors in the notes will be rewarded for missing on the dividends and taking on credit risk. In that case, the notes are a good alternative to the fund.

"However, if the gains are less than 42%, investors are better off with the ETF.

"On the downside, the notes outperform the fund due to the 15% buffer."

Risk

The notes fit into the "leveraged return" category in Future Value Consultants' methodology, defined as any structure with an upside participation rate greater than 100%. The category enables the research firm to compare the product to similar ones when assigning scores.

Future Value Consultants begins its evaluation with a risk assessment.

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. It is made of two sub-riskmaps, market risk and credit risk, which are added to produce the general score.

The notes have a market riskmap of 2.43, compared with an average score of 2.60 for leveraged return products, the report showed. At 0.58, the credit risk score is similar to the 0.61 average score for the category.

Overall, the product presents less risk than its peers with a riskmap of 3.01 versus the 3.21 average score for leveraged return notes, the report showed.

"The buffer gives you less market risk, but this advantage is slightly offset by the greater volatility of the Euro Stoxx compared to the S&P, which is why the difference between the two scores is not that big," he said

"Credit risk is not a factor. The scores are just about the same."

Risk-reward

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

The return score for the notes is 8.34, compared with a 7.72 average score for the category.

"It's a good score, better than average," he said.

"This is due to the enhanced participation and also to the no-cap component. Both factors combined make a lot of difference. If you use the bullish scenario as we do here to calculate the return score, the upside potential with uncapped leverage over a longer period of time makes a lot of difference."

The buffer also contributed to the high return score, he noted, as many similar products have no protection or just a barrier.

"It's a buffer, not a barrier. If the index is down 50%, you lose 35%. It reduces the size of the losses dramatically," he said.

Probabilities

With its probability chart, Future Value Consultants estimates how the product is expected to perform under the five key assumptions. It assigns a probability of return outcome to each of the payoff buckets.

The chart is generated using a Monte Carlo simulation using various parameters such as volatility, dividends and interest rates.

With these notes and under the bullish assumption used to compute the return score, the model shows an 81% probability of getting a positive return versus 19% for losing principal.

Price, overall scores

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The 7.65 price score for the notes is only slightly higher than the 7.60 average score, according to the report.

"The price score is pretty close to the average. Leveraged return products are quite simple, and they're often linked to similar indexes. It tends to make pricing tight and more competitive, which is why you don't see a huge difference," he said.

The overall score measures Future Value Consultants' general opinion on the quality of a deal. The score is the average of the price score and the return score.

The product received a 7.99 overall score versus an average score of 7.66 for the product type, according to the report.

"It's a straightforward leveraged note linked to the Euro Stoxx with a decent return score. A very reasonable offering," he said.

The notes (Cusip: 22547QNF9) will price June 25 and settle June 30.

Credit Suisse Securities (USA) LLC is the underwriter.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.