Interest Rate-Tied Structured Notes May be a Good Play on Rising Yields in 2017

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I have written many articles on structured notes on this website over the past several years and fielded a lot of questions from readers of the site about these notes.  These types of investments are not FDIC insured and ordinarily require a brokerage account with an investment bank like Morgan Stanley or Merrill Lynch to access.  Hence, they are not for everyone.  In fact, even for the most aggressive depositors and investors, they should only make up a small part of your portfolio.   But, against the indisputable backdrop of rising yields and a steepening yield curve in 2017, it is a good time to take another look at these types of notes.

The interest rate-tied structured notes that are most prevalent are ordinarily tied to US Constant Maturity Swap Rates.  The prospectus underlying these notes will always identify Reuters Screen ISDAFIX1 Page as the governing measurement, but the rates can be estimated by looking at the Constant Maturity Swap (CMS) rates at the bottom of this Federal Reserve webpage; the 2-year, 5-year, 10-year or 30-year swap is the difference between those CMS rates and the 6-month rate.

Interest rate-tied structured notes come in many different forms.  For example, banks can issue notes that are tied to the 3-month CMS or LIBOR that have a cap and a floor (i.e., trade between, say, 3% and 10%).  Just a few years ago, they issued notes that paid a fixed rate as high as 8% so long as the 6-month LIBOR stayed between 0 and 6%.   However, since the long end is likely to rise much faster than the short end of the yield curve, investors and depositors should look predominantly at two categories in 2017: those that are based directly on the 10 year CMS swap rate and those that are based on a spread between a short swap rate (either 2-year or 5-year) and the 30-year CMS swap rate times a certain multiplier (usually 4x or 5x for the 2-year CMS-based notes, and as high as 8x or 9x on the 5-year CMS-based ones).   There is always a second condition that notes will not pay interest for those days where an equity indices (usually the S&P 500 or Russell 2000) falls below a barrier level.  The barrier level is ordinarily 75% of where the index is trading on the day the notes are priced.   These notes ordinarily have a capped maximum interest rate that they can pay (between 9 and 12%) and often guarantee payment of that interest rate for the first year.  These notes are usually very long term in duration and are sometimes callable after the first year.

In a rising interest rate environment, these notes are likely to produce strong interest as determined at each reset date.   For example, those notes that are geared to the 2-30 CMS spread could easily get to their maximum capped interest rate as the spread gets to (and assuming it stays above) around 2%.  An interest rate around 8% to 10% will probably be a nice interest rate to make over the next few years as rates rise, especially as those in bonds begin to lose money quickly.   (Likewise, however, if we were to see an inverted yield curve, even one with much higher yields across the board, these spread notes could, in fact, yield nothing).

In addition to the interest rate risk, these interest-rate structured investments are not without other real risks.   We define three main risks, although there are many more.

First, there is credit risk.  These notes are tied to the debt of the issuing banks and are not FDIC insured.  While Morgan Stanley, Chase or Citibank are pretty good credit risks, so too was Lehman Brothers as we entered 2008.   Natixis, BNP Paribas, Societe Generale, Deutsche Bank and Credit Suisse are also big issuers, and while their notes can now be acquired at a discount, you should not be a purchaser of these notes at the moment unless you recognize and understand the credit risk that you are assuming.

Second, you have liquidity risk.  These notes extend out for very long periods of time, and if you (or your estate) need to get out of them, you are going to get hosed.  You can often benefit, however, from the hosing of others by buying notes through your broker on the secondary market.   Under any circumstance, you should recognize that you are never likely to be liquid quickly, and even if the interest rate play that you want to make materializes and your notes are callable, you could still be holding the notes in some distant interest rate environment that you cannot really foresee at the moment.  

Third, you have a risk of phantom income in the form of Original Issue Discount (OID) that your broker will be required to report on your 1099 by virtue of your ownership of these notes.  OID is determined largely based on the discount that the issuer sells the notes to your broker and an amortization schedule in the prospectus, and may substantially reduce the effective income of these notes in the first few years after the notes’ original issuance.  In order to fully understand the effects of OID on your taxable income, you will need to read the prospectus carefully and speak with your tax advisor.

