US: 2-Yr FRN Note Auction

September 28, 2016 10:30 CDT

Actual Previous
Total Amount $13 B $13 B
Bid/Cover 3.09 3.46
Discount Margin 0.175% 0.165%

Results are mixed for the monthly 2-year floating rate note auction, with a 3.09 coverage that was the second lowest of the year but also with very tight bidding showing aggressive demand. The high margin awarded at 0.175 percent came in at a large 1.5 basis points below the 11:30 bid. End investor demand was quite solid, but came solely from indirect bidders who took down a sizable 43.75 percent of the $13 billion offering while direct bidders stayed away for a zero share, leaving the dealers with 56.25 percent, about in line with the recent average. The 0.175 percent high margin was 1 basis point higher than in last month's auction.

A FRN (floating rate note) is a security that has an interest payment that can change over time. As interest rates rise, the security's interest payments will increase. Similarly, as interest rates fall, the security's interest payments will decrease. The FRN is the first addition to the Treasury's offerings since inflation protected notes were introduced in 1997. Floating rate notes offer investors a chance to gain yield when interest rates rise and with short-term interest rates very low at the time of the introduction, they offer investors a low risk, high quality alternative to Treasury bills and their associated rollover costs.

For the Treasury, the notes will help it attract new investors and, as a funding substitute to T-bills, will help limit its short-term cash needs. The notes also limit rollover risk, that is the Treasury's dependence on bill holders to rollover their holdings with each new bill issue. But there is risk for the Treasury as substituting 2-year floating notes for short-term bills exposes it to a rise in interest rates, an increase that would increase its borrowing costs. Treasury FRNs will be indexed to the most recent 13-week Treasury bill auction High Rate, which is the highest accepted discount rate in a Treasury bill auction.

Treasury published amendments to its marketable securities auction rules to accommodate the auction and issuance of Floating Rate Notes (FRNs). These securities will complement Treasury's existing suite of securities, which include Treasury bills, notes, bonds and inflation-protected securities (TIPS). Treasury's introduction of FRNs will provide a number of benefits, including assisting Treasury in managing the maturity profile of the nation's marketable debt outstanding, expanding Treasury's investor base, and helping to finance the government at the lowest cost over time.

FRNs will add a new level of diversity to Treasury's existing suite of securities, thus providing Treasury debt managers with additional capability to expand the Treasury investor base and extend the weighted average maturity of marketable debt outstanding. Moreover, Treasury believes that the issuance of FRNs will contribute to the mission of financing the government at the lowest possible cost over time. Treasury FRNs will pay interest quarterly.

FRNs pose similar risks to the Treasury as Treasury bills. For example, an FRN that allows the interest payment to change on a weekly basis would expose Treasury to the same interest rate risk as issuing a series of weekly Treasury bills. However, FRNs allow Treasury to better manage its debt by issuing securities with longer maturities than Treasury bills.

For purposes of calculating auction settlement amounts and quarterly interest payments, floating rate notes will initially have a two-business-day lockout period prior to their auction settlement date or an interest payment date. Therefore, a 13-week Treasury bill auction whose rate becomes effective during the lockout period will be excluded from the calculation of accrued interest for purposes of determining that settlement amount or interest payment. Any changes in the index rate that would otherwise have occurred during the lockout period will occur on the first calendar day following the end of the lockout period.