SunTrust CD linked to gold offers high minimum payout plus ticket to gold rush, sellsider said

By Emma Trincal

New York, Nov. 4 - SunTrust Bank's plan to sell certificates of deposit linked to gold gets investors' attention, a distributor said, as the deal offers a high minimum coupon and the opportunity for investors to get exposure to gold, a commodity that has enjoyed a spectacular run lately amid inflation fears.

SunTrust Bank plans to price 0% certificates of deposit due Nov. 26, 2014 linked to the price of gold, according to a term sheet.

If gold rises above the upper barrier on any day during the life of the CDs, the payout at maturity will be par plus 10%. This 10% rate represents the minimum interest amount payable at maturity. It equates a 1.92% annual yield, according to the term sheet.

The upper barrier is expected to be 185% to 195% of the initial gold price, with the exact amount to be set at pricing.

If the price of gold never hits the barrier, the payout will be par plus the greater of 10% or the gold return.

High minimum coupon

"It's a very generous deal," said Tim Bonacci, president of CD Funding Group LLC in Cincinnati who distributed a similar version of the same deal last month.

"You're basically guaranteed to earn at least 10% in five years, or about 2% a year. That is very close to the 2.5% or maybe 3% annual yield you can expect on a traditional CD. But the difference is that here they're paying you 2% plus the potential to make much more."

Bonacci illustrated the various payout options for the investors, using examples based on the current price of one ounce of gold, which reached a new high Wednesday at $1,092. He also assumed that SunTrust would set the upper barrier to 185%.

"Basically you get the absolute return of the index, meaning the point to point appreciation of gold prices if gold moves up but not up to 85%. If at any time gold breaks the 85% barrier you get the 10% minimum payout. And if gold goes up during the five years but not as high as 10%, you still catch your 10% return. We think a minimum 2% annual return with the potential to earn much more is a pretty good deal," said Bonacci.

"We sold this deal last month," added Bonacci. "People like it because the minimum return is fairly close to the traditional CD rates."

Brokered CDs yield more

Tony Romero, cofounder and managing partner at deposit brokerage firm Suncoast Capital Group in Miami disputed the notion that 2% was close to the best available rates for a five-year CD, stressing that brokered CDs have higher rates.

"There may be plenty of banks offering five-year CDs with a 2% coupon. But I am able to give my clients a 3% rate on a five-year CD," he said.

Bonacci noted that last month's offering from the same issuer featured a 12% minimum coupon, instead of the 10% for the new upcoming issue. "With interest rates coming down a little bit, they've changed the coupon, but 10% is still very attractive," he said.

Barrier issue

Romero also pointed to the upper barrier in the structure, viewing it as a negative for investors.

"The issuer is betting that the price of gold will exceed the upper barrier at least one day out of the entire five year and if it does, their cost of funds - and the payout to investors - amounts to 2% annually, a very inexpensive alternative to fixed rate five-year CDs which would cost an issuer north of 3% right now."

Romero added that the security was in his view "peculiar" as "the investor is being potentially penalized by an increase in the underlying index." He said that the reason issuers put such barriers in place was to "attract deposits at the lowest cost of funds. "

But for Bonacci, the rationale for the upper barrier is different. "This is just a way for the issuer to be able to afford the payment of the high minimum coupon," he said.

For gold bugs

The deal also appeals to investors eager to get exposure to gold but unwilling to pay the high price of the commodity.

"If you're bearish on the market and think inflation is coming and that gold is a good play, this is an attractive product," said Bonacci. "Most investors we spoke to believe that gold will go up. However, they don't think gold will break out the cap. For gold to rise by 85%, its price would have to go beyond $2,000. Most of the investors we talked to believe that it won't. The chances of gold breaching the upper barrier are slim. But even if it did, 10% in five year is still pretty good," he said.

Romero said that for investors who seek gold exposure, the SunTrust offering may be an option. But he is not convinced that the deal terms and the structure represent the best way for investors to achieve this strategy.

"The investor is assured a floor of a 2% annual return with no chance of loss of principal so really the investor is only giving up the opportunity cost of perhaps an extra 1% return they would have realized on a fixed rate five-year CD for the possibility of achieving a higher return if certain conditions are met," said Romero. "There is a place for metals in any portfolio although it is debatable as to which vehicle would best achieve this aim."

Preliminary queries

"We may be selling this new deal coming out again this month," said Bonacci. "We've have seen continued interest. I got four calls yesterday," he said.

The CDs are expected to price on Nov. 20 and will settle on Nov. 25.

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