Therefore, while interest rate-tied structured notes can be an effective way to generate yield in both a rising rate environment and a steepening yield curve, they are very risky and aren’t for everyone.  Even the most aggressive investors should therefore keep a portfolio that is much more skewed towards cash accounts and very short term CDs.

Note: There has recently been a large issuance of interest-rate tied structured notes that involve a return of principal of less than 100% if a second defined barrier level is breeched on the date of maturity.  For the same reasons that we strongly recommend that depositors avoid all equity-linked, commodity-linked and commodity-linked structured notes, interest rate-linked notes that do not guarantee 100% of principal at maturity should be categorically avoided in all circumstances.

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How to Choose a Savings Account When Interest Rates Are Increasing

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It is quite evident that every bit of extra cash of interest makes a huge difference. Selecting the best savings account can sometimes prove to be a daunting task in a market where the interest rates are finally beginning to increase.

Here a 7 tips to help you find the best option for your savings:

1. Shop around.

To identify the best bank with the most friendly interest rates, you must come out of your comfort zone and shop around. You might have had a savings account at a certain lending institution since your childhood. But, this does not imply that that particular bank is the best place to save your money when the rates are increasing.

Banks offer extremely different interest rates. It is possible to find that banks in the same geography and targeting the same market may have interest rates on similar products that are very different.  One bank can offer a one percent interest rate on a certain product, while another might provide a rate of zero, and yet another might provide a rate of two percent. Additionally, keep in mind that just because a certain bank has increased its rates, it is not guaranteed that your bank will do the same.

Thus you must compare the rates among the different types of banks and other credit unions. Failure to conduct such a comparison of the rates might as well hinder your personal financial progress.

A great starting point might be the We enable individuals to check both local and online money market account rates, as well as yields on certificates of deposits.

Click here to check the best online rates! If you are looking to save more, check the latest cd rates!

It has been proven that most customers find it quite difficult to abandon their previous banks. This could be the moment to make the decisive move.

2. Consider bypassing the brick-and-mortar institutions.

Online banking institutions offer comparatively higher interest rates to the brick-and-mortar banks.

Most savers are always concerned with the security and safety of the online banks but you should know that these banks are always secure as long as you stay within established FDIC or NCUA limits.

The online bank accounts are insured by the Deposit Federal Insurance Corp (F.D.I.C), just like the traditional banks. Most of them are owned by big players in the financial service sector including Discover Bank, American Express Bank, and GE Capital Bank. Others include the online sub-divisions of the so-called brick-and-mortar banks.

Since banks operating online are cheaper to manage they are likely to share a part of that savings to their customers. Most of them always accept clients throughout the nation.

Older customers might be hesitant to change to online-only financial institutions, whereas younger millionaires don’t even want to be seen walking into a bank nowadays.

3. Go local.

If you want a bank that you can visit occasionally, you should definitely consider working with either a community bank or a credit union.  In a rising rate environment, some such smaller institutions often increase their rates more often than the behemoths.  Often, these organizations need to generate deposits much faster.

Even though the rates of these banks might be higher, on most occasions their branch network is limited. This could be a major disadvantage, especially if you are a frequent traveler who always wants to access a branch or use a fee-free card of ATM while traveling.

Yet, most credit unions are part of a network that enables individuals to conduct their banking services with any credit union that is a member and use its ATM for free.

4. Avoid at all cost bait-and-switch.

Individual banks might provide attractive interest rates in a bid to seek your attention, only to decrease them after a few months.

Financial institutions can increase or lower their respective rates on savings. But promotional or introductory rates are only meant to last for a shorter period.

You should conduct a small research and read and understand the fine print before opening a savings account.

(As a policy, BestCashCow does not list short term bait-and-switch rates or exploding rates, such as those offered by EverBank as these are always a bad deal of the depositor).

