Floating Rate NotesFloating Rate Notes

PresentationPresentation

byby

King & Shaxson King & Shaxson

DefinitionDefinition

A Floating rate note (FRN) is a A Floating rate note (FRN) is a money market instrument normally money market instrument normally issued in the form of a Eurobond issued in the form of a Eurobond but with a floating/variable rate of but with a floating/variable rate of interestinterest

Basic CharacteristicsBasic Characteristics

Issuer typeIssuer type

Status of DebtStatus of Debt

MaturityMaturity

CurrencyCurrency

Fixing MechanismFixing Mechanism

ValueValue

Issuer TypeIssuer Type

BankBank

CorporateCorporate

Sovereign Sovereign

Supranational Supranational

Special Purpose Vehicle (SPV)Special Purpose Vehicle (SPV)

Status of DebtStatus of Debt

SeniorSenior

SubordinatedSubordinated

Quasi-equity (Perpetual)Quasi-equity (Perpetual)

MaturityMaturitySenior debt would typically be issued for periods Senior debt would typically be issued for periods of between 1 to 5 years although on rare occasions of between 1 to 5 years although on rare occasions there could be a 7 to 10 year issue.there could be a 7 to 10 year issue.

Subordinated debt at the LT2 level would Subordinated debt at the LT2 level would typically be issued for a minimum period of 10 to typically be issued for a minimum period of 10 to 15 years, normally with a call/step-up structure.15 years, normally with a call/step-up structure.

Longer dated UT2/T1 issues would normally be Longer dated UT2/T1 issues would normally be issued for periods from 20 years to Undated (T1) issued for periods from 20 years to Undated (T1) with a call option and possibly a step-up structure. with a call option and possibly a step-up structure. The future regulatory capital requirements of The future regulatory capital requirements of Banks are of course currently being considered by Banks are of course currently being considered by the Basle committee and expected by end 2010.the Basle committee and expected by end 2010.

CurrencyCurrency

Most issues that we follow tend to be Most issues that we follow tend to be denominated in Sterling, Euro or USD. denominated in Sterling, Euro or USD.

Floating rate notes can however these days Floating rate notes can however these days be issued in virtually any currency given the be issued in virtually any currency given the flexibility of an EMTN program.flexibility of an EMTN program.

Fixing MechanismFixing MechanismAn FRN will normally re-fix its coupon every 3 An FRN will normally re-fix its coupon every 3 months over LIBOR and over recent years has months over LIBOR and over recent years has been based over the official 11am daily fixings been based over the official 11am daily fixings of the British Bankers Association (BBA).of the British Bankers Association (BBA).

Variations could include different re-fix periodsVariations could include different re-fix periods

for example 1,6 or 12 months or maybe over a for example 1,6 or 12 months or maybe over a different basis like LIBID or LIMEAN. different basis like LIBID or LIMEAN.

Euro denominated issues will of course be Euro denominated issues will of course be

re-fixed over EURIBOR. re-fixed over EURIBOR.

ValueValue

The value of an FRN is judged by its The value of an FRN is judged by its

‘‘Discount margin’Discount margin’

The Discount Margin is basically made up of The Discount Margin is basically made up of three components :-three components :-

Re-fix spreadRe-fix spread

Straight line amortisation of discountStraight line amortisation of discount

Re-investment value of discountRe-investment value of discount

Price movementPrice movement

The price of an FRN will normally move for The price of an FRN will normally move for one of the following reasons:-one of the following reasons:-

Interest Rate fluctuationsInterest Rate fluctuations

Credit Risk changesCredit Risk changes

Supply & DemandSupply & Demand

Market depth & liquidityMarket depth & liquidity

DocumentationDocumentation

These days documentation has become These days documentation has become considerably easier with legal agreements considerably easier with legal agreements becoming more standardised and also because becoming more standardised and also because most issuers have established EMTN programs.most issuers have established EMTN programs.

Issues being raised off an EMTN program just Issues being raised off an EMTN program just require a basic term sheet to cover the specific require a basic term sheet to cover the specific details of the new issue. details of the new issue.

Individual prospectuses will only be required if Individual prospectuses will only be required if the issuer has not established its own EMTN the issuer has not established its own EMTN program.program.

