Dec. 13 (Bloomberg) -- Investors are turning to secondary markets to buy notes that pay fixed interest rates before switching over to a floating benchmark, as securities issued more than a year ago offer better terms than new issuance.
First-time sales in the U.S. of fixed-to-floating rate securities were $29.1 million in November, according to data compiled by Bloomberg. That’s less than one-eighth of the $247.1 million in notional trading volume in the month for notes that have been issued since January 2010, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Investors prefer the higher yields on older securities, even though they often pay a premium to acquire them as the Federal Reserve extends its commitment to low rates, said Jason Walsh, managing director at Wunderlich Securities Inc. in Chicago. Securities dealers buy the notes on the secondary market and sell them to financial advisers, he said.
“The secondary market has been on fire for this stuff,” Walsh said.
The increased volume of secondary trades suggests that individual investors are betting that interest rates will rise, said Deryk Rhodes, vice president of structured product trading at Incapital LLC in Boca Raton, Florida. “It’s typically been an institutional trade and it looks like more and more retail are participating.”
October trading volume was $282.2 million in face value for fixed-to-floating rate notes issued since 2010, when Bloomberg began collecting comprehensive data on structured notes registered with the U.S. Securities and Exchange Commission. That compares with $54 million of new issuance.
Two months earlier, the ratio was reversed. Banks issued $420.7 million of the securities in August, the biggest month this year, and almost four times the trading volume of $117.5 million that month.
Advisers are buying the bonds on the secondary market for their clients because more Americans are retiring and are looking for fixed-income securities that offer yields higher than inflation, Walsh said. The consumer price index, a gauge of inflation in the U.S., is at 2.2 percent.
A four-year security issued by Bank of America Corp. on April 20 was the most traded fixed-to-floating rate note last month. It returns 5.1 percent for one year, then pays 1.5 percent more than the three-month U.S. dollar London interbank offered rate until maturity, according to a prospectus filed with the SEC. Investors bought 20,000 notes in four trades on Nov. 28 at prices between 99.75 and 100.45 cents on the dollar.
The Fed anticipates it will keep its benchmark rate between zero and 0.25 percent until at least mid-2015. The central bank announced yesterday that it will purchase $45 billion in mortgage-backed securities this month as part of its quantitative easing program.
Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.
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