SunTrust's CDs tied to Brazilian real protect downside with potentially high annual coupon

By Emma Trincal

New York, Sept. 18 - SunTrust Bank's planned structured certificates of deposit linked to the exchange rate between the Brazilian real and the dollar are unusually appealing, a CD structurer said, as they offer the potential for a high annual interest rate with a guaranteed minimum above that of comparable Treasuries - along with the traditional benefits of owning a structured CD, such as principal protection and the Federal Deposit Insurance Corporation guarantee.

'Pretty impressive'

"This foreign exchange CD is pretty impressive. There's very little negative in this deal," said Tim Bonacci, president of CD Funding Group LLC, a firm that creates and distributes structured CDs in Cincinnati."We're not selling this, but we should."

SunTrust plans to price certificates of deposit due Sept. 22, 2014 linked to the exchange rate of the Brazilian real against the U.S. dollar, according to a preliminary term sheet.

Investors bet on the appreciation of the Brazilian real against the dollar. If they're right - in other words, if the exchange rate is lower than the initial exchange rate, reflecting the strengthening of the Brazilian real - investors earn a 6% coupon for the year in question. If they're wrong and that the dollar raises against the Brazilian currency, they get a minimum coupon of 2.75% for that year. In both cases, they are guaranteed to earn at least 2.75% per year.

"The 2.75% minimum makes it one heck of a deal," said Bonacci. He pointed to the current five-year Treasury yield at 2.37%, which is less than the offered minimum with the SunTrust offering.

He said that his firm recently dealt with "a couple of 6%s linked to currencies" but that such deals did not offer a 2.75% minimum.

"SunTrust has been pretty aggressive recently," he said. He added that the 2.75% minimum coupon is even competitive with the traditional five-year CD rates, which he priced right now between 2.70% and 2.80%.

"This is a very attractive structure. You've got the government guarantee, plus a guaranteed payment above the current Treasury yield and equal to traditional brokered CD rates, all of that with the potential to earn a pretty high coupon based on the performance," said Bonacci.

Five possible wins

Another very attractive feature in this deal is the payment of the variable coupon on an annual basis rather than at maturity, Bonacci noted. The exchange rate is evaluated five times through the term, on Sept. 24, 2010; Sept. 26, 2011; Sept. 24, 2012; Sept. 24 2013 and Sept. 16, 2014, according to the deal terms. "Each year, you have the opportunity to earn either 2.75% or 6%. That's five times the opportunity to earn a 6% coupon and it increases the likelihood of having an overall return above the traditional 5-year CD," Bonacci said.

"Traditionally, a lot of foreign exchange CDs pay at the end of the deal. It's been a theme this year to give investors the opportunity to get periodical income," said a market source. "We've seen it so far with equity CDs paying periodically. But it's still rather new to see it done with currencies."

Some credit risk

Among some of the risks, the preliminary term sheet points to the credit risk of the issuer, as most offerings do. In this case though, the market source said that the relatively generous terms of the SunTrust deal may reflect financing problems.

"I assume that their costs of funding must be high and that the alternatives are limited," he said.

Traders on the International Securities Exchange have purchased high volumes of puts on SunTrust Bank over the past week, reflecting pessimistic views on this name, according to Schaeffer's Investment Research, Inc. in a report published Thursday. In April, Moody's Investors Services cut the commercial banks' ratings to Baa1 from A3, citing high credit costs on SunTrust's loans.

However, as for any CDs, investors in the real-linked deal have their capital protected up to $250,000 from the FDIC.

Investors may also incur some loss of principal if they choose to redeem early.

The term sheet describes a quarterly schedule starting Sept. 15, 2010 that gives investors the option to redeem - on March 15, June 15, Sept. 15 and Dec. 15 of each year. The redemption amount will be calculated differently than the payout at maturity. It will include an early withdrawal penalty and could be less than par, according to the preliminary document. The payout at maturity will be par.

"Most of the time there is a secondary market available, so investors don't really need to put to the issuer. They just sell at market prices," said the market source. "In theory, they could get a price above par, but most likely they won't."

This offering is not suitable for investors who are not willing to seek exposure to the foreign exchange market or who do not have a bullish view on the Brazilian real against the dollar, according to the preliminary term sheet.

Bonacci said that "We are seeing some interest in foreign exchange movements and offering this idea in a CD format makes investors more comfortable exploring this asset class."

While the product may in appearance reflect an overall bearish sentiment on the dollar, said Bonacci, he said that the CD is more the expression of an emerging market view than a mere currency play. "Most folks we talk to are betting on the strength of the emerging markets as opposed to the weakness of the U.S.," he said.

The CDs will price on Sept. 24 and settle on Sept. 29. InCapital LLC is the distributor.

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