Credit Suisse’s reverse convertibles show high coupon on three low-priced, volatile stocks

By Emma Trincal

New York, March 22 – Credit Suisse AG, London Branch’s 19% to 21% autocallable reverse convertible securities due March 29, 2019 linked to the lowest performing of three stocks caught advisers’ eyes for coupon, which is high and guaranteed.

The notes are linked to the common shares of Cleveland-Cliffs Inc., the class A ordinary shares of Ensco plc and the shares of Transocean Ltd., according to a 424B2 filing with the Securities and Exchange Commission.

The worst-of only applies to the autocall and the principal repayment at maturity.

Interest is payable monthly, with the exact coupon to be set at pricing.

The notes will be called at par if each stock closes at or above its initial level on any quarterly trigger observation date.

The payout at maturity will be par unless any stock finishes below its 65% knock-in level, in which case investors will receive a number of shares of the worst performing stock equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

Positive outcomes

Advisers are used to seeing contingent coupon notes. The traditional reverse convertible with a guaranteed coupon has become rare. But the recent rise in volatility must have helped, they noted. Other coupon boosters include the use of a worst-of and three highly volatile stocks.

“That’s a pretty high coupon. And it’s surprising that it’s a fixed rate. It’s rare. I didn’t expect to see these kinds of deals anymore,” said Steve Doucette, financial adviser at Proctor Financial.

“It’s quite a reward if you’re willing to take the risk.

“The only way this thing gets ugly is if one of the stocks is down more than 35% at maturity.”

On the plus side, the fixed payments and the autocall provided some benefits.

“If you don’t get called your 20% coupon is kind of a buffer that protects the downside,” he added.

“And if you get called right away, you get 5% in three months. That’s better than a full year bond’s yield.”

Due diligence

Before considering buying the notes, Doucette said he would have to do the necessary research on the three names.

Cleveland-Cliffs is an iron ore mining company.

Ensco is an offshore contract drilling company.

Transocean is a provider of offshore contract drilling services for oil and gas wells.

“I’ve heard of Transocean but not of the other two. Maybe that’s why you get a 20% coupon!”

Small stocks

All three underlying securities are low-priced stocks. One of them, Ensco, is a penny-stock. It closed at $4.68 a share on Thursday. Transocean finished at $10.00 and Cleveland-Cliffs at $6.66.

Small-stocks tend to be more volatile as their percentage price moves are greater.

Ensco for instance is down 24% year to date, but the price drop is only $1.50 from its $6.17 price at the beginning of the year.

Thursday was a bad day for equity markets back in correction territory again. The S&P 500 index dropped 2.5% on the day. But Ensco plummeted 9%.

The implied volatility of the three underlying stocks is high: over 50% for Ensco and Cleveland-Cliffs and over 40% for Transocean.

Equity allocation

Doucette said he would probably pass on the deal “unless you’re willing to take a gamble.”

He said he did not view the notes as a fixed-income replacement despite the guaranteed income stream.

With a 20% return, the correct allocation should be to equities, he noted.

“I’d rather stick to large benchmarks rather than three stocks. When you get your exposure to broad indices you take a lot of risk out of the equation.”

Penny stock

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the fixed rate caught his attention. But so did the risks.

“I like the coupon concept of this type of note. It’s nice to get a fixed coupon,” he said.

“But I’m really curious about the choice of the underlying stocks. Ensco seems particularly peculiar to me because it’s a penny stock.

“The lower the price of a stock, the greater the risk of a drawdown.

“I would need to do a lot more research before I become comfortable with this.”

While the note pays income, Medeiros also views the note as a pure equity play.

“If I was a buyer I would look at it as a component of my equity bucket just because of the risk of the underlying.”

Fee another issue

Cost was another issue.

The maximum fee on this note is 2.875%, according to the prospectus.

“It’s a one year. I’m not sure why it could be so expensive. Is it due to the cost of hedging those stocks? I’d be curious to know,” he said.

More modest coupon

Changing the risk-reward profile of the note would probability make this investment more in line with his firm’s investment philosophy.

“I like the coupon side of it. But there seems to be a lot more volatility with these underliers.

“If I could find something paying a fixed return with less volatility and a decent coupon – it doesn’t have to be 20% – it would be very interesting,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on March 27 and settle on March 29.

The Cusip number is 22549JRU6.

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