SunTrust's contingent coupon S&P 500-linked notes could offer higher yields in low-rate market

By Kenneth Lim

Boston, Sept. 13 - A series of contingent coupon notes linked to the S&P 500 index offers investors the potential to get better returns than they would otherwise get on a piece of straight debt, an investment adviser said.

SunTrust Banks, Inc. plans to price a series of principal-protected contingent coupon notes due Sept. 29, 2016 linked to the S&P 500.

If the underlying index closes at or above its initial level on each of five annual observation dates, investors will receive an annual coupon of 3% for the first three years and 6% for the next two years. If the index closes below its initial level on an observation date, no coupon will be paid for that year.

At maturity, investors will receive the principal amount plus an interest payment of 6% to 6.5%. The actual final payment will be set at pricing.

Yield attraction

The notes are being offered at a time when many investors are hungry for higher yields in fixed-income assets, the adviser said.

"Investors who want to put money into their fixed-income portfolios in this low-interest-rate environment are finding extremely low yields," the adviser said. "And there's an expectation that rates will stay low for quite a while."

Investors who want additional returns have to take on higher risks by buying longer-dated debt, lending money to less creditworthy issuers or buying structured products.

"There are many ways to accomplish it, but the bottom line is that if you want better yields, you have to accept higher risks," the adviser said.

The SunTrust notes offer potentially higher returns by linking the yield to the more volatile S&P 500 index, the adviser said.

"The investor is buying a floating coupon, but the coupon is pegged to the S&P 500," the adviser said.

The note can be compared against straight debt by SunTrust, which would probably yield around 2.5% for a straight two-year piece of debt and 4.8% for a piece of seven-year paper, the adviser added.

"So 3% for three years and 6% for the next three years for a piece of BBB debt is slightly better," the adviser said.

But investors could do comparatively worse if the S&P 500 does not close at or above its initial level on the observation dates.

"If you miss a coupon payment for just one year, let's say the first year, your return's only going to be 3.65%, which is probably worse than the straight bond," the adviser said. "It's quite a risk."

Equity bull

Investors must therefore be confident that the S&P 500 is going to increase over the next six years, the adviser said.

"The nice thing is it's pegged to the initial price on day one, so once it goes up you're more likely to continue getting the coupons," the adviser added, "The flip side is that once it goes down it becomes harder for you to collect the coupons."

The adviser acknowledged that investors could also potentially do better in a direct investment in the S&P 500 but said risk exposure should also be considered.

"Of course you could do better investing in equities instead of bonds, but when you just look at it that way you haven't adjusted for risk," the adviser said. "If you don't have the risk appetite for holding equities, then there's no point saying you can make more holding the S&P 500."

Time factor

Investors should also consider that they will probably have to hold on to the notes for six years, until maturity. In that time, investors could be exposed to sharp rises in interest rates and negative changes in SunTrust's creditworthiness.

"You get a coupon, so you have a bit of income, which can be good, but your principal is basically stuck in this for six years," the adviser said. "It's hard to sell these things in the secondary market."

The notes are expected to price Sept. 24.

SunTrust Robinson Humphrey, Inc. is the agent.

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