Credit Suisse’s notes tied to Swiss Market show aggressive pricing, first use of index

By Emma Trincal

New York, April 6 – Credit Suisse AG, London Branch’s 0% CS notes due April 18, 2023 linked to the Swiss Market index intrigued market participants for their pricing and underlying.

Price-wise, the real surprise was not the upside itself, which shows between 1.8 to 1.9 times leverage with no cap. It can also be done, especially on a five-year, with other high-yielding indexes such as the Euro Stoxx 50, sources said.

The real eye-catching feature was the full protection on the downside.

It is also the first time that the Swiss Market index (SMI), the Swiss blue-chip index, will be used as a stand-alone underlying in a structured note, according to data compiled by Prospect News, which collects all U.S. registered structured notes.

Basket residence

The Swiss Market index has been employed thousands of times as one of the components of an unequally weighted basket of international benchmarks, the data showed. The benchmarks which comprise this basket are typically the FTSE 100 index, the Euro Stoxx 50, the S&P/ASX 200 index, a Japanese index and at times a Chinese index.

But the SMI by itself has not been used before, according to data going back to 2004 when Prospect News began to track equity indexes.

Enigma

“I find this deal extremely attractive. I’m not sure how they’re able to price it,” said Clemens Kownatzki, independent currency and options trader.

“You get almost two times the return. If the Swiss market is up 100% you make 200% because there is no cap. Plus they give you 100% principal protection.

“You’re getting a very inexpensive at-the-money call option.

“It’s a strange note...a strangely attractive note.

“I can’t see any downside.”

Forwards

Investors in the notes will not earn the dividends paid to owners of the 20 stocks that comprise the index. This helps the economics of the structure, including the defensive aspect of it. But it’s also true of all structured notes.

The average dividend yield of the 20 constituents of the SMI is 3%.

Some of those individual companies pay dividends in excess of 5%, such as Zurich Insurance Group and Swiss Re.

A market participant pointed to the relationship between interest rates and dividends, known as forwards.

“The fact that the dividend yield is high and the Swiss Franc yield is negative definitely helps make the call option much cheaper if you compare pricing this with the S&P 500 where you would never get full protection,” said a market participant.

But Kownatzki said there must have been another element than the price of the forwards to explain how the issuer was able to protect 100% of the downside against market risk.

“You’d have to have a 5% yield to explain how they can do that,” he said.

Imperfect comparison

A somewhat comparable deal from Morgan Stanley Finance LLC set to price this month shows a gap in pricing that calls for further examination.

It is a four-year note tied to the Euro Stoxx 50 index paying 2.15 times the gain with no cap and providing a 25% buffer.

The Euro Stoxx 50 index offer similar characteristics to the Swiss Market index with high dividends and negative interest rates.

While the terms are not exactly the same, the difference in protection levels had to be explained.

The vol factor

“There’s a third factor,” said a structurer who looked at the Credit Suisse prospectus.

“The volatility of the SMI is lower. It’s about 4% lower.”

“With volatility being lower, it costs you less to buy the call options,” he said.

This helps the economics of pricing the leverage.

“With the Euro Stoxx you need to take the downside risk. You have to pay for the calls and so you’re selling puts,” he said.

“Here the upside is so cheap...you don’t have to take the downside risk.”

“The lower volatility explains how the full protection was made possible. It’s a little bit the same idea as those notes linked to low volatility indices.”

Hedge

The notes can be used for different purposes, sources said.

Serge d’Adesky, president of Northstar Strategic Investments, said he liked the notes as an equity substitute offering a hedge against inflation without market risk.

“It looks too good to be true but it’s not,” he said.

“You are foregoing the dividends. But this gives you a good protection to hedge inflation risk.

“In general, you own equities to hedge inflation. But when you own equities, you have the downside risk.

“Here, you don’t have the downside risk. So if you can live with the fact that you have to hold the notes for five years it makes sense.”

Credit risk, time value

D’Adesky said that investors were facing two risks with the notes, one of which can be hedged.

“Credit Suisse goes out of business. That’s one risk you want to eliminate. You can easily do that by buying a deep out-of-the-money put option on Credit Suisse. It’s cheap. You only want to buy it against the bankruptcy risk,” he said.

The second risk is loss of time and opportunity cost.

“You don’t lose. You don’t gain. You’ve tied your money for five years for nothing,” he said.

“That is the only risk you’re taking really...the only one you can’t really hedge.

“It’s a pretty good deal. I would look at it for my customers.”

Underloved assets

A play on Switzerland, which is not part of the eurozone, may present some opportunities for the value, contrarian-type of investor, said Kownatzki.

“Switzerland is an island in the eurozone. The Swiss Franc is very strong, which penalizes the country’s exportations.

“That’s part of the reason why the Swiss market has been underperforming the U.S. since 2007.”

“A contrarian investor looking for value may see an opportunity there.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on April 13 and settle on April 18.

The Cusip number is 22550WNS2.

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