The tightening of Treasury-swap spreads this year has created opportunities for institutions to deploy cash into securities and swap to floating at an attractive spread - but don't ignore the opportunity to add floor protection.
The tightening of Treasury-swap spreads this year has created opportunities for institutions to deploy cash into securities and swap to floating at an attractive spread. But the opportunity isn't just the spread- it's using some of that spread to finance downside protection, creating self-insuring floaters that are accretive to earnings and reduce interest rate risk.
Synthetic Floaters
The cheapness of Treasurys and MBS relative to swaps provides the raw material for self-insurance. Buying and simultaneously swapping Treasurys and MBS to floating results in a synthetic asset with spreads as high as SOFR + 1.10%:
Crucially, these synthetic floaters do not include embedded caps like conventional floaters and retain upside in rising rate environments.
Self-Insuring Floaters
While adding floating income without being short an option may be welcomed by interest rate risk managers and bank executives alike, institutions can extract additional value from these spreads. Taking the synthetic MBS floater as an example, by allocating approximately 30bps of the SOFR + 1.10% income, institutions can purchase an interest rate floor that ensures total income never falls below 3.60%. This "self-insuring floater" adds positive convexity to the balance sheet while creating income that pays for its own insurance:
It's important to remember that swapping assets (even those held at a 0% risk weight) to floating is not a risk-free transaction. While these structures may be "self-insuring" in the context of rate floors, there is no such thing as a free lunch—institutions remain exposed to spread duration, credit risk, and other market risks. Treasury-swap spreads could narrow further, and if held shorter than maturity, both bonds and swaps may not converge to par.
Below we've provided high-level pricing for relevant synthetic floaters and floored floaters:
Reach out with any questions or for pricing on specific structures.
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