Credit Suisse's buffered notes tied to MSCI EAFE offer access, alternative to ETFs

By Emma Trincal

New York, Nov. 2 - Credit Suisse AG, Nassau Branch's 0% buffered enhanced participation equity securities linked to the MSCI EAFE index are designed for investors looking for diversification away from the U.S. markets and as an alternative to a direct investment in the index, said Suzi Hampson, structured products analyst at Future Value Consultants.

"It's a typical access product," she said. "The investor may want exposure to the underlying index but with a different, more defined return profile."

Access

The notes will mature between 24 and 27 months after pricing, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.5 times any gain in the index, up to an underlying cap of 28% to 32%. The exact cap will be set at pricing.

Investors will receive par if the index falls by up to 10% and will lose 1.1111% for each 1% decline beyond 10%.

"These notes should appeal to investors seeking exposure to the EAFE to diversify away from U.S. equities," she said.

The MSCI EAFE index is a stock index designed to replicate the equity market performance of developed markets outside of the U.S. and Canada. It covers Europe, Australia and Asia.

"It may be an alternative to an ETF. In a moderate growth environment you would outperform the ETF because of the leverage and the cap, which is quite high. The 10% buffer will give you more protection on the downside."

One of the positive aspects of the structure is the cap, said Hampson.

For instance at a 30% final cap, the maximum annual return would be 15% on a two-year note, she said. Future Value Consultants used as hypothetical tenor of 24 months and a cap of 31%. In addition, the 10% buffer benefits investors and has a greater appeal than a comparable barrier for instance, she said.

"And yet, the product does not score all that well," said Hampson referring to a comparison of various metrics measuring risk, risk reward and pricing with two groups of notes - same product types or other leveraged notes first and all products, second.

"A big problem for us when we generate these reports is when issuers announce variable terms as they did here with a 24 to 27 [month] tenor and a cap between 28% and 32%," said Hampson.

"It becomes difficult to analyze the payoff when you don't know what the product is going to be."

The lower scores on the product cannot really be attributed to Future Value Consultants' assumptions, she said. Making the assumption of a 24-month tenor and a 31% cap are not negative assumptions, she noted.

Risk

The riskmap measures the risk associated with a product on a scale of zero to 10 - with 10 being the highest. It is the sum of two risk components - market risk and credit risk.

The 4.37 riskmap of the notes is greater than 4.05 (riskmap for all products) and also greater than the 4.07 riskmap for leveraged notes, she said, which points to a more elevated level of risk.

The 3.59 market riskmap is also greater than similar products - 3.09 and greater than all products at 3.30.

Similarly, the risk return rating is not very high.

"The risk return measured by the return score is driven off by the probabilities of losses," she said.

"The notes, in a neutral market scenario, showed a 38.8% probability of losing capital."

"It's quite high," she said.

"You do have the 10% buffer. But you have to compare it with similar products. Those are usually shorter in duration - typically between one year and 18 month. A 10% buffer is better for a one year than it is for a two-year."

Hampson also pointed to the index' implied volatility.

"There is also the volatility factor here.

"Most leveraged notes are tied to the S&P 500. The EAFE index is more volatile, which increases the risk of losing money beyond the buffer level.

"The relatively longer maturity than other leveraged notes and the more volatile underlying add risk," she said.

The two-year duration, longer than the average for this product type, should have increased the credit riskmap. But it was not the case, she said.

The notes, with a 0.78 credit riskmap, have in fact a better score than their peers with a 0.98 average credit riskmap.

"This is probably due to the issuer," she said.

"Credit Suisse's CDS are at 116. It's quite low compared to most banks."

Return, pricing

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions - neutral assumption, high and low growth environments, 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, at 7.02, was not as good as similar products - at 7.29. However, it was better than all products at 6.59.

"It may seem strange that with quite a high cap like this, you would get a lower return score than your peers. But this rating measures the return per amount of risk. Because the underlying and the term represent both added risk, you should expect the potential return to be greater. It has to be balanced. If you take a risky underlying, you need to have a higher return.

"Keep in mind that you compare this with other leveraged notes that tend to have two or three times leverage. A one-and-a-half factor is less common and less favorable.

This return score simply suggest that investors should get slightly more return for the amount of risk. They could either raise the cap or increase the leverage," she said.

Related to the return score is the price score, also lower than average, she added.

The price score is Future Value Consultants' measure, on a scale of zero to 10, of the market value of the underlying components of the product. Calculated as a percentage of the initial investment, the score gives an estimate of the fees taken per annum.

The higher the score, the lower the fees and the greater value offered to the investor because more money has been spent to purchase the options.

At 6.20, this product's price score is lower than its peers, which show an average price score of 7.32.

"This is the result of not spending enough on the assets. The issuer could have increased the leverage or the cap, and the price score would have been more elevated," she said.

"There is also the time factor. Maturity makes a difference for the pricing. The longer the maturity, the cheaper it is for the issuer in terms of options price, so you would expect better terms.

"Also investors take more credit risk with a longer duration, which they should be compensated for although in this case we saw that the credit risk is mitigated by the issuer's creditworthiness."

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

The notes received a 6.61 overall score, much less than similar products, which averaged 7.30. The overall score was also lower than that for all products at 6.82.

"The price score is the biggest element here. It lowers the overall significantly," she said.

"In general, it's a bit of a challenge to rate a deal with terms announced in a range. There are so many variables; it's difficult to put too much weight on the score."

"I can also imagine that it must be difficult for investors to make a decision," she said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price and settle in November.

The Cusip number is 22546TF71.

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