Credit Suisse’s $2.57 million trigger callable yield notes on S&P Midcap 400 show low barrier

By Emma Trincal

New York, July 21 – Credit Suisse AG, London Branch’s $2.57 million of 7.6% trigger callable yield notes due July 20, 2021 linked to the SPDR S&P Midcap 400 ETF Trust provide a modest but guaranteed coupon with a relatively conservative barrier at maturity, said a financial adviser, who would consider the notes as a possible source of fixed income.

However, any loss of principal would be substantial and should be considered in the risk evaluation process, said an investment strategist.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are callable at par on any monthly call date after three months.

The payout at maturity will be par of $10 unless the ETF finishes below its 55% trigger level, in which case investors will be fully exposed to the ETF’s decline.

Weak coupon

“The 7.6% coupon isn’t a really high rate relative to other things that are out there,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

The call, which the issuer can exercise monthly after only three months, was another drawback making the investment a time-consuming proposal, he added.

“You do your research, three months down the road, it gets called ... you have to do all that work all over again. You only have so many hours in a day,” he said.

At first, Kalscheur looked at the note as a pure equity play given its underlying equity index.

“As an equity investment, the interest rate is not as enticing as I would like it to be. If you take equity risk, you should expect equity returns,” he said.

Risk off

But he reconsidered his approach when evaluating the “low barrier level” at maturity.

“It’s an income play in that it eliminates as much equity risk as it can with such a deep barrier,” he said.

“The index would have to drop more than 45% in one year for the investor to lose money.

“It’s virtually impossible.”

To illustrate his call, he looked at performance data his firm has collected on some U.S. equity indexes.

“I don’t have data on the S&P Midcap 400, but I do have figures for the S&P 500 index going back to 1950 and on the Russell 2000 index since 1987,” he said.

Kalscheur found that the S&P 500 index fell by more than 45% only 10 days in 70 years on a 12-month rolling period basis. The back-testing for the Russell 2000 revealed that the frequency for the barrier breach event was only 12 times in 33 years.

“The odds of hitting that barrier are extremely small. You have a better chance of having a car accident on your way home than losing money on this one,” he said.

“So, what you’re doing really is making an income decision.

“Sure, there is equity risk. But we’re talking about extremely small probabilities. If you’re that worried the market is going to be cut in half in the next 12 months, you probably shouldn’t be in the market.”

Fixed-income replacement

The chances of losing money are “taken off the table” with this payoff. He concluded that the product could be viewed as a bond-like instrument.

“Then you have to ask yourself if for the same amount of risk you can get a better yield elsewhere,” he said.

He concluded that the answer to this question was: no.

“Treasuries aren’t paying that, he said.

The one-year T bill yields 0.14%.

“CDs aren’t’ paying that.

“Corporate bonds aren’t paying that. And you get interest rate risk and market risk. Even municipals can move. “Perhaps you could get that type of yield in an international high-yield fund, but there’s still volatility there.”

Kalscheur said the notes could appeal to a conservative investor concerned about market risk but preoccupied with getting sufficient income.

“You have to be prepared to hold it for 12 months. You also have to tell them they might get called in three months,” he said.

“The income you’ll get is not going to knock your socks off. But relative to other high-yield instruments, this note can be appealing.

“The equity risk in my opinion is pretty much removed. So, you can use it as a way to reduce your bond risk and transfer it into a very small equity risk.”

“I wouldn’t discount it.”

Tail risk

Lance Roberts, chief investment strategist at Clarity Financial, was more concerned about the downside risk.

“If I own the underlying ETF and need to hedge it, it makes sense to issue a structured note against my position to hedge the risk,” he said.

“But as a buyer of the note, I’m giving up my upside. Why would I do that?”

The answer of course was to get income, he said. But Roberts questioned the soundness of the trade-off.

While he agreed that a 45% decline was substantial, he would not completely rule out such scenario in the current market environment.

“It may not be likely, but if this barrier is breached you lose nearly half of your investment, and that’s a minimum,” he said.

“Big drawdowns like that only happen very rarely. But we are in an environment where the risk of that event happening is higher.”

Treacherous environment

He said the economic picture is not particularly bright, pointing to the latest estimate of the Federal Reserve Bank of Atlanta calling for a 34.7% decline in the GDP for the second quarter.

“I would be cautious,” he said.

“Midcap stocks are the most susceptible to weaken in a recession.

“The market is nearly at an all-time high. Fifty million people are unemployed.

“If this deal was issued on March 23, I would be all over it.

“But I wouldn’t take the risk right now.”

The S&P 500 index bottomed on March 23. Since then, the benchmark has gained 48.6%. It remains only 4% off its all-time high of Feb. 19.

“To build a stable income stream is relatively challenging in this environment,” he said.

UBS Financial Services Inc. and Credit Suisse Securities (USA) LLC are the agents.

The notes settled on Monday.

The fee is 0%.

The Cusip number is 22550X170.

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