Betting on lower interest rates, long-term bond funds bought $130 million Pennsylvania Higher Education Assistance Agency student loan revenue bonds yesterday to capture the attractive 8.405% yield on $65 million of residual interest bonds.
A 17-member account, led by Lehman Brothers as senior manager, priced and then repriced the bonds, decreasing the amount from $155 million. The underwriters also lowered the series A yield five basis points and raised the series B maturity by five basis points.
The final terms, subject to the federal alternative minimum tax, included $65 million series A select auction variable rate securities priced with a coupon of 4.95% in 2026 while $65 million series B residual interest bonds were priced with a coupon of 8.405% in 2026.
The issue is AMBAC insured and triple-A rated by both Moody's Investors Service and Standard & Poor's Corp.
A Lehman officer said that long-term bond funds took most of the bonds, but said there was some retail participation on the series B bonds.
Traders noted that there is little secondary market activity in the securities, and most market players are still familiarizing themselves with the securities.
"The major buyers have been the long-term bond funds and a couple of major guys," said one Wall Street-based bond trader. "The big question is what is the liquidity of the RIB market when somebody wants to get out. It's going to take more deals of compatible products to make the secondary work."
This variation of the variables rate bond structure first appeared in early 1990. Then what was known as Shearson Lehman Hutton first unveiled what it called RIBs and SAVRs, its service marks for "residual interest bonds" and "select auction variable rate securities."
The structure made its debut in a negotiated $120 million issue for the Nebraska Investment Finance Authority.
The deal comprised $50 million in SAVRs, $50 million in RIBs, and $20 million used to refund some earlier bonds. Bankers who worked on the deal then termed it "a fixed-rate obligation that is being issued as two floating-rate obligations," and said this particular issue saved the authority 21 basis points: the normal net interest cost would have been 7.875%, they said, but the new structure enabled the authority to bring that down to 7.666%, which meant a $6.3 million savings on the $100 million portion of the loan.
The original deal worked this way: Both portions of the loan came due in 2022. The SAVRs portion of the loan had a variable rate set at Dutch auction, at which investors stipulate the lowest rate they will accept, every 35 days. The initial rate was set at 6%.
The other half of the loan, RIBs, had a rate determined on the difference between the 7.666% payment stream made by the issuer and the variable rate interest paid on the SAVRs.
In other words, the authority's debt service was capped at $7.66 million per year on the $100 million RIBs and SAVRs. If at the next Dutch auction the rate paid on the SAVRs is 6%, that meant about $3 million of debt service went to paying SAVRs holders. The remaining $4.66 million was divided among holders of the $50 million RIBs. At the first sale, that translated to an 8.89% yield.
Thus, every five weeks, the debt service payments by the issuer were dividend up. The lower the short-term SAVRs sell for at auction, the higher the RIBs' interest rates will go; the cost to the issuer does not change.
If short-term rates skyrocket there is the potential for a RIBs' holder to receive no payment. Bankers interviewed at the time predicted that if rates looked like they were about to soar, an investor could always buy a SAVR, and in essence hedge his bet and get the equivalent of a fixed-rate bond.
Yesterday's Market
New issuance was otherwise very light yesterday. the 30-day visible totaled a mere $1.74 billion, up $220 million from the previous session.
Standard & Poor's Corp.s The Blue List of municipal bonds rose $65 million from the previous session, to $1.4 billion, down $110 million from last week.
In follow-through business, Goldman Sachs & Co., senior manager for $602 million California various purpose taxable GO bonds reported an unsold balance of $244 million late in the session.
Secondary trading was again very light. Traders reported prices mixed in a very narrow range.
There were several customer bid-wanted lists of moderate size, but traders continued to report a dearth of activity ahead of Friday's unemployment data.
In the debt futures market, the December municipal futures contract settled unchanged at 92.26 with the December MOB spread narrowing to negative 139 as Treasuries continue to outperform tax-exempts.
In secondary dollar bond trading, New Jersey Turnpike Authority 6.90s of 2014 were quoted unchanged on the day to 99 3/8-1/2 to yield 6.94%. Florida State Board of Education 7 1/4s of 2023 were quoted up 1/4 to 103 1/2-104 to yield approximately 6.76% to the 2004 par call. New York LGAC 7s of 2016 were up 1/8 point to 98 1/2-3/4 to yield 7.10%. Puerto Rico Electric Power Authority 7s of 2021 were unchanged at 99 1/8-3/8, where they returned 7.05%. And Colorado River Authority insured 6 5/8s of 2021 were unchanged at 97-3/8 to yield 6.83%.
In the short-term market, note yields rose about five basis points as the sector was surprised by significant upcoming supply. Traders said that retail buyers hit the sidelines after news that Pennsylvania plans to bring $1.4 billion notes in the near-term. Exacerbating supply concerns, Texas will soon issue $800 million notes and Connecticut plans a $1 billion issue. Street float early in the session totaled approximately $400 million, traders said.
In secondary trading, Jersey notes were quoted near the end of cash trading at 4.60% bid, 4.55% offered, where they were quoted early in the session at 4.57% bid, 4.50% offered. March New York State Trans were quoted at 5.22% bid, 5.18% offered near the close, while Los Angeles notes were quoted at 4.60% bid, 4.55% offered. March California notes were quoted at 4.55% bid, 4.45% offered at the end of cash and June California notes were quoted at 4.58% bid, 4.50% offered.