5. Stay liquid.

Keep your cash liquid at a time when the rate is starting to increase.

The prospect of keeping your money in the savings account offers you the flexibility that a certificate of deposit cannot provide. A CD requires individuals to lock in their rate for a particular time. It could be for as short as three months or as long as several years.  While CDs can always play a role in a balanced portfolio, you should be careful a large part of your portfolio to CDs if you feel that we may be entering an environment with increasing interest rates.

Most short-term CDs offer similar rates to the top paying saving accounts. Also, other CDs have even lower rates of interest. Let us assume that you purchase a one-year certificate of deposit that offers an interest rate which is the same as that of a savings account. If the rates on the savings account start rising, you will be forced to keep your money in the lower-rate CD until the end of the year. And if you withdrew the money from the CD early, so as to transfer it to a savings account, you would get penalized!

6. Put savings on autopilot.

You should look for an institution that offers a savings account that pays higher rates of interest coupled with a checking account. This way you the paycheck will be deposited into your checking account and a portion of it will be transferred automatically to your savings account.

When you first pay yourself automatically and complement it with higher rates, it makes your savings grow a little bit quicker.

7. Understand the account conditions and terms.

You must know that not each and every bank has the same conditions and terms for opening a new savings account.

Certain banks may allow opening an account with one deposit; while others might require a minimum deposit of ten thousand.

Also, you might need to keep some amount of cash in your account so as to earn interest. On the other hand, you may get a lower interest rate if you have only a few hundreds of dollars, rather than thousands, on deposit in your account.

And certain banks normally charge a service fee on a monthly basis, if you don’t keep a certain minimum amount in your account. So you should really read the account disclosures before opening an account.

If You Have $5 Million at Morgan Stanley, Merrill Lynch or JP Morgan, You Can Make $50,000 over the Next Year with 1 or 2 Hours of Work

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It is almost Labor Day and in the Hamptons the refrain at the end-of-summer cocktail parties is the same that we have heard all summer.

The refrain goes something like this:

“I’ve got $5 million in cash at Merrill Lynch.  It is earning me zero.  I don’t know what to do.  We may just elect in the very near future a truly unprepared and unstable President and the stock market is at an all time high.  I for one am not getting in now.  And, interest rates are at an all time low, so I cannot buy bonds.  My broker calls me and tries to sell me crap that neither he nor I understand.  I have no way to earn anything.”

The answer to this refrain is pretty simple.  At the moment, BestCashCow’s savings tables show that there are eight online savings accounts that currently pay at least 1% interest.  Depending on where you live, you may also find as many as another four or five local banks and credit unions servicing your market that are paying over 1%.   You’ll then find another eleven online banks - not including those banks you have already identified from the savings tables - that pay over 1% on 12-month certificates of deposit (CDs).

If you put $250,000 in each of 12 of so banks paying over 1% on savings accounts that are either online or in your market, you will put $3 million to work safely.  By putting another $250,000 into eight other banks that will give you over 1% in a one-year CD, you will be safely stocking away another $2 million.  Between now and next Labor Day, you will generate at least $50,000 that you would not otherwise make over the next year, albeit that money is fully taxable and the money in CDs cannot be accessed without paying an early withdrawal penalty.

There is a second Labor Day refrain in the Hamptons and it goes something like this:

“I cannot believe that I need to write another check for $45,000 to Horace Mann for my 12-year old’s tuition for next year.”

The answer to this refrain is also pretty simple.   By opening these accounts, you will generate much of the money to cover those annual tuition payments, even after you pay your Federal and New York State and City taxes.

US Faces Extraordinary Risk of Economic Catastrophe – Much like 2004 Atocha Scenario

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Even if the polls indicate that Hillary Clinton is the likely next President, there is a high risk right until the day of election that outside influences could cause the US to elect a President who is in the best case "unfit".

