Credit Suisse’s autocallable step-up notes linked to Euro Stoxx 50 are likely to cap upside

By Emma Trincal

New York, July 13 – Credit Suisse AG’s 0% autocallable market-linked step-up notes due July 2018 linked to the Euro Stoxx 50 index offer investors several ways to generate returns depending on whether the autocall feature is triggered or not, financial advisers said.

Though the structure offers a diversity of payout outcomes, the number of likely outcomes is limited, said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

According to a 424B2 filing with the Securities and Exchange Commission, the notes will be called at par of $10 plus an annualized call premium of 11% to 12% if the index closes at or above the initial level on either of two annual observation dates. The exact call premium will be set at pricing.

If the index finishes above the step-up level, 130% of the initial level, the payout at maturity will be par plus the basket return

If the index gains by up to the step-up level, the payout will be par plus the step-up payment of 30%.

If the index finishes negative, investors will be fully exposed to the losses.

The capped return could come from the call premium if the notes are called; if the notes mature, the capped upside would be the step-up payout. The chances of getting an uncapped gain, however, are very limited, Chisholm said, while potential losses on the downside are a real possibility.

Three outcomes

“There are basically three outcomes to this note,” he said.

“Getting unlimited upside above the 30% step-up looks very appealing. ... What’s interesting is that the outcome of getting above 30% at maturity is highly unlikely. Since your note by definition has not been called at the end of the second year, the index would have to grow by 30% in one year – the last one. It’s highly unlikely to happen.”

The three most possible outcomes, he added, are the following: “You don’t get called and the index is down at maturity: you lose principal.

“You don’t get called and the index is up at maturity but it’s not up 30% or more. That again is very unlikely. You then get the 30% step-up return. That’s 10% a year.

“And of course you can get called either at the end of the first year or at the end of the second year. Either way, you make 12% a year. That’s a real possibility.

“So the two most likely outcomes are either a loss or a 12% return. I would say that’s probably 50/50.”

Market view

Chisholm conceded that a 12% per annum annual return is “pretty decent.”

But one has to be really comfortable with the euro zone.

“There’s a lot of uncertainty in Europe, and so I think the note is not that appealing from that perspective,” he said.

A deal was announced on Monday between Greece and its European creditors, prompting a global equity rally.

“Despite the news, it’s a matter of time before Greece leaves the European Union. It’s inevitable, especially with the political implications of the new austerity package that has yet to be voted.

“If I was to invest in Europe, I would want the full upside, not being limited to 12%.

“Ideally I would also want the notes protected on the downside.

“As an investor in an illiquid asset for three years, I would want both the protection and the upside.”

Chisholm said he does not see the benefits of the notes unless the index is nearly flat.

“If you expect the index to be up 1% to 2% a year for the next three years, it might be OK,” he said.

“But it’s far from being a strong possibility given the European economy, the level of uncertainty and the volatility seen in this part of the world.”

Another drawback is the dividends. The Euro Stoxx 50 index pays a 3.25% dividend yield.

“Obviously on top of that, you’re not getting the dividends, although in this case, it’s not so much of an issue at least on the upside since you’re getting 12%. But missing 9% of dividends on the downside is like giving up a nice 9% buffer,” he said.

Equity allocation

Carl Kunhardt, wealth adviser at Quest Capital Management, has a different approach, saying he likes the notes from the point of view of an asset allocator.

“I would consider it. It’s not as attractive as other notes I’ve seen, but the reality is you should always have some international exposure, and the predominant part of any international exposure is always going to be Europe because of the way we construct our portfolios. We would overweight with large cap just like what most people do with the U.S., so the natural candidate is the Euro Stoxx index,” he said.

Versus long only

“Given that I want exposure to the Euro Stoxx anyway, I just need to compare the notes versus a long position in the index,” he said.

“If I buy the index long, I’m still exposed to the downside. In that regard, it doesn’t cost me anything to do the note. It’s neutral.

“If I hold the notes until maturity and the index is above 30%, I get the same return. If it’s less than 30%, I get a digital return, which is better than the index.

“And if the notes are called, I get my premium and my money back. I’ll never see the third year. But I’ve made 12% a year.

“Now you have to decide if the benefits of the notes can offset some of the costs.”

The first “cost” is the 2% fee. “It’s not an issue,” said Kunhardt, adding that other “negatives” have to be examined.

“You’re stuck for three years in a semi-liquid instrument. That’s one.

“Second, the index could be up a lot and you get called, missing on some of the upside because your 12% call premium is your cap.

“Do the benefits of the deal outweigh the negatives? Of course they do.

“First, being called could be your strategy. You may want to have this 12% return and not be invested for three years. Most people buy those notes for that reason.

“The 2% fee is not even an issue for what you get.

“Of course you’re giving up the 3% dividends of the index. But the higher the price return gets, the less relevant giving up dividends is. Besides, the dividend issue is a concern with every note.”

Asked whether the full downside exposure is a drawback, he said, “I don’t see it as an issue simply because of the reason I would invest in the notes. I would not buy the notes as a hedge but as part of my equity allocation. I want to have exposure to this index, so it’s either directly or with a structured note. Either way, I don’t have protection.

“If you look at this note as an equity substitute and compare it with a long-only exposure to the index, its positive characteristics by far outweigh the negatives.”

BofA Merrill Lynch is the agent.

The notes will price in July and settle in August.

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