When Puts Marry Calls

A new breed of bond features a dual option.
Emily S. PlishnerMay 1, 1998

For companies that might otherwise resist raising cash at today’s low interest rates, Wall Street has devised a new temptation: synthetic put bonds, or put-call notes.

“We probably wouldn’t have refinanced without this structure,” says David Van Benschoten, vice president for treasury operations at General Mills Inc., in Golden Valley, Minnesota. So far, General Mills has done two $100 million synthetic put issues. His counterpart at Parsippany, New Jersey­based Nabisco Inc., senior vice president and treasurer Frank Suozzi, arranged a billion dollars’ worth of synthetic puts in January as part of a refinancing. “It wouldn’t have worked with a conventional refinancing,” Suozzi declares.

These new structures combine two instruments: a plain-vanilla short-to-medium-term note and a put/call combination with a different maturity. The note portion is sold to traditional fixed-income investors, and the put/call option is sold to the underwriter’s derivatives desk. The originator of the structure, UBS Securities, in New York, called them pass-through asset trust securities, or PATS. To Morgan Stanley Dean Witter & Co., they are “reset put securities,” or REPS, while Merrill Lynch customers are hearing about mandatory par put remarketed securities, or MOPPRS (pronounced “moppers”). For the sake of clarity, UBS now uses the generic term “put- call notes.”

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The alphabet-soup brand names denote very similar new securities that have been pouring into the marketplace. Several billion dollars’ worth of synthetic puts were placed with investors in January alone. Investors are grabbing them up so fast that many issues have more takers than they can accommodate.


“We were oversubscribed,” says Darell Zink Jr., executive vice president and CFO of Duke Realty Investments Inc., an Indianapolis-based real estate investment trust (REIT) that arranged a $100 million­a-year PATS issue through UBS Securities last August. Although the structure was only a few months old at the time, Zink was comfortable with it. “By the time we did it, we’d seen others done,” Zink says. Cox Enterprises Inc., a diversified media company in Atlanta, and its public cable subsidiary, Cox Communications Inc., also increased the sizes of two separate issues to fill demand for PATS sold last June and August, respectively. “I love the product,” says Cox’s enthusiastic Richard Jacobson, vice president and treasurer at the private Cox entity.

The novel structure gives rise to terminology that resembles a quarterback’s signals before the ball is hiked. The $100 million Duke Realty deal was, for example, a “14-year-put- 7” arrangement (shorthand: 14-put-7), meaning a 14-year maturity for the underlying fixed- income instrument held by bond investors and a 7-year maturity for the options. Chateau Communities Inc., a REIT in Englewood, Colorado, went to market with a 17-put-7 deal and raised $100 million. “We were very pleased with the results,” says CFO Tamara Fischer.

Crestar Financial Corp., a $25 billion bank holding company in Richmond, Virginia, recently raised $150 million with a 20-put-10 deal. UBS acted as the lead underwriter, with Morgan Stanley and Lehman Bro-thers Inc. also participating in the distribution.

According to Eugene Putnam, Crestar’s senior vice president for corporate finance and investor relations, his company saved as much as 35 to 40 basis points versus the tab for plain vanilla, 10-year subordinated that was the alternative under consideration.


While the bondholders collect interest payments, the combined option resides in a derivatives portfolio until the option holder exercises it at the put date by calling the bond. Afterward, the option holder can resell the bond if interest rates have gone down or put it back to the issuer if rates have gone up. Because no synthetic puts have yet been called, issuers must take it on faith that the transaction suffers no unforeseen side effects.

The downside of a synthetic put lies chiefly in an uncertain repayment date, which can occur at one of two predetermined dates. But whenever repayment occurs, the issuer faces choices that are less than optimal. If interest rates rise, an option holder will put the bond back to the issuer as soon as the option matures, forcing the issuer to refinance in a higher interest rate climate.

On the other hand, if rates soften, the bond will remain in circulation until the later maturity, preventing an issuer from refinancing at lower rates. In any event, synthetic puts also tend to shift an issuer’s maturity profile, with either good or ill implications, depending on how rating services interpret the shift.


So why do issuers engage in such a bargain? The answer appears to lie in their confidence that current interest rates are unusually attractive. “We would be happy to do a 30-year financing at these rates,” says Nabisco’s Suozzi. Meantime, interest rates for the bond portion of synthetic puts exceed rates for medium-term notes by only three to five basis points– before considering the value created by selling the option package.

To protect itself, nevertheless, against the possibility that rates will decline, an issuer can limit exposure by matching synthetic puts to other fixed-income securities it has issued. General Mills, for example, hedges the synthetic put in its portfolio against other callable bonds that allow the $5.6 billion consumer food company to take advantage of a decline in rates, according to Van Benschoten.

Synthetic puts are products of their environment. “The 10-year [Treasury] note has been above 5.25 percent for 99.1 percent of the time over the last 25 years,” says Morgan Stanley managing director Thomas Thees. This protracted period of low interest rates has given CFOs at most creditworthy companies an opportunity to lock in all the capital they really need at rates they can feel pretty smug about. Fee-hungry investment bankers have to scramble to find reasons for new refinancing.

Happily, fierce competition for refinancing customers has kept a lid on fees–even for these newfangled securities. The investment banking fee for the underlying bond component of synthetic puts is no different from the fee for an ordinary bond of the same maturity. On the other hand, the underwriter pays the issuer for an option, and the price tag reflects its value to the underwriter’s derivatives portfolio.


While synthetic puts are still an evolving structure, the learning curve has been steep. The first synthetic puts, brought to market by UBS Securities in September 1996, had a convoluted structure that involved a trust.

With the trust, the underlying bonds had to be placed privately and were less liquid than later versions. According to Nabisco’s Suozzi, who has done deals both with and without the trust, investors were initially skeptical about the unfamiliar structure, needing a 10- basis-point premium on the yield over puttable bonds without the stripped off swaption feature.

Nabisco has been very happy with the structure as it has evolved. It has enabled the food company to refinance at a savings of $10 million to $15 million annually on its debt service, and improve its credit profile by redistributing its debt maturities more manageably. As of the end of January, $1.2 billion of Nabisco’s $4.5 billion total debt was structured with synthetic puts.

General Mills’s Van Benschoten cheerily agrees that it’s a win-win situation for all parties– the issuer, the investor, the derivatives desk, and the corporate finance crew at the underwriter. “That’s unusual on Wall Street, where somebody usually gets taken advantage of,” Van Benschoten says.

Emily Plishner is a freelance writer based in Brooklyn, New York.