Donald Trump and his surrogates have spouted complete nonsense for months, and appeal strongly to a single segment of the US population.  There is also a highly reactionary element of the US population that may already realize that he is unfit to leave his gilded perch above 5th Avenue (and is unfit to serve in any elected role), but who just might vote in his favor in the event of a terrorist attack in the weeks immediately preceding the election.  It goes without saying that Donald Trump’s election and his economic policies would lead to immediate and unprecedented global economic crises.

Unfortunately, the scenario isn’t entirely unprecedented.  As it entered 2004, Spain had the strongest economy in Europe.   Under Prime Minister Jose Maria Aznar and the Partido Popular (PP), Spain’s economic policies were attracting investments of large multinationals from around the world.  Aznar also lead Spain to be active in the US-led campaign in Afghanistan and was preparing to deploy troops to Iraq, which was highly controversial.

Aznar had been decisively leading in polls prior to the general elections scheduled for the Spring of 2004.  However, when Al Qaeda operatives struck Madrid’s Atocha station on March 11, 2004, they not only killed 192 and injured over 2000, but also caused Aznar to be defeated days later by Jose Luis Rodriguez Zapatero and the Spanish Socialist Workers’ Party.    In the years that followed, Zapatero and the Socialists pursued a xenophobic policy that removed Spain from involvement in military campaigns abroad.  They also adopted economic policies that laid waste to the Spanish economy.

One way to partially protect oneself from a similar situation in the US is to move money now to online savings accounts and short term CDs.

Editor’s Note: Unlike the situation that the US faces, Jose Luis Rodriquez Zapatero was not a Donald Trump.   While he destroyed the Spanish economy, he did not wage war against minorities or women in Spain.  He did not unilaterally control access to nuclear weapons.   While the US faces a risk of a similar scenario, it faces a still much greater risk to the country, and to putting world civilization in danger in the current election.

Now is a Good time to Check Your FDIC and NCUA Coverage

With the election of a real estate heir unprepared to serve as the President of the US, and the increased potential of a new financial crisis, this is a great time to check to be sure that your bank deposits are financially secure.

I recently had a drink with a friend who I consider to be moderately smart who proceeded to explain to me that he had all of his savings concentrated in one or two online savings account, including over $1 million in a savings account at a bank that appeared for at least 24 hours after the Brexit vote to be spiraling towards receivership.

Having money in excess of the Federal Deposit Insurance Corporation ("FDIC") limits - or National Credit Union Administration ("NCUA") limits for credit unions - defies the very point of having a savings account, and exposes you to unnecessary risks.  There are so many FDIC insured banks with strong savings and short term CD rates that even the very wealthy can divide their money in $250,000 increments in a way to avoid overexposing themselves to a bank failure.  (The super wealthy – those with tens of millions of dollars in cash - should look at CDARS programs to protect their assets from bank failures).

What is covered?

FDIC insurance is pretty simple.  All you need to know is that it covers bank accounts, such as checking accounts, savings accounts and Certificates of Deposit.  It does not cover other products you may purchase from a bank, such a mutual funds, commodities, annuities, or life insurance.   (In the event of a bank failure, SIPC insurance may protect certain securities from disappearing, although it does not insure the value of those securities).  The attraction in FDIC insurance is that backed by the full faith and credit of the US.  As long as you stay within the limits, every penny in your bank accounts is going to be deposited in an account with your name on it the day after the bank becomes insolvent.

To be fully insured, you must make sure that your deposits follow the FDIC guidelines and limits.  These guidelines are based on different account ownership categories, with up to $250,000 of coverage allowed for each category of account ownership you have in one bank, not by how many accounts you have in that bank.  It is important to understand that if you have a CD with $250,000, a savings account with $250,000, and checking account with $100,000 at the same bank in the same ownership category, you are exposed to the bank in the amount of $350,000.

The account ownership categories are:

1.  Single Accounts

A single account is a deposit held in one person’s name only or held in account for one person only.

2.  Certain Retirement Accounts 

This includes Traditional IRAs, Roth IRAs, SEP-IRAs, SIMPLE IRAs and self-directed defined contribution plans

3.  Joint Accounts

A joint account is a deposit owned by two or more people.

