Societe Generale’s s callable CMS spread notes show high yield based on steepening bet

By Emma Trincal

New York, Aug. 22 – Societe Generale’s callable CMS spread notes due Sept. 2, 2025 linked to the 30-year Constant Maturity Swap rate and the two-year CMS rate is one of the latest examples of a growing trend in rate structuring. The steepening trade has caught the eyes of income investors and brokers alike as it offers high income potential along with full principal protection.

Investors are betting that the yield curve will steepen looking over long maturities. They get paid accordingly based on the spread between two points on the curve.

For many the so-called “teaser rate” offered on the first and sometimes also the second year is what makes the deal particularly compelling, as rates remain low enough to drive a quest for yield.

Societe Generale in its upcoming deal offers a 7% fixed interest rate for the first year, according to a term sheet.

After that, the interest rate will be 10 to 11 times the sum of the spread of the 30-year CMS rate over the two-year CMS rate plus 25 basis points. Interest will be payable quarterly.

The payout at maturity will be par plus the final coupon, if any.

Beginning a year after issuance, the notes will be callable at par on any coupon payment date.

Growing trend

“The new steepeners being issued are really attractive now that the yield curve is essentially flat,” said Jerry Verseput, president of Veripax Financial Management, who is considering this note as well as others from other issuers.

“Steepeners are selling like crazy right now. You get huge leverage. The curve is flat. Forwards look cheap.”

“We see tons of deals like that,” a rate-linked notes broker said.

Teaser appeal

Matt Rosenberg, sales trader at Halo Investing, said he is familiar with the Societe Generale deal.

“These fixed-to-floater issues are in high demand right now especially with a strong credit, those kinds of terms and the principal protection,” he said.

“How often can you get 7% on the first year?”

The fact that the issuer may call the notes after one year was not a deterrent for investors.

“At the contrary. A lot of people are actually hoping to get called on the first year. If not, they’re betting that the curve is going to steepen from where it is now. And right now, it’s pretty flat.”

High and capped

The spread between the 30-year and the two-year CMS rates is at 39 bps. Applying the formula described in the term sheet would provide investors with a 6.40% variable rate.

“That’s not far from your 7% initial coupon,” he said.

“That’s a pretty neat return and that’s with a flat curve. You could easily get the maximum coupon.”

The floating rate is subject to a cap of 8% per year.

No recession in sight

Some analysts have expressed concerns about the current flatness of the curve, pointing to the risk of an inversion, which often signals a recession.

The opposite view, which reflects an investment in fixed-to-floating steepeners, states that the economy is strong enough to move the curve the opposite way.

“The curve has been flattening because the Fed has been hiking rates. Even though they’ve done it moderately they’re on a consistent tightening trajectory,” said a bond trader.

“They’re out of their league really. They’re acting as if inflation was a threat. But it’s not.

“People are starting to realize that the curve has gotten pretty flat already and that it has no other way to go but positive because we’re growing. When the economy grows the curve steepens. It’s always been like that. We borrow short-term and lend long-term. That’s how it works.”

Easy swaps

A market participant expects to see more steepeners coming to market.

He noticed that the typical underlying will be CMS spreads.

“You don’t see steepeners on Treasury spreads that much,” he said.

The difference between CMS and Treasury spreads is not very significant however.

On Wednesday the spread between the 30-year and two-year Treasuries was 38 bps.

“I think you see CMS spreads all the time because swap products are much more retail-oriented. You can do options on Treasuries futures but it’s a little bit more involved than pricing it on swaps.

SG Americas Securities, LLC is the agent.

The notes will price on Aug. 28.

The Cusip number is 83369FB89.

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