Blog

Tax Advice Santa Rosa – THE TREASURY PLAN TO ISSUE FLOATING RATE NOTES

//
Posted By
/
Comment0
/
Categories

What are FRNs, and why is the government moving to offer them?

Floating rate notes are nothing new – Fannie Mae and Freddie Mac have issued them for years, along with foreign banks and some corporations. What is new is the U.S. Treasury’s move to offer these bonds. It plans to do so by Q1 2014.

As the term implies, the yield on a floating rate note adjusts with movements of a benchmark interest rate. Since many types of Treasury bonds have fixed interest payments until maturity, this makes a Treasury-issued FRN an attractive prospect. In their absence, investors are buying fixed-rate Treasuries and using the swaps market to convert them into floating-rate debt.

Interest in FRNs has grown, and so corporations have started to offer or resumed offering them. However, many of these companies have dividends with greater yields, and corporate floaters have no federal guarantee behind them.

If the Treasury joins the ranks of FRN issuers, it will risk having to have to pay bond investors more if interest rates rise. In its estimation, that risk is apparently worth taking.

What will the Treasury use as the benchmark for its FRNs? The LIBOR rate is definitely out, according to MarketWatch. Minutes from a Treasury Borrowing Advisory Committee meeting released in February mentioned an industry preference for using repo rates, which arise from bank repurchase agreements. Others liked using the 3-month T-bill as the base index.

Overseas issuers commonly base yields for FRNs on the LIBOR rate. The yield is often expressed as “LIBOR + 0.50%”, “LIBOR + 0.25%”, and so on – so if the LIBOR rate is 0.75%, the yield of such a note would therefore be 1.25% or 1.00% after three months.

Yields on Treasury FRNs would be expressed similarly, just on a different base. Coupons on FRNs may be reset daily, monthly, quarterly or yearly; most FRNs have maturities of 10 years or less.

Hunters of high-quality short-term assets could snap up Treasury floaters. Besides indiscernible default risk and the lure of increasing yield, they would offer a nice alternative for investors tired of transaction costs linked to rolling over short-term debt instruments.

A Treasury FRN would be the first new government debt security offered since TIPS were introduced in 1997. With the bond bull market seemingly over and the 10-year TIPS yield firmly in the red, they could end up in more than a few portfolios.

Your personal financial consultant – Monty

(707) 576-8700