Credit Suisse’s notes tied to SPDR S&P Regional Banking offer cautious access to sector’s rally

By Emma Trincal

New York, Feb. 16 – Credit Suisse AG, London Branch’s 0% knock-out notes due March 7, 2018 linked to the SPDR S&P Regional Banking exchange-traded fund offer a range bound play aimed at investors who expect the bull market in the sector to “have legs” while being still cautious about a correction, sources said.

If the fund finishes at or above its 84% threshold level, the payout at maturity will be a 10.50% digital payout, according to a 424B2 filing with the Securities and Exchange Commission.

If the fund falls by more than the 16% contingent buffer, investors will be fully exposed to any losses.

Big run

“If you buy this, you’re trying to capture the digital and you’re comfortable with that. After a run like that, you’re confident the index is not going to deliver more than 10% in a year,” said Steve Doucette, financial adviser at Proctor Financial.

The underlying ETF has indeed rallied sharply. It has significantly outperformed the S&P 500 index and for some time. Since the Elections the SPDR S&P Regional Banking fund has gained 35% versus 12.5% for the equity benchmark. The fund is up 68% for the past year versus 24% for the S&P 500 index. Even over a longer stretch, the sector ETF has done a lot better, up 120% in the past five years while the broader index rose 75% during that time.

Politics

The underlying sector really became a momentum trade after the Election of Donald Trump, noted Doucette.

“Banks can all benefit from the tax cuts and deregulation that Trump is proposing. But then you run the risk that some of this run-up depends too much on what happens or doesn’t happen in Washington,” he said.

“If those reforms don’t come to pass, the rally could end abruptly. Theoretically you could have a bear market.”

The 16% contingent protection was “a little shy of a bear market,” defined by a 20% decline, he noted, making the barrier size probably insufficient given how the share price recently skyrocketed.

Bull has legs

At the same time, the bull trend may still have some legs within the next year.

“There’s nothing that says it might not go forward. If new reforms pass, it may go even higher,” he said.

Doucette said that unless an investor had a strong conviction that the sector would trade sideways over the next year, the notes presented too much risk on both the upside and the downside.

“To finish between down 16% and up 10.5% is what I would call a pretty narrow window...and that’s a pretty volatile index,” he said.

“You’re talking about a pretty specific view and one that’s affected by political issues.

“You could easily bust through this barrier or go through the roof. Both are risks,” he said.

Doucette said he would not use the notes because of such risks.

Instead he would be looking for a participation note with a buffer and if possible no cap.

“Obviously, you’d have to go longer to get this kind of thing,” he said.

Growth story

For more bullish investors, the digital payout was just a deal-breaker. This was the view expressed by Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“In general, I am not wild about caps,” he said.

“But I like a cap even less with this one. I am bullish on the banking sector.

“I think it should do well with the anticipated market developments in particular rising interest rates and the potential easing of some regulations, all factors that are beneficial for banks, large and small,” he said.

The regional banking sector has been undervalued for “many years,” he said.

Just as larger banks, the regional banks have been “struggling” in a low growth and low interest rate environment.

“Combine stringent lending requirements and low, very low interest rates...this type of environment doesn’t allow banks to generate earnings,” he said.

But things could improve under market forces, he suggested, which should have an even greater impact than new policies.

“I think if banks’ profits improve, it’s going to come from economic growth. Once the Fed is confident that the economy is stronger, they will hike rates,” he said. “Rates will rise, and that will support higher profits for banks.

“I don’t think it’s as policy-dependent as people think. I think it’s going to be market-driven.”

No cap please

Bullish on the economy, Medeiros sees a continued increase in regional banks’ share prices looking forward.

As a result, he would not consider the notes.

Medeiros said he understood why the issuer had to limit the upside.

The notes are short term; the digital offers a double-digit return; and investors can get paid even if the fund drops 16%.

“These are beneficial terms. They couldn’t give you that without a cap. I get that,” he said.

“But I’m much more optimistic on the asset class. I don’t want my return to be capped.”

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

The notes will price on Feb. 17 and settle on Feb. 23.

The Cusip number is 22548QVJ1.

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