Credit Suisse’s autocallables tied to ETFs offer double-digit coupon but with American barrier

By Emma Trincal

New York, July 10 – Credit Suisse AG, London branch’s contingent coupon autocallable yield notes due Feb. 3, 2020 linked to the lesser performing of the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund and the SPDR S&P Biotech exchange-traded fund are using volatile underlying funds and a riskier type of barrier to boost the coupon over a relatively short period of time, sources said.

The worst-of option with two volatile and not positively correlated ETFs allowed the issuer to extract more premium for the coupon, observed Paul Weisbruch, vice president of ETF/options sales and trading at Street One Financial.

Also, the use of a so-called “American barrier” created more risk and therefore a more attractive coupon rate compared to recently announced deals quasi-identical to this one with a more conservative barrier type.

American barriers are monitored each day during the life of the notes, as opposed to European barriers, which are observed only at maturity.

Terms

Each quarter, the notes will pay a contingent coupon at a rate of between 11% and 13% per year unless either ETF closes below its coupon barrier level, 50% of its initial level, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

Beginning Jan. 31, 2018 and ending Oct. 30, 2019, the notes will be automatically called at par if both ETFs close at or above their respective initial levels on a quarterly redemption date.

The payout at maturity will be par plus the final coupon unless either ETF closes below its 50% knock-in level during the life of the notes, in which case investors will lose 1% for each 1% decline of the worst-performing ETF or receive par if the return of the worst-performing ETF is flat or positive.

The notes (Cusip: 22550BBX0) are expected to price July 31.

Value

Weisbruch said he believes the worse-performing fund may not be the one people would have in mind first.

“XOP is trading at its 52-week low. In fact, last week Friday was the low. Crude prices have weighed on the ETF, but at this point the impact of oil may not be a factor anymore,” he said.

He referred to the two ETFs by their respective NYSE Arca symbols, using “XOP” for the SPDR S&P Oil & Gas Exploration & Production ETF and “XBI” for the SPDR S&P Biotech ETF.

“XOP is not a screaming buy. But there is a limited downside, at these levels, because it’s already so depressed,” he said.

“Usually after such a sell-off there is potential for a rebound.

“Has the sector done well? Absolutely not. ... It’s been terrible in the last six months.”

The ETF has lost nearly 25% since mid-January.

“But to think it could drop another 50% from those levels you would have to be extremely bearish, not just on oil but on the sector.”

The situation is very different with the biotech ETF, he said.

“It didn’t do well after the elections. And then Trump in January said drug prices were too high. That didn’t help,” he said.

“But he took no action to cut prices, so people realized it was just rhetoric. Rhetoric doesn’t matter.”

The ETF is up more than 30% for the year.

“This explains the recent rally. There is this renewed speculation that Trump is pro-business, that he’s not going to hurt big pharma.”

Unpredictable

The two-and-a-half-year tenor is “a long time,” according to Weisbruch.

Both ETFs are historically volatile in the short term, he noted.

The SPDR S&P Oil & Gas Exploration & Production ETF has an implied volatility of 33.72%. The biotech ETF shows a 29.14% implied volatility. These levels compare with about 10% on the S&P 500 index.

“I wouldn’t speculate trying to figure out which ETF could drop 50%, although the biotech would seem more likely given the bull run we had this year,” he said.

“Two and a half years is a long time, so it’s hard to say. On top of [that], it can strike any day during that time.”

The risk is compounded by the volatility and lack of correlation between the two ETFs.

The coefficient of correlation between the two ETFs is negative 0.1%.

The less correlated two underliers are in a worst-of structure, the greater the chance to breach the barrier.

“Very hard to say in advance what your exposure is going to be like,” he said.

Likely call

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said he did not like either ETF given both the automatic call and the worst-of.

“The biotech one has pretty good potential for growth, but then you know the note is going to be called away in six months,” he said.

“And I don’t see much potential for growth for XOP. It has been down for a while for good reasons, and I don’t see how it could go back.”

He said he anticipates the worst-performing fund to be the SPDR S&P Oil & Gas ETF since he sees the sector stagnant or even bearish.

Yet his main objection to the deal was the possibility of an autocall.

“A 50% barrier is quite large. Can you breach it? It’s possible but very unlikely. I’m not concerned as much about that than being called, maybe just in six months.

“I see this note being called relatively soon unless we have a recession.

“I don’t find it interesting at all. I’m putting money on this thing, and what am I getting out of it?”

Twins

Two other nearly identical notes are in the works. The main difference with the previous one is that they use a European barrier, which is perceived as more attractive by investors. But introducing the European barrier requires trade-offs on the part of investors.

One of the notes is also issued by Credit Suisse; the other comes from Goldman Sachs’ issuing arm.

The notes in each case have exactly the same terms, structure and pair of underlying ETFs as the previous one except for the maturity, the coupon payment and the barrier levels.

GS Finance

GS Finance Corp.’s notes offer a slightly lower coupon. But the 10.5% to 11.5% rate remains in the double-digit range.

The two-year tenor is shorter. In exchange for the European barrier, the issuer offers less contingent protection with a 65% barrier.

The notes (Cusip: 40054LKP8) will price on July 26.

Another Credit Suisse

Credit Suisse’s second product has a two-and-a-half-year tenor like the first one.

The barrier is maintained at 50% but is measured point to point. The trade-off in this case is a lower coupon in the 9% to 11% range versus 11% to 13% previously.

The notes (Cusip: 22550BBR3) will price on the same day as the Goldman deal, July 26.

Worst-of

For Chisholm, those quasi duplicates of the first deal, despite the introduction of a barrier observed at maturity, make little to no difference.

“Whether it’s European or American doesn’t matter. I’m still taking the full downside risk with a strong likelihood of being called after just six month,” he said.

“In addition to that, I found that worst-of securities are not very marketable.

“Your upside is limited by the worst index. You can get called easily. If you don’t get called, your principal is at risk at maturity. The risk/reward is not advantageous to the investor.”

The two deals to be issued by Credit Suisse will have Credit Suisse Securities (USA) LLC as the agent.

Goldman Sachs & Co. will be the agent for the GS Finance’s offering and Goldman Sachs Group, Inc. its guarantor.

© 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.