SettlementSettlement

Trades are executed on a ‘trade date’ plus Trades are executed on a ‘trade date’ plus three good business days basis, with delivery three good business days basis, with delivery against payment using normally either the against payment using normally either the EUROCLEAR or CLEARSTREAM EUROCLEAR or CLEARSTREAM settlement systems.settlement systems.

USD denominated issues may sometimes USD denominated issues may sometimes have to clear through the DTC system.have to clear through the DTC system.

Capital AdequacyCapital Adequacy

Basle II became operative in January 2008 Basle II became operative in January 2008 and did not really get off the ground due to and did not really get off the ground due to the financial crisis. Commenting on capital the financial crisis. Commenting on capital adequacy weightings has as a result become adequacy weightings has as a result become difficult and Basle III (revised Basle II) is difficult and Basle III (revised Basle II) is currently being worked upon. We do however currently being worked upon. We do however only comment on weightings from a UK only comment on weightings from a UK perspective and await further guidance. perspective and await further guidance.

ContactsContacts

Mike Cocks 0207 929 8491Mike Cocks 0207 929 8491

Julia Wane 0207 929 5300Julia Wane 0207 929 5300 

DisclaimerDisclaimerGeneral Past performance is no guarantee of future performance and the value of investments and the income from them may go down as well as up and is not guaranteed. Rates of exchange may cause the value of investments to go up or down. The level of yield may be subject to fluctuation and is not guaranteed. No Offer The information contained in this presentation does not constitute an offer to buy or sell securities of any type. Nothing in this presentation should be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment or to engage in any other transaction. Furthermore, by offering information, products or services via this presentation, no solicitation is made to any person to use such information, products or services in jurisdictions where the provision of such information, products or services is prohibited by law or regulation. Products and services mentioned or described in this presentation may not be available to or suitable for you. You should consult an investment and/or tax advisor concerning your financial situation and tax obligations before making any investment decision.

No basis for decision-making All information contained in this presentation has been prepared by King & Shaxson on the basis of publicly available information, internally developed data and other sources believed to be reliable. It is for general information purposes only and should not be considered an individualised recommendation or personalised investment, tax or legal advice. The information is subject to change without notice. Reasonable care has been taken to ensure that the materials are accurate and that the opinions stated are fair and reasonable. All opinions and estimates constitute our judgement as of the date of publication and do not constitute general or specific investment advice. All numbers are unaudited unless otherwise stated. Furthermore, please note that King & Shaxson and/or its affiliates and employees may have interests or positions in relevant securities or may have a relationship with the issuers.  

Risk Warning: 

Dealing in bonds may involve the following specific risks: 

Insolvency risk - the issuer risks becoming temporarily or permanently insolvent, resulting in its incapacity to repay the interest or to redeem the bond. The solvency of an issuer may change according to the issuing company, the issuer’s economic sector and/or the countries concerned, as well as political developments with economic consequences. The deterioration of the issuer’s solvency will influence the price of the securities that it issues and of any existing securities already in issue.

Interest rate risk - uncertainty concerning interest rate movements means that purchases of fixed-rate securities carry the risk of fall in the prices of the securities if interest rates rise, the longer the duration of the security (ie: loan by the entity concerned) and the lower the interest rate, the higher a bond’s sensitivity to a rise in market rates.  Credit risk - the value of a bond will fall in the event of a default or reduced credit rating of the issuer. Generally, the higher the rate of interest, the higher the perceived credit risk of the issuer. Early redemption risk - the issuer of a bond may include a provision allowing early redemption of the bond if market interest rates fall. Such early redemption may result in a change to the expected yield.  Risks specific to bonds redeemable by early drawing have a maturity which is difficult to determine, so unexpected changes in the yield on these bonds may occur. Risks specific to certain types of bonds - additional risks may be associated with certain types of bonds, for example, floating rate notes, reverse floating rate notes, zero coupon bonds, foreign currency bonds, convertible bonds, indexed bonds, and subordinated bonds. For such bonds, you are advised to make inquiries about the risks referred to in the issuance prospectus and not to purchase such securities before being certain that all risks are fully understood. In the case of subordinated bonds, you are advised to enquire about the ranking of the debenture compared to the issuer’s other securities. Indeed, if the issuer becomes bankrupt, those bonds will only be redeemed after payment of all higher ranked creditors. In the case of reverse convertible notes, there is a risk, that you will not be entirely reimbursed, but will receive only an amount equivalent to the underlying securities at maturity. 

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