EXTRA CREDIT: SEC Rule Change Makes Putables More Popular

By Anusha Shrivastava A DOW JONES NEWSWIRES COLUMN NEW YORK (Dow Jones)--A recent rule change by the Securities and Exchange Commission has led to the resurgence of a debt instrument called step-up certificates of deposit, or putables. Nearly $15 billion of step-up putables--loans that mature in six months to one year, but can be terminated, or put, in as little as seven days--have been written in the past two weeks. European banks have been the biggest users of putables, using them to address investors' concerns about euro-zone debt levels by giving them a way to cut short their loans if they are spooked by news from the region. At the same time, putables let banks borrow for less than they would pay in their traditional source of short-term borrowing, the commercial paper market. The put option also allows institutional investors, mainly money-market funds, to meet new SEC rules designed to maintain liquidity in the credit markets. The agency has said at least 30% of all money-market fund assets must be in cash, Treasurys or other specified government securities with remaining maturities of 60 days or less, or securities that convert to cash within one week. During the recent credit crisis, investors rushed to redeem their money fund holdings, forcing them to sell relatively illiquid assets at steep discounts and worsening the squeeze on the system. "Money fund investors need to buy paper that matures in seven days or less, and these putables offer them better value and a steadily increasing coupon the longer they hold it," said Chris Conetta, managing director and head of global short-term credit trading at Barclays Capital in New York. While putables allow investors to get their money back on relatively short notice--each deal comes with a schedule of dates when they can do so--they are designed to encourage investors to hold the debt to its final maturity by increasing, or "stepping up," the interest rate every month. "This is a structure we like and find useful for our prime funds," said Deborah Cunningham, chief investment officer at Federated Investors in Pittsburgh who has bought putables from European banks. She added that Federated was "comfortable" with its credit assessment of banks, but appreciated the opportunity to get its money back if some unforeseen problems arise. Investors have recently had to deal with concerns about high and rising debts of Greece and other countries in Europe, whether the countries will be able to repay their debt and how a default would affect European banks that own much of those governments' bonds. Putables are an alternative to commercial paper, another type of short-term debt. Putables have the advantage of not involving the transaction cost of renewing, or rolling over, debt every seven days as would be the case in commercial paper, Cunningham said. On June 9, the New York branch of Intesa Sanpaolo SpA (ISNPY, ISP.MI), issued a one-year $1.6 billion certificate of deposit that gives investors the option of getting their money back with seven days' notice, according to Moody's Investors Service. Investors who don't exercise the option will receive interest payments that rise by at least 5 basis points, or 0.05 percentage point, each month. Other issuers include Spanish bank Banco Bilbao Vizcaya Argentaria SA (BBVA, BBVA.MC) with $3.717 billion in putables, and two French banks, Natixis (NTXFY, KN.FR) with $3.5 billion and BNP Paribas SA(BNP.FR, BNPQY) with $2.2 billion. "We decided to issue putables in response to our customers changing needs," said Adam Miller, U.S. treasurer of BNP Paribas. "The new SEC regulations have imposed new constraints on money-market funds, to which BNP Paribas has tried to answer constructively." The bank will issue more such putables, he said, adding its first issue was "well received," leading it to believe it "matches" with investor demands. While step-up putable CDs marry the needs of issuers and money-market funds, some analysts point out drawbacks, including problems in pricing and liquidity, the very qualities that seem to have made them popular. "While the step-up induces them to stay, it may be difficult to price these bonds," said Kathryn Kerle, senior vice president at Moody's Global Managed Investments Group, "and if something is tricky to price, it is difficult to sell." Borrowers also could face a liquidity problem because they cannot be sure when or if investors will ask for their money back: They could ask at inconvenient times for the banks, or all at once. Another problem is that of logistics, especially for small investors, said Kerle, who recently wrote a report on the market. "Investors also have to keep track of when they can exercise the put, and this could be an operational problem," she said. Still, she added, more putable step-up CDs are coming "because money-market funds don't have many attractive options." (Anusha Shrivastava covers asset-backed securities and commercial paper for Dow Jones Newswires.) (TALK BACK: We invite readers to send us comments on this or other financial news topics. Please email us at TalkbackAmericas@dowjones.com. Readers should include their full names, work or home addresses and telephone numbers for verification purposes. We reserve the right to edit and publish your comments along with your name; we reserve the right not to publish reader comments.) (END) Dow Jones Newswires June 24, 2010 13:44 ET (17:44 GMT)