Credit Suisse’s autocalls on two bank ETFs should weather recession, advisers say

By Emma Trincal

New York, June 7 – Credit Suisse AG, London Branch’s 0% market-linked securities – autocallable with contingent downside due July 7, 2025 linked to the performance of the Financial Select Sector SPDR fund and the SPDR S&P Regional Banking ETF should allow investors to withstand an economic downturn, at least one that’s not too severe, a financial adviser said.

The notes will be automatically called at par plus an annualized call premium of 13.25% if both ETFs close at or above their initial levels on any semiannual observation date after one year, according to an FWP filing with the Securities and Exchange Commission.

If the notes have not been called and the final level of each ETF is equal to or greater than its initial level, the payout at maturity will be par plus 39.75%.

If any ETF declines but each finish at or above its threshold price, 70% of the initial level, the payout will be par.

If the final level of any ETF is less than its threshold price, investors will lose 1% for each 1% decline of the lesser performing ETF from its initial level.

It’s the economy

Tom Balcom, founder of 1650 Wealth Management, said the success of the notes will be closely tied to the business cycle.

“Bank stocks could go one or two ways: higher with rising interest rates or lower if we have a major recession,” he said.

“If we have a mild recession, the 70% barrier should protect you. But if the recession is a major one, bank stocks will take a hit because lending will be impacted.”

Whether the U.S. will fall into a recession will depend on oil prices to a large extent, he said.

“If crude oil prices continue to climb, it will affect everyone – businesses and consumers. It’s like a tax that reduces the disposable income of the average American.”

Three-year term

Balcom said he was unsure whether the economy was headed for a “major” recession.

“But even if we are, you’re getting compensated for the risk. The 13.25% premium is very attractive. The 70% barrier is healthy. We see a lot of 75% barriers. 70% of course is better.”

The tenor also contributed to mitigate risk.

“Even if the economy hits a rough patch, this is a three-year note. We’re likely to have recovered by the time the notes mature assuming you don’t get called in the interim,” he said.

Limited worst-of risk

Another advantage was the correlation between the two underlying.

“Although we’re talking big banks versus smaller banks, both types of companies operate within the same sector and industry. They’re all banks,” he said.

The coefficient of correlation between the two ETFs is 0.88 with 1 being a perfect correlation.

The big banks are more stable given their capitalization, sources of revenues and global diversification, he noted.

“But both the big and the small banks do well in a strong economy and poorly during economic downturns. The two ETFs are likely to move in the same direction, which reduces the risk created by the worst of,” he said.

Reinvestment risk

Balcom said he also liked the six months of call protection giving investors a “no-call” period of at least one year.

“It’s always nice to get the full one-year premium if you get called or even more,” he said.

“When you get called too soon, you have to roll into something else where the terms may not be as favorable as the previous deal. You don’t want a call after three or six months. This note protects you from that. It greatly reduces the reinvestment risk.”

Term, entry

Donald McCoy, financial adviser at Planners Financial Services, also said the tenor added some safety to the structure.

“The three-year term gives you an awful lot of time to recover from any downstroke,” he said.

The underliers are not currently overpriced thanks to the sell-off, he added, noting that both funds are in correction territory.

The Financial Select Sector SPDR fund is 15.5% off its January peak. The SPDR S&P Regional Banking ETF dropped 18% from its January high.

“That takes some of the air of the market making your starting point more attractive,” he said.

The structure itself offered some defensive features.

“Even if we were to go through a recession during the period, you still have the 70% barrier. It should give you some comfort,” he said.

“The call can reduce your risk. In 12 to 18 months, you can get easily called.

“In that scenario, you get 13.25% per year, which is an attractive premium.”

Regional banks

One risk factor was the volatility of the regional banks ETF, with a three-year standard deviation of 28.5%, he noted.

“That’s pretty high. And it makes sense. These are smaller banks. They’re not the JPMorgan, Bank of America and Citigroup. The big banks will likely survive the recession. The regional ones are more sensitive to economic downturns. They’re likely to suffer more,” he said.

This led this adviser to assume that investors in the notes may likely be exposed to the regional banks ETF in a recession scenario.

“From that standpoint, the decision to buy the notes will depend on a person’s comfort level in this ETF, whether they think it’s going to be a suitable investment or not,” he said.

“I don’t know if too many people are going to be bullish on regional banks. From year to year, they take big swings from negative to positive and vice versa.

“When the stocks of those companies are down, they’re down a lot.”

But overall, McCoy’s view on the notes was positive.

“You’re buying at lower prices from the start. You have a significant downside protection. When called, you get a rewarding upside. And three years should be enough time to recoup from a recession.

“So, if you’re comfortable with the underlying funds, it’s not a bad deal.”

The agent is Wells Fargo Securities, LLC.

The notes will price on June 30 and settle on July 6.

The Cusip number is 22553Q2E6.

© 2015 Prospect News.
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