Citigroup’s $4.36 million leveraged CMS spread, S&P notes offer high teaser rate

By Emma Trincal

New York, June 27 – Citigroup Inc.’s $4.36 million of callable fixed-to-floating-rate leveraged CMS spread range accrual notes due June 27, 2034 contingent on the S&P 500 index caught some market participants’ attention for the size of its first-year coupon at 13%.

The notes included an equity component with a range accrual based on the S&P 500 index.

After paying the fixed 13% coupon for the first year, the notes pay investors a variable coupon of four times the spread of the 30-year Constant Maturity Swap rate over the two-year CMS rate minus 25 basis points multiplied by the proportion of days on which the index’s closing level is greater than or equal to 70% of the initial index level, according to a 424B2 filing with the Securities and Exchange Commission The interest rate is subject to a floor of zero and a cap of 13% per year. Interest is payable quarterly.

The notes are callable after one year, beginning June 27, 2015.

The payout at maturity is par.

Fat rate

“It’s a fat 13% coupon, definitely an eye-catching rate for both brokers and investors,” a sellsider said.

“It’s a bet on a steeper curve. But if the Fed raises rates on the short end of the curve, you can say goodbye to 13%. It’s going to drop a lot potentially even with the leverage.

“This is sure to get people’s attention because of the big coupon. But that’s just for one year,”

One factor that helps boost the coupon is the range accrual feature, he said.

“We don’t see that many CMS range accrual deals. It’s mostly pure rate. Only a few banks do them because the hedging of it can kill your books.”

The banks involved the most in the structuring of CMS spread range accrual notes are Goldman, Citigroup, Morgan Stanley and Société Générale, he said.

Recent deals

The 13% coupon is the highest seen among all types of CMS spread deals recently, according to data compiled by Prospect News.

Earlier this month Morgan Stanley priced a $15 million offering of fixed-to-floating leveraged CMS curve and S&P 500 index-linked notes due June 30, 2034.

The first-year coupon is 11%. After that, it is five times the spread of the 30-year CMS rate over the two-year multiplied by the proportion of days on which the index closes at or above the 50% barrier level, subject to an 11% maximum coupon.

But unlike the Citigroup structure, which offers full principal protection, the Morgan Stanley notes put investors’ capital at risk.

If the index finishes at or above the 50% barrier level, the payout at maturity will be par. Otherwise, investors are fully exposed to losses, according to the prospectus.

30-five spread

The type of spread used in the structure is also a key factor in pricing, the sellsider said.

The use of the 30-year CMS rate/two-year CMS rate spread will give a wider spread (2.90% today) than the 30-year CMS rate minus the five-year CMS rate, which is currently approximately 1.73% based on Treasury rates.

In mid-June, Citigroup priced another deal notable for its size as well as for the leverage applied to the spread. This offering was $50 million of leveraged callable CMS curve-linked notes due June 18, 2034 linked to the 30-year CMS rate and the five-year CMS rate. The first year coupon was “normal” according to the sellsider at 10%. But the nine times leverage factor was less ordinary. Morgan Stanley was the dealer.

“Citi has good funding rates at the moment,” the sellsider said.

“A series of factors come into play when you price those deals. The spread you use, the maturity. Maturity is usually 10 to 15 year. Your typical coupon on the first year is 9% to 10%. Most of those deals are pure CMS. The equity component isn’t that common. But with the range accrual, you can price a much higher coupon because that’s two conditions instead of one.”

Citi’s latest notes (Cusip: 1730T0T58) priced on June 24.

The underwriter was Citigroup Global Markets Inc.

The fee was 5%.

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