JPMorgan’s $4 million range accrual floaters linked to CMS rates offer higher participation

By Emma Trincal

New York, Sept. 2 – With its $4 million of range accrual floating-rate notes due Aug. 29, 2024 linked to the 30-year Constant Maturity Swap rate, the 10-year CMS rate and the two-year CMS rate, JPMorgan Chase & Co. allows for 100% participation in the reference rate by introducing the range accrual provision, sources said.

The interest rate is equal to the 10-year CMS rate, subject to a minimum of zero and a maximum of 6.5% per year, multiplied by the proportion of days on which the spread of the 30-year CMS rate over the two-year CMS rate is greater than or equal to zero. Interest is payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par.

Inserting a range accrual provision into a CMS floater is not the standard way to structure these deals, although it has been seen before, sources said.

“This is not too uncommon,” a market participant said.

“The note pays the 10-year CMS rate multiplied by a day count ratio, which is basically a strip of digital contingency – in or out. If the 30-year [CMS rate] minus the two-year CMS [rate] is positive, it’s ‘in.’ Otherwise, it’s ‘out.’

“The maturity of the note itself is 10 years. The investor is betting that the 10-year CMS will stay high or go higher and that the yield curve – the 30 minus two-year spread – will stay positive.”

Fixed multiplier

The most common CMS floater deal tends to have a fixed multiplier of less than one.

As an example of one of the most recent 10-year CMS floaters, Wells Fargo & Co. priced $9.19 million of floating-rate notes due July 30, 2024 linked to the 10-year CMS rate on July 25, according to a 424B2 filing with the SEC.

Interest is paid quarterly at an annualized rate of 0.765 times the 10-year CMS rate.

The payout at maturity will be par.

Wells Fargo Securities, LLC was the agent.

In this more common structure, investors get a participation rate of less than 100%, but they also have a minimum rate, which in the Wells Fargo deal is 2%.

“The accrual is basically a contingency, so if the contingency is met every day – meaning every day, the spread of 30-year CMS minus two-year CMS is positive – then you get the whole 100% of the 10-year CMS rate per annum paid on the principal for that interest period. If the contingency is only met 70% of the time, then it is like having a multiplier of 0.70. This is not good or bad; it’s just what the pricing requires,” the market participant said.

“This is basically a variable multiplier, as opposed to a fixed multiplier. If the contingency is met only 70% of the time, the multiplier ends up being 0.70. If the contingency is met only 30% of the time, then the multiplier ends up being 0.30.”

Getting more

A sellsider agreed that the structure is not really new and that JPMorgan probably built the deal that way in order to present a more enticing return.

“It’s not extremely unique. I’ve seen it before,” this sellsider said.

“It’s a way of getting 100% of the 10-year CMS. CMS spreads are very tight right now. If you want to get 100% of the rate, you would be looking at an extremely low cap, which is counterintuitive, or the range accrual. “Without the range accrual here, you might have a 4.5% cap instead of 6.5%.”

Whether investors use the floater with or without the range accrual provision, they have to have the conviction that rates will rise, he said.

“The range accrual component goes in the same direction; if you believe that rates are going to go higher, you have exposure to the steepness. If the curve is flat, it’s not going to take away the trade because the CMS floater wouldn’t do well anyway if the curve was flat,” he said.

“But if the curve is steep, you get a higher coupon, and that’s the investor’s view behind these types of products. The client believes the rates will go higher, and if rates go up, the curve should be steeper.

“In a regular CMS floater, you usually get 80% or 85% of the rates. By adding the range accrual, you’re getting 15% more in participation, so you can go from 85% to 100%.

“When the client buys a CMS floater, it’s because they believe that the curve will stay steep or be steeper. This trade is just the expression of that that view. They agree to have the range accrual because they want a higher coupon.”

The risk introduced by the range accrual provision is to see the accrual rate decline, or the number of days on which the accrual conditions are met decrease, which would lead to a lower interest rate.

“If they’re right, if the curve is positively sloping, they’ll be rewarded for the added risk by getting 100% of the rate,” he said.

The notes (Cusip: 48127DNQ7) priced on Aug. 26.

J.P. Morgan Securities LLC was the agent.

The fee was 1.55%.

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