Credit Suisse, RBC price two absolute return note issues with buffers, a novelty, sources say

By Emma Trincal

New York, Oct. 4 - Two offerings of absolute return notes priced on Monday with what sources said is an unusual feature: a buffer rather than the typical barrier for the downside protection.

The notes are also notable for their size and for their quasi similar structures, sources also noted.

Credit Suisse AG, Nassau Branch priced $48.56 million of 0% absolute return barrier securities due March 30, 2015 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus the index return, subject to a maximum return of 20%.

If the final index level is less than the initial index level but greater than or equal to the knock-out level, the payout will be par plus the absolute value of the index return. The knock-out level is 80% of the initial index level.

If the final index level is less than the knock-out level, investors will lose 1.250313% for every 1% that the index declines below the knock-out level.

"This one has a buffer. It's a neat feature we haven't really seen with absolute return notes," said Steve Doucette, financial adviser at Proctor Financial.

"As with most absolute return deals, you must have a range-bound view of the markets to invest in this.

"The absolute return component in a product is a very powerful thing. If the index is down 19%, your return is going to be a 19% gain. You outperform the market by 38%. That's quite attractive."

Royal Bank of Canada priced almost the same structure with its $19.38 million of 0% absolute return index-linked notes due March 30, 2015 linked to the MSCI EAFE index.

The cap and knock-out amount are 20.05%, and the downside leverage factor is 1.2508%.

Credit Suisse Securities (USA) LLC was the agent for the larger deal; RBC Capital Markets, LLC distributed the second offering.

Buffered

"This is interesting," a sellsider said.

"In the past, we've seen 30% barriers, but once you pass that barrier, you begin to lose money from the initial level. With these two, you have a buffer and you start to lose money only after the buffer. It looks like a new type of structure, another way to put together an absolute return product."

Only one absolute return deal so far this year was buffered, according to data compiled by Prospect News, which screened 77 absolute return deals that have priced as of Oct. 2.

It was Morgan Stanley's $5.25 million of 0% dual directional buffered Performance Leveraged Upside Securities due May 16, 2014 linked to the iShares Dow Jones U.S. Real Estate index fund, which priced in May. This two-year note has a 15% buffer and a 30% upside cap.

All other products were built around barriers, which once breached, put investors at risk of losing principal from the initial price.

Commenting on this week's two pricings, the sellsider said, "It's a little bit different in terms of structure. I haven't seen very often these types of products using buffers. It's unusual."

One may assume that if the majority of absolute return notes have barriers instead of buffers, they may at least be uncapped. But that is not the case, according to the data.

In fact, only six deals out of the 77 offerings reviewed from the data were uncapped. Barclays Bank plc brought to market one of them, which was linked to Brent crude oil. RBC issued the other five, all based on equity benchmarks.

Other exceptions exist with unregistered products. BNP Paribas for instance is expected to price later this month a two-year "twin win" note linked to the S&P 500 due Oct. 31, 2014, which is an absolute return structure.

The downside barrier level will be 75% to 77% of the initial level, and the upside will not be capped, according to a pricing supplement.

Caps

"Perhaps the difference is that barrier products have higher caps. With those two deals you get more downside protection, but your upside may be more limited," the sellsider said.

According to the data, absolute return notes with a two-and-a-half-year tenor that have priced this year had an average cap of 27%. They were based on the S&P 500 index.

"We have two two-and-a-half-year products with a 20% cap. It's less than 10% a year. It's not that much," the sellsider said.

Another difference is duration. The Credit Suisse and RBC notes are slightly longer than the average duration of 1.77 years based on the reviewed data.

The two notes also feature a downside leverage factor, which is nonexistent with other absolute return deals. It makes sense since negative leverage is a feature associated with buffers, the sellsider noted.

Indeed, the only structure to feature a downside leverage factor in the data was the buffered notes from Morgan Stanley. Investors will lose 1.1765% for every 1% decline beyond the 15% buffer.

"But you're not at a disadvantage with that because you have a buffer. With a buffer, you're still better off than with a barrier," the sellsider said.

Another singular aspect of the double offerings of Monday is that the products are almost twin deals and yet were sold by different agents, he noted.

"They have identical structures. It's possible that it may be for one specific client who decided that they liked the structure. They bought both deals, one with the S&P, the other with the MSCI EAFE index. And the idea was to get notes from different issuers to diversify credit," he said.

"But what's odd with this picture is that the fees are not the same," he added.

The RBC notes have a 2.2% fee, and the Credit Suisse deal is at 1.4%.

"So I'm not sure really why the deals are identical. I don't think it is from the same client," he said.

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