Structured Deposits – A Case Study

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Disclaimer : The following analysis does not represent financial advice of any form. The analysis is a personal view point and not an attempt to discredit the bank offering it.  Nor is it an attempt to malign the bank’s reputation in any way. Its main aim is to provide a balanced view of the product that is being offered.

Commentary on X Bank’s 5 Year Savings Structured Deposit

When you compare the interest rates you should be receiving from X Bank against your current or time deposits, it is a no-brainer. How can a one year time deposit of 1% or less, compare with their first year interest rate of 1.85% ?

The typical approach is to compare X Bank’s structured deposit with the 5year interest rates prevailing in the market. How does the structured deposit stack up if we have all the information?

The prevailing 5year interest rate relevant to this discussion is at 1.6%.

But the investor is getting 1.85% and increments of 0.05% every year, ie 1.85% in year 1, 1.90% in year 2 and so on till 2.1% in year 5. This looks like a great deal for the investor. X Bank gets 1.6% but pays their investor more. They are out of the money.

Or is it?

In the small print, X Bank reserves the right but not the obligation to early terminate this product at the end of each year. Is this right worth any money?

In essence, the investor has sold at option to the bank (called a swaption). What is this option worth? Based on today s value, it is approximately 0.50% per year.

So X Bank could be making 0.7% every time an investor buys the product, calculated thus : cost would be 1.6% plus 0.50% =2.1% multiply by 5years. But X Bank pays you 1.85+1.90+1.95+2.00+2.1 %. 0.70% over 5 years look like a very thin spread for a 5 year product. Unverified sources say it can be 0.40% or higher depending on market conditions.

Risks
1. Credit risk of X Bank because this structured deposit is not insured like a normal deposit.
2. Re-investment risk should the structured deposit be called and interest rates are still very low.
3. Interest rate risk  – should interest rates rise, you will still be stuck in your contractual structured deposit rates.
4. Early termination (penalty) risk.

This product would appeal to the investor who does not have access to the bond market and access to X Bank’s bonds. For a minimum investment of say, S$30,000, one can achieve an enhanced yield over time deposits that pay a pittance.

X Bank’s 7 year bonds maturing in 2021 have yield to maturity of about 3.2%. If you do a rough intrapolation and ignore the difference in credit rating (because the bond is a sub debt), they should be paying approximately 2.7% if they were to raise money in the capital markets.

Issuing this structured deposit allows the bank to access cheaper long term Singapore dollar funds and perhaps even gain new customers.

Its a win-win situation for both investors and the bank.