European insurance companies and pension funds were last week snapping up multi-callable notes to boost yields in anticipation of a further round of interest rate cuts. Deutsche Bank, J.P. Morgan and Morgan Stanley Dean Witter are heavily involved in structuring and marketing the notes. Multi-callable notes are attractive in a falling interest-rate environment because they pay a juiced-up yield. In return investors run the risk that the issuer will call the bonds. "It will be a frantic year for these products as insurance companies position themselves for a low interest-rate environment," said a derivatives professional at Crédit Agricole Indosuez. An interest-rate derivatives trader at a German bank in Frankfurt estimated that volumes shot up to EUR300 million (USD285 million) in the last week from a third of that at the end of last year.
Michele Faissola, managing director and head of European over-the-counter derivatives at Deutsche Bank in London, expects to see a large increase in demand for these products continuing next week when investors return from vacation. This is part of a trend to move cash out of the volatile equity markets and into fixed income products and has been kick-started by the Fed's rate cut, he noted.
A head of interest-rate derivatives at a U.S. bank in London said a typical EUR25-50 million 15-year multi-callable note will have a 7.8% coupon in the first year and 6% coupon after that. This compares favorably to a comparable non-callable note, which likely would pay 25-30 basis points over the 15-year swap rate, which stood at 5.56% on Friday. Multi-callable zero-coupon notes are also popular.
In addition to the pickup in yield, investors like these notes because they are simple to understand in comparison to other yield enhancement products, such as constant maturity swaps.
