Banks and credit card specialists are energizing the sleepy market for credit card securities by using derivatives.
In recent days, investment banks have been tacking on interest rate swaps to fixed-rate securities issued by such companies as Citicorp, Chase Manhattan Corp., First USA Inc., and MBNA Corp.
The swaps let investors get the fixed-rate securities they crave in these times of diminishing bonds yields, while at the same time providing banks with the floating rate of funding they prefer.
Analysts say the swaps also permit investors to capture some additional yield, which helps make the enhanced securities all the more attractive.
These financial engineering moves have invigorated the asset-backed market during the normally somnolent late-summer stretch. Indeed, investors snapped up some $5 billion worth of swap-enhanced securities Tuesday.
Swap-enhanced securities behave like this:
Suppose a bank's floating-rate credit card securities trade at 15 basis points over the London interbank offered rate. The spread on interest rate swaps, in which a floating rate of interest is exchanged for fixed, is 30 basis points over U.S. Treasuries.
By adding the swap to the security and adding the extra yield, investors can receive yields of up to 43 basis points, said UBS Securities analyst Jeffrey P. Salmon.
Suddenly a plain-vanilla, low-yielding credit card security is a much more attractive package.
Hence, the sudden investor interest, not to mention flood of issuance, in what so far this year had been an unexpectedly quiet market.
Still, the conditions that have created such demand are unlikely to last, Mr. Salmon said.
First, interest rate swap spreads change, and when they do they may not add enough in yield to make them worth the bother.
And second, many institutional investors will buy only a limited number of swap-enhanced securities, because they are less liquid. In other words, in order to sell them on the secondary market, investors must persuade someone to buy the swap before they can sell the asset-backed security.
What puzzles some analysts is that the rush of investors into swap- enhanced securities has not yet driven down yields yet to levels that make the securities unattractive.
"We'll have to see how long this arbitrage opportunity lasts," Mr. Salmon said. "It's happened before, but only for a few days at a time. This has gone on over a week. I'm kind of surprised that it's lasted as long as it has."
In another effort to enhance investor interest in asset-backeds, investment banks have started attaching some pretty exotic derivatives to some deals.
Last week Chrysler Financial Corp. issued securities backed by dealer floor plans that included an index amortizing note, a kind of mortgage- backed derivative.
Although these complex instruments offer attractive yields, Goldman, Sachs & Co. analyst Anthony Thompson warns they are not suitable for ordinary asset-backed investors.
"These securities contain a prepayment risk that asset-backed investors must pay particular attention to," Mr. Thompson said. "It's not a risk they're used to seeing."