4.  Revocable Trust Accounts

In general, the owner of a revocable trust account is insured up to $250,000 for each unique beneficiary.

5.  Irrevocable Trust Accounts

Irrevocable trust accounts are held in connection with a trust in which the owner gives up all power to cancel or change the trust.

6.  Employee Benefit Plan Accounts

These are a deposit of a pension plan, defined benefit plan or other employee benefit plan that is not self-directed.

7.  Corporation/Partnership/Unincorporated Association Accounts

Deposits owned by corporations, partnerships, and unincorporated associations, including for-profit and not-for-profit organizations.

8.  Government Accounts (also called Public Unit accounts)

The United States, including federal agencies

  • Any state, county, municipality (or a political subdivision of any state, county, or municipality), the District of Columbia, Puerto Rico and other government possessions and territories
  • An Indian tribe

For complete guidelines for each type of ownership category, the FDIC has prepared this page.   If you have specific questions about your own circumstances you should use the FDIC’s Electronic Deposit Insurance Estimator.

What about NCUA coverage?

The National Credit Union Administration provides very similar, though not identical coverage, to the FDIC that is also based on a $250,000 cap for each ownership category (with similar ownership category) for federally chartered credit unions.  State chartered credit unions may also be protected so long as they display the NCUA logo on their website and in their facilities.   If you think you may be in excess of NCUA limits at a single credit union, you should download and read the NCUA’s insurance brochure

While all banks listed on are insured by the FDIC, please note that we also provide information on state chartered credit unions on that are not insured by the NCUA (this information can be found on the credit union's information page).

Check the best online savings rates and leading CD rates.

Starting to Look Like Japan - One-Year CDs Offer Small Upside, But Miniscule Risk

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With long CD rates compressing and yields in savings accounts enigmatic, this is a good time to look at one-year CDs.

Global markets are continuing to reward risk and to provide very little yield in risk-free assets.  While rates were expected to go up in 2016, we have seen a decline in long-term rates in the US (caused by a dramatic drop in long term rates in Europe).  We have also seen rate compression in risk free assets (US Treasuries and now CDs).  In 2014 and 2015, 5 year CDs offered rates as high as 2.50% APY.  Now, even the best rates are closer to 2.00% APY (see the best rates here).  Savings rates are barely holding constant with only a couple of the leading online rates holding above 1%.  It seems that we are all starting to look like Japan where savers have been rewarded with extraordinary low interest rates for decades.

Find all of the best savings rates – online and locally – here.

As we look at a continuation of what has become a virtual zero rate phenomenon, a handful of banks are offering 1 year CD rates at or above 1.25%.  In fact, the best CD rate available online today is 1.35% with a $5,000 minimum deposit.  If you have money that you are resigned to keeping in cash and that is earning 0.90%, you can easily pick up an additional 50% return by getting into a one-year CD.

Ok, I hear you.  I know that the actual pick up here is pretty low.  In fact, you would need to move over $222,000 from an account earning 0.90% to a CD earning 1.35% just to make $1,000 more over the next year.  And, that $1,000 is going to be fully taxable at the federal, state and local levels.  However, if savings rates do not rise and you continue to earn 45 basis points more by being in short tern CDs, the additional gain becomes real.  As the Japanese have found, when waiting for savings rates to rise, one year quickly turns to two, and two to 10 or 20, and the value of the additional interest, when compounded, does become meaningful.  Using BestCashCow’s savings booster calculator makes this clearer.

Rates may be going up, but it is clear that they are not going to be rising very fast.  If you have money that you cannot keep in risky assets (such as the stock market) and that you are unlikely to need for the next year, it may be time to start shifting into 1-year CDs.  If savings rates were to spike or if you need your money for an unforeseen expense, you can ordinarily get it back by paying a modest early termination penalty (Sallie Mae, Colorado Federal and BAC Florida all have penalties on their 1-year CDs that are only 3 month of interest).  

See the best one-year CD rates - online and in banks and credit unions near you - here.