The Alice-in-Wonderland Consequences of QE

Own some floating-rate notes? Read the documentation.

Even the Mad Hatter didn't predict negative rates.

Photo by Rischgitz/Getty Images

We've all become comfortably numb to some of the wackier side effects of the global quantitative easing experiment. Charging euro depositors for keeping money in their current accounts? Commonplace. Paying European governments for the right to safeguard cash in their bonds? Old hat. But handing over money to a company every three months for the privilege of lending to it?  

Less Than Zero

On Jan. 20, the interest rate on 1 billion euros ($1.08 billion) of floating-rate notes sold to investors by BMW in April is scheduled to reset. The notes, which expire in 2018, pay investors 20 basis points more than whatever banks are charging each other to borrow euros for three months. So bondholders got 0.202 percent from their first April interest payment, then 0.181 percent in July, then 0.149 percent in October.

In the current crazy world though, that reference rate (known as Euribor) is now so far below zero that it threatens to drag the interest rate on BMW's bonds into negative territory:

BMW versus Euribor

In the past year, Euribor has dropped by a bit more than 20 basis points. A decline of just seven-hundredths of a percentage point more -- which is the same pace as we've seen in the past nine weeks -- and BMW would have the right to ask its creditors to pay it money.

It probably won't happen by the time of next week's January reset. But BMW has at least four other floating-rate notes outstanding, including 300 million euros that will reset on Feb. 15 with a negative rate if Euribor declines by just five-hundredths of a percentage point in the coming month.

Lest you think I'm picking on the German automaker, a search on my Bloomberg terminal for FRNs paying less than 0.14% produces more than 2,000 securities, mostly issued by banks. But there's a twist. Many issuers include a "minimum interest rate" clause in their bond documentation specifying zero as the floor. BMW, though, failed to tick that box or specify a rate. Here, for example, is the relevant section from the notes that reset next month:

BMW No Min Rate
Source: Bloomberg

I confess that I haven't read the legal papers for all 2,000 securities. But for the one that stood out -- 750 million euros of notes sold by Unilever that pay 18 basis points more than Libor -- I checked in with the company, which said it has indeed specified a minimum rate of zero in the documentation.

For its part, BMW confirmed that it hasn't set a minimum rate on its notes, but says it won't be asking bondholders for money even if the rates drop below zero.

At this point, dear reader, you may feel I've led you down a garden path to a non-story. But consider those other 2,000-odd notes out there. Who can say how many are also missing a specified minimum rate? And can you be sure that the issuer won't enforce a negative rate? I know if I owned any of those notes, I'd be spending the rest of the week carefully reading the legal documentation -- and perhaps putting a quiet call into the issuer's treasury department.

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    Mark Gilbert at

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