Interest rate products gain in demand; Lehman prices $750 million of exchange-traded notes

By Kenneth Lim

Boston, Feb. 14 - Products linked to interest rates are becoming more popular as investors seek better yields amid higher volatility, said Keith Styrcula, chairman of the Structured Products Association.

"It's basically a search for yield," Styrcula said. "In a low interest rate environment, you have an opportunity to be a bit creative with your investments."

Meanwhile, Lehman Brothers Holdings Inc. got busy after markets closed with $750 million worth of Opta exchange-traded notes linked to commodity and private equity indexes.

Rates yield interest

Interest rate-linked offerings have seen better demand recently as a low interest rate environment spur investors to seek better returns, Styrcula said.

"Given the volatility of interest rates, especially when there's downward pressure on rates, you'll see interest in products linked to interest rates," Styrcula said.

Among recent deals, Morgan Stanley on Thursday priced an additional $5 million of constant maturity swap (CMS) curve linked accrual notes due Feb. 22, 2023. The add-on brings the total offering to $15 million. The notes initially priced Feb. 6 at $5 million.

Until Feb. 22, 2011, the notes will bear interest at 7.5% per year. From then on, the interest rate will be 7.5% per year times the proportion of days on which the spread of the 30-year CMS rate over the two-year CMS rate is at least 0%. The notes are callable at par on any interest payment date beginning on Feb. 22, 2011.

Lehman Brothers also upsized by $1 million its non-inversion notes due Feb. 25, 2028 that are non-callable for one year. The total offering is now worth $19 million. The notes originally priced Jan. 30 at $7.5 million.

Interest is payable monthly. During each interest period, the 10% coupon will be multiplied by the proportion of days on which the spread of the 30-year CMS rate over the two-year CMS rate is greater than or equal to 0.1%. The notes are callable beginning Feb. 25, 2009.

"Investors could be interested in range-bound range notes that play off of taking a market view of whether interest rates will be trading within a range or not," Styrcula said. "And because interest rates are so low and there's increased volatility in some of these AA rated names, it gives you potentially something better than money markets. These are interesting times for interest rate notes."

Styrcula said interest rate-linked products usually fall under two categories.

"I'd say there are two popular structures," he said. "Typically a barrier note, which is usually an all-or-nothing. At JPMorgan, for example, how much you get depends on if it it's a barrier of around 10%, for example. The other type is the classic range note, which has a thousand bells and whistles."

Lehman prices $750 million of Optas

Lehman Brothers priced three series of 0% Opta Exchange-Traded notes late Thursday, each series set at $250 million.

The first series comprises notes due Feb. 25, 2038 linked to the Lehman Brothers Commodity Index Pure Beta Agriculture Total Return, a rules-based total return index that tracks the exchange-traded futures of corn, soybean meal, soybean oil, soybeans, wheat, coffee, cotton and sugar.

The payout at maturity will be par times the index factor on the valuation date times the fee factor. The annual investor fee is 85 basis points.

The second series consists of notes due Feb. 25, 2038 linked to the Lehman Brothers Commodity Index Pure Beta Total Return, a rules-based total return index that tracks the exchange-traded futures of 20 commodities.

Payout at maturity is calculated the same way as the first series. The annual investor fee is also 85 bps.

The third series is made up of notes due Feb. 25, 2038 linked to the S&P Listed Private Equity Index Net Return, which tracks the stocks of 30 leading listed private equity companies.

The payout at maturity is calculated in similar fashion to the other two offerings. The annual investor fee is set at 75 bps.

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