SunTrust with leveraged notes tied to the Dow re-enters structured notes market; BofA is agent

By Emma Trincal

New York, May 15 – SunTrust Banks, Inc.’s announcement of 0% Leveraged Index Return Notes due May 2023 linked to the Dow Jones industrial average comes as a double surprise.

First surprise: SunTrust Banks, Inc is a lesser-known and dormant issuer of structured notes. Second: BofA Merrill Lynch will be the agent in what appears to be its first deal with this issuer, sources noted.

SunTrust Banks

SunTrust Banks, Inc., a holding company based in Atlanta, has shown a limited number and notional size of structured notes, according to data compiled by Prospect News, which tracks all structured notes registered with the Securities and Exchange Commission.

In contrast, this financial institution’s largest subsidiary, SunTrust Bank (with no “s”) is well-known as an issuer of certificates of deposit.

Small track record

SunTrust Banks has only issued five structured notes deals for a total of $15.85 million, according to data compiled by Prospect News since January 2004. Those five deals priced in a tight one-year span between Oct. 26, 2010 and Oct. 26, 2011, the data showed.

The notes at the time offered principal protection against market risk. They were distributed by SunTrust Robinson Humphrey Inc., an affiliate of the issuer, according to the data.

BofA distribution

Now BofA Merrill Lynch is the agent and the notes are principal-at-risk in nature, which suggests a new approach.

“When I think of SunTrust I think of them more as a CD name than anything else,” said a market participant.

He noted that BofA Merrill Lynch has expanded its platform using more issuers, for instance, tapping into Canadian issuers’ credits.

“It’s going to be distributed internally within Merrill network. I’m not sure who in their platform increasingly needs new names but they’re definitely looking for name diversification,” he said.

SunTrust Banks has a BBB+ rating from S&P Global Ratings.

“It’s investment-grade but not great investment-grade,” he said.

“I guess the diversification factor is the main driver.”

The structure of the notes is relatively simple.

The payout at maturity will be par plus 101% to 121% of any index gain, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will be exposed to any losses beyond 20%.

Tough to commit

The most unusual term of an otherwise plain-vanilla structure was the 1.01 to 1.21 times range for the leveraged upside exposure, sources said.

“I have never seen in a structured note that kind of a range,” said Jerry Verseput, president of Veripax Financial Management.

“I’m used to seeing ranges with 4 percentage points, maybe 5 percentage points...but 20?”

He said the “wide range” would make it difficult to buy the notes. He explained why.

“Usually you place your order and you know the final terms at the end of the trading day. But once my custodian receives the order, they’re up and running. They expect delivery,” he said.

“Now maybe if they have a big enough order they will pre-hedge and commit to a guaranteed leverage factor but that’s provided they have a large enough order.”

The broad multiple range was all the more problematic for Verseput in that he relies on leverage for managing his portfolio.

“We like the leverage so we don’t have to commit as much in assets. It’s a form of protection. If the market does well, you make money. If it doesn’t, you don’t lose as much.

“But again it’s one thing to have 1.2x, it’s another to have virtually one-to-one.

“My only gripe with this note is the uncertainty around the leverage. I don’t know what note I’m buying,” he said.

Hard sale

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, said he did not like the leverage terms either.

“I have never seen such a broad range. You get either zero leverage or 20% leverage. We would never commit before knowing the details. That’s a no-starter,” he said.

The market participant said that he was also “a little bit surprised” that the leverage range was 20 points wide.

“Usually it’s a tighter range than that. You really don’t have a sense of what your leverage is going to be.”

He suggested that selling the notes may be more of a challenge for the agent given that uncertainty.

“If they don’t get critical mass they won’t print it.

“If the numbers don’t work out on the trade date, the deal doesn’t get done,” he said.

Buffer, index

Verseput however was positive about one aspect of the deal.

“I really like the 20% buffer. As an adviser if your goal is to beat the market you know that on the downside you’re going to beat the market by at least 20%,” he said.

He was less satisfied with the underlying.

“The Dow is a ridiculous index. It’s 30 stocks only and it’s price-weighted. Boeing is at $342 and Apple at $186. Boeing will be more heavily weighted than Apple even though Apple’s market cap is so much bigger. It doesn’t make any sense,” he said.

Statements

Verseput said he was not familiar with SunTrust Bank as an issuer of structured notes.

One factor would make him hesitant to do business with a new name, citing the pricing discount on clients’ statements.

“I have a history with Goldman Sachs, HSBC, Barclays, SocGen, Morgan Stanley. I know what to expect on their pricing. Clients react strongly when they see discounted prices on their statements. It’s something I have to deal with from an emotional standpoint,” he explained.

Custodians have to give an estimate of the price of a structured note for the advisor’s clients. But prices vary on the statements from an issuer to another without necessarily reflecting differences in creditworthiness, he explained.

“Because I’m not familiar with this issuer I don’t know what kind of pricing will show up on the statements.

“I’m not saying there’s anything wrong with this particular issuer. I’m just not familiar with them.

“So, I would probably not try a new one for that reason,” he said.

Foldes brought up the issue of creditworthiness, saying that he would have to do more due diligence because he was not familiar with SunTrust’s credit.

Term, no cap

Regarding the structure, Foldes’ first objection was the length of the investment.

“Five-year is too long. That’s a problem for us. We prefer notes under three years.”

The unlimited upside on the other hand was a plus.

“We like having no cap. It’s very important for us,” he said.

Dividends, buffer

Aside from the vagueness of the description of the leverage amount in the prospectus, Foldes took issue at the amount, stressing that he would not consider anything below the higher end of the range.

That’s because of the dividends: investors must forego a 2% annual dividend yield over a five-year period, he noted.

“Dividends for us are a hurdle rate to overcome. That’s why it’s necessary to get enough leverage,” he said.

The buffer was not seen as a benefit but as a cost.

“On a five-year note, we don’t need a 20% buffer. In fact, we don’t need a buffer at all. The likelihood of the market being down over a five-year period is pretty remote,” he said.

“Having a higher participation rate would be much more important to us.”

The notes will price in May and settle in June.

The fee is 2.5%.

© 2015 Prospect News.
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