Make Whole Calls: What You Don’t Know CAN Hurt You
Subtle language changes to the Fed’s official statement and comments from Janet Yellen’s first press conference as Chair shifted the anticipated timing of a Fed funds rate hike to the first half of 2015. The dot chart that maps FOMC members’ interest rate predictions showed that the majority expect the first rate hike to come in 2015 and the median expectation for the funds rate at the end of next year increased to 1.00% from 0.75% at December’s meeting. So, after over five years of consistent Fed policy, 2015 may be the start of the first rising rate cycle in nearly ten years. As has been the case in the past, the coming cycle may expose vulnerable cash portfolios that weren’t properly screened for credit and structure risk or had poor price execution. After a morning reviewing offerings on our trading desk one can get an idea of what an unscreened portfolio may look like as we are passing on a majority of the securities we see even though they are eligible according to most cash investment policies. We assume these securities find another home either through direct (discretionary) placement by “no fee brokers” or through other managers. The intent of deliberately screening for not only credit, but also for structure and price, is to choose securities that will hopefully maintain strong market values and secondary liquidity throughout the holding period. Rising rate environments tend to expose poor security choices or security choices that accrue more benefit to the seller than the buyer. So, as we appear to be getting closer to an environment where the light will shine brightly on security choices, this month we wanted to take a detailed look at make whole call provisions of corporate notes. While the bonds these provisions are attached to are usually popular, highly rated credits that will not likely experience credit deterioration, there is potential for significant market value losses related to trade execution.
Best Regards,
Ben Campbell
President & CEO
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