Bloomberg News

Operation Twist Slows Sales of Structured Notes Tied to Rates

June 14, 2012

Sales of U.S. structured notes that gain when the gap grows between short- and long-term interest rates have fallen by 82 percent after the Federal Reserve decided last year to drive down longer rates.

Issuance of the securities dropped to $99.2 million over the last nine months, compared with $571.1 million in the same period a year earlier, according to data compiled by Bloomberg. The notes are often called “steepeners” because they rise if the difference between long- and short-term rates increases.

“I’m not going to buy a steepener now if I know with reasonable certainty that nothing is going to happen to rates in the next year,” said Guus Oonincx, founder of G.O. Capital Markets Consulting Services LLC and a former managing director at ING Financial Group. “There’s more hunger for looking for other sources of yield than interest rates. Interest rates are just dead.”

The Fed said Sept. 21 it would seek to improve “broader financial conditions” by buying $400 billion of bonds with maturities of six to 30 years through June, while selling an equal amount of debt maturing in three years or less. The move has been dubbed Operation Twist by economists and analysts because policy makers are attempting to twist the yield curve by reducing longer rates, which are normally higher than short- term.

Falling Spread

Since the announcement, the spread, or the difference between yields on two-year and 30-year rates has fallen 43 basis points to 185, Bloomberg data show. Yields on 30-year bonds fell to as low as 2.5089 percent on June 1, a record according to Federal Reserve figures beginning in 1953. Steepeners are often tied to constant-maturity swap rates, benchmarks that measure the cost of exchanging floating and fixed interest payments through the swaps market.

Bank of America Corp. issued $25 million of 20-year notes May 1 in the largest steepener offering since the Fed decision. The securities yield 11.25 percent for the first year, then switch to four times the difference between the 30- and 2-year rates, capped at 11.25 percent, according to a prospectus filed with the Securities and Exchange Commission. The second-largest bank by assets has issued the most of the securities this year at $50.1 million, Bloomberg data show.

Broadly, sales of U.S. structured notes linked to interest rates have declined 29 percent to $2.89 billion in the first five months of 2012, compared with a year earlier, Bloomberg data show. General Electric Co. has issued the largest deals this year with four offerings each of $100 million, according to prospectuses filed with the SEC. Those notes, called step-up callables, yield a fixed interest rate that periodically increases unless they’re redeemed early.

Structured notes are securities created by banks, which package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net;

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net;


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