Appetite for step-up fixed-rate notes seen as unabated amid series of recently priced or planned deals

By Emma Trincal

New York, Feb. 2 – More step-up fixed-rate notes have hit the market recently or have been announced, according to data compiled by Prospect News, and some are showing relatively attractive initial rates, sources said.

Those products, which many firms do not consider to be structured notes given that they are not linked to a particular asset, offer a fixed interest rate for an initial period, which accrues according to a pre-set schedule. The payout at maturity is par and the notes are callable.

Goldman Sachs Group, Inc. said it will price this month 10-year step-up fixed-rate notes with a 3% initial rate for the first six years. The rate will be stepping up to 3.5% in February 2021 and to 4% in February 2024. Interest is payable semiannually.

The notes will be callable at par quarterly in a year. Incapital LLC is the agent.

Asset swap volatility

“This note is swapping around 65 basis points over Libor. Compared to where Goldman is trading for, it seems like a good value versus a benchmark deal,” said a market participant.

A recent volatility increase in the one-year/10-year swap curve may explain some recently attractively priced offerings.

“Volatility has picked up on the one-year/10-year swap curve since the heart of the summer. As a result, you get more value for selling the option,” he said.

In July, the volatility was 74 bps points. It is now 83 bps, he said.

“It has gone up 15% since July. That’s probably why you get better terms. Options have more value.”

Last Tuesday, Incapital priced on the behalf of Goldman Sachs $21.75 million of 12-year callable step-up notes. The coupon was also 3% but for the first five years, then 3.5% for the next three years, 4% for the following two years and 5% for the last two years. The notes are callable after one year.

Barclays Bank plc last week priced $5 million of 15-year step-up fixed-rate notes. The interest rate was 3% for the first eight years, stepping up to 3.25% on Jan. 30, 2023, to 4% on Jan. 30, 2025 to 5% on Jan. 30, 2027 and to 6% on Jan. 30, 2029. The notes are callable after one year.

Moving parts

“We’ve seen a few of those. It’s not really unusual, but this stuff looks good with rates going down a lot,” said an industry source.

“You have to look carefully at step-ups, though. Some can give you 2% over one year, others 3% over four years.

“The frequency very often changes the entire structure of a deal. How often do you get paid more? And how soon? Sometimes they keep the lower coupon for a longer period of time,” the source said.

“I mean, you can play with these things forever. But, yes, people do like them.”

This source added that investors should not rule out the safety and yields offered by Treasuries.

“U.S. government bonds are the cheapest in the world. We have a stable economy, a strong dollar. Yields are higher than in other countries. Why wouldn’t you buy our bonds?”

The 10-year Treasury yields 1.66%. In comparison, 10-year government bonds in other countries have much lower yields, he said, pointing to Canada (1.24%) Germany (0.31%) and Japan (0.28%).

With Treasury yields decreasing however, investors are tempted to look for higher-yielding alternatives.

“Those initial fixed rates in the step-ups are going to look attractive,” he said.

“But you have to look at comparable bonds. Sometimes, it has a lot to do with the funding cost of the bank that’s issuing the paper. With those step-ups, you can’t just look at the initial period or the final coupon. You have to look at the yield to maturity.”

CIBC, TD Securities

Another recently announced deal was Canadian Imperial Bank of Commerce’s 10-year step-up notes with an initial rate of 2.25% for the first five years. The rate will step up to 2.75% in 2020, to 3.5% in 2022, to 3.75% in 2023 and to 4.75% in 2024. The notes are callable in whole beginning in 2016.

“This gives you a 2.25% for five year. That sounds good. But it’s really a 10-year note,” he said.

Canadian banks have shown more visibility in the step-up market recently.

Toronto-Dominion Bank, which made its U.S. debut in the structured products market last year, recently priced $4.04 million of 10-year callable step-up coupon notes. The interest rate will be 2% for the first three years and will step up to 2.75% in years four through six, to 3.5% in years seven and eight and to 5% in years nine and 10. The notes can be called after only three months. TD Securities (USA) LLC is the agent.

“All of these are okay. It’s not like ‘wow,’ but they’re okay,” said the industry source.

“There’s a niche, and people – retail clients – are buying. But you have to look at the interest payment periods, how long they pay for the initial rate paid, the call feature, when it can get called, the term, the yield to maturity, the credit risk. There are lots of moving parts.

“If you buy a 10-year step up with a 3% yield to maturity, you have to compare it to a 10-year bond. Even if it pays 3% for six years, it’s still a 10-year. When somebody comes to the market place, he has a choice,” he noted.

“We’ve seen for instance a Goldman 10-year CD with a 2.80% yield. It’s FDIC-insured and it has a death put. So, yes, Goldman also has a 10-year step-up that pays 3% for the first six-years. But it’s callable and you’re not protected against Goldman’s credit risk. It’s a choice.”

Other issuers that have announced or priced step-ups at the end of last month include Royal Bank of Canada, JP Morgan Chase & Co. and Credit Suisse AG, Nassau Branch, according to data compiled by Prospect News.

© 2015 Prospect News.
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