Salomon to buy up to $8 billion in structured notes for bond offer


NEW YORK -- Salomon Brothers Inc. said yesterday it will buy as much as $8.1 billion of structured notes and transform them into less-risky, easily traded bonds in one of the biggest bond tender offers ever.

Salomon, traditionally among Wall Street's biggest and most creative bond traders, is trying to capitalize on the lessons it learned advising Orange County, Calif. Salomon helped the county unload $5 billion of structured notes -- derivative securities whose value is based on, or derived from, movements in market rates or indexes -- after the county declared bankruptcy in December.

Salomon said it will offer to buy 59 structured bonds issued by Federal Home Loan Banks, Federal National Mortgage Association, Student Loan Marketing Association, Federal Home Loan Mortgage Corp. and Federal Farm Credit Banks.

"As a result of Orange County, we have realized that the secondary market for these securities is not that liquid," said FTC Marwan Marshi, a Salomon Brothers official. "We wanted to provide liquidity."

The suggestion that investors would have trouble selling structured notes touched a nerve on Wall Street, where firms regularly buy structured notes on a bond-by-bond basis. Just four hours after the announcement, Morgan Stanley & Co. said it will bid for all the notes that Salomon is tendering for.

Ted Dumbauld, a vice president at Deutsche Bank Securities Corp., said he was bidding for a number of the bonds that Salomon tendered for and would be willing to bid for the others too.

"We would bid for every bond on the list," Mr. Dumbauld said.

Salomon said it will take the securities and turn them into new "plain vanilla" bonds with interest rates tied to the London interbank offered rate, said Marwan Marshi, a Salomon official. Libor-based bonds are easy to sell because, unlike with structured notes, investors may easily determine their returns.

Salomon stands to profit from the difference between what it pays for the structured notes, many of which are trading at depressed prices, and the amount it receives for the Libor-based bonds.

Some regulators have blamed structured notes for some of the biggest losses in the bond market last year. They can be created in such a way that their gains or losses outstrip those of regular securities.

Orange County officials said investments in structured notes contributed to the $1.7 billion loss in an investment pool that bankrupted the county.

One of the notes in the tender offer, Federal Home Loan Banks' notes due in 1998, illustrates their volatile returns. The notes, sold in May 1993, paid investors a 6 percent interest coupon through June 1994. Now, the bonds pay the interest rate on a 10-year U.S. Treasury note, plus 3.15 percent, minus the six-month London interbank offered rate. As of December, the coupon was 4.425 percent, illustrating how the returns on this bond declined.

Salomon is among the world's biggest bond traders and had $172.7 billion of assets at the end of the year.

Still, Salomon's bets in the $16 trillion worldwide bond market can lead to losses.

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