It was another quiet week in the derivatives market, with most attention focused on last Wednesday's $600 million New York City issue.
The deal included two derivatives portions. CS First Boston sold $17 million of derivatives on bonds due in 2003, and Merrill Lynch sold $5 million of derivatives on the 2013 maturity.
First Boston sold auction-based floating-rate notes and corresponding triple-leveraged inverse floating-rate securities. The triple leverage will give holders of the inverse floaters a substantial play on rates. Each 1% reduction in the interest payment made on the floating-rate notes will cause the rate on the inverse side to rise three times as much.
Merrill Lynch sold $5 million of deferred fixed-rate bonds on the New York issue. The new product will pay a short-term floating rate for up to the first year.
Each month during the first year, investors will have the option of converting the bonds to a fixed rate based on the yield of the Treasury's 10-year note.
The taxable 10-year rate will be adjusted to pay investors a tax-exempt rate. But the adjustment will be based on the ratio of taxable to tax-exempt debt that existed when the bonds were priced.
Roger Anderson, New York City's bureau chief for debt management, said the derivatives saved 10 basis points over straight debt issuance.
Other firms also looked at selling derivatives, but no other trades materialized in the primary market.
"Derivatives are very market sensitive. Sometimes the savings may be there but there are no buyers," Anderson said.
New York City would like more variable-rate exposure, to match its assets invested at floating rates. Limited credit enhancement capacity restricts the city's ability to issue many types of floating-rate securities.
Some Wall Street derivatives professionals wanted to sell the city swaps to convert a portion of the fixed-rate debt issued last week to synthetic floating-rate debt. Such a transaction would not require credit enhancement for the bonds.
But the city does not have authorization to enter into that type of swap, Anderson said "We'd love to do it, but we need authorization from the state first."
A few upcoming deals may include derivatives. Market sources said Chicago's