Credit Suisse's twin-win notes tied to S&P 500, Russell offer good terms, additional risk

By Emma Trincal

New York, March 19 - Credit Suisse AG, Nassau Branch's 0% absolute return notes due April 4, 2014 linked to the S&P 500 index and the Russell 2000 index offer attractive terms by combining two different structures in one, a structurer said.

But the product should be offered to speculative investors only given the risks, financial advisers said.

Hybrid

"The product is a twin-win certificate using a worst-off type of payout," a structurer said.

A twin-win or absolute return product, also called dual directional note, gives investors positive returns even when the underlying return is negative as long as the closing value is above a certain threshold.

Worst-off notes give investors a payout at maturity linked to the worst performance of two or more underlying assets.

This product uses both features, according to a 424B2 filing with the Securities and Exchange Commission.

Each index's return will be subject to a cap of 24% to 26%. The exact cap will be set at pricing.

If the final level of the lowest-performing index is greater than or equal to its initial level, the payout at maturity will be par plus the return of the lowest-performing index.

If the final level of the lowest-performing index is less than its initial level but is greater than or equal to its knock-in level, 70% of its initial level, the payout will be par plus the absolute value of the lowest-performing index's return.

If the final level of the lowest-performing index is less than or equal to its knock-in level, investors will be fully exposed to the decline of the lowest-performing index from its initial level.

Pricing

"What makes this appealing to investors is that they can get a positive return even when the worst index declines as long as it doesn't exceed a certain limit," the structurer said.

He compared this product to a regular digital note that would offer a fixed-payment if the index was to close above the knock-in level.

"In both cases, you get a positive out of a negative. But here, instead of getting a 10% bonus for instance, you get an absolute return according to how much the worst index declines.

"The profit potential of this product is higher.

"The more you fall, the higher you return unless it falls too much," he said.

The twin-win structure also uses a worst-off payout, he said, which adds more risk but improves the terms compared to a product that would be solely tied to a single index or a basket of indexes.

"You sell a call. That's your cap. With the premium, you can buy the options," he said.

"You also have some value from the worst-off because you get compensated for the correlation risk.

"Finally, the issuer uses the unpaid dividend to get more value.

"With those three value elements, you can buy two down-and-out puts, one to give you the protection from the 70% to 100% price, the other to give you the positive performance in that range.

"Introducing the worst-off in the structure enables the issuer to offer very attractive terms," he said.

Long the Russell

Carl Kunhardt, wealth advisor at Quest Capital Management, said that he liked the product for a speculative investor. In his view, the security offered no less downside risk than a direct investment in the Russell 2000 index.

"For an aggressive investor I wouldn't mind it. It's got sufficient downside protection," he said. "I like the idea of being able to make a positive return even if you're down."

"I'd be tempted to use that but for sophisticated investors," he said.

Examining the downside risk, Kunhardt explained that investors are really exposed to only one of the two benchmarks.

"If you're a bull and if you're right, what you're going to get is the return on the S&P 500 because the Russell will outperform the S&P 500 in a bull market," he said.

"On the other hand, in a down market, the worst of the two will be the Russell because small caps are more volatile so they're likely to go down more than large caps.

"In a bull market, I bet on the Russell. I'll get the S&P instead.

"In a bear market, I'll get the Russell.

"I can almost ignore the S&P 500 on the downside.

"So it's like being long the S&P without any downside risk on the S&P. My downside risk is limited to the Russell.

"But I do have a 30% protection on the downside. So I'm better off than being long the Russell directly.

"The only risk I'm taking is liquidity. I am having a two-year product.

"If I'm comfortable with the risk parameters: risk on the downside on the Russell, return on the upside on the S&P 500, I think this is a pretty good structure," he said.

Excessive beta

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that he liked the terms of the product but that the risk was too high to be of interest to his clients.

"The terms of the structure are pretty impressive," he said. "It's a two-year, it's not terribly long.

"Credit Suisse is single-A plus. It's a decent credit.

"The absolute value is fantastic because if your index is down in that range, you're not just going to break even; you're going to get a positive return.

"And it's a point-to-point, not a daily close. That I really like.

"Even if the trigger gets hit once, as long as the index doesn't finish below the threshold, you're fine."

"It limits your risk very significantly," he said.

Kalscheur agreed that in a down market, the Russell 2000 index was likely to generate a performance worse than that of the S&P 500.

"Your risk is associated with the Russell because this is the more volatile of the two," he said. "So while 30% is a decent cushion, you also have a greater chance of hitting this trigger."

"At this point, I can see the market run up 25% or 30% in two years and hit the top. I can also see the market breaking through the 70% barrier easily," he said.

Noting that the three-year annualized standard deviation on the Russell 2000 index is almost 23% while it is 17% for the S&P 500, Kalscheur said that, "The Russell can certainly hit 30% down. If this 30% had been applied to the S&P 500 only, I would feel very comfortable with it."

Rolling the dice

Kalscheur said that these notes defeated the purpose that drives his investing in structured products in the first place.

"I want risk reduction, not just risk mitigation.

"I always prefer having a buffer because I know that I am going to outperform the market. Let's say that I have a 10% buffer. The market is down 20%, I'm down only 10%. I've outperformed the market. The client is happy.

"With this one, I could get a 30% loss because of the Russell while the S&P 500 could finish less down. And yet your client had exposure to both benchmarks. How do you explain that? That's a conversation I don't want to have with my clients," he said.

Kalscheur said that only aggressive investors would want to invest in the product.

"It's only useful for someone willing to leverage up risk.

"This note thrives on a big move either way.

"If you're looking for a product to roll the dice with and you're willing to take on risk, this is a great product. But I wouldn't build my portfolio around anything like this. I wouldn't even put 1% of it in any of my clients' accounts."

"I am buying a structured note, I take additional credit risk. I'm tying my money up for two years. I want to get downside protection. This is not what I buy structured products for," he said.

The notes (Cusip: 22546TNZ0) are expected to price March 30 and settle April 4.

Credit Suisse Securities (USA) LLC is the underwriter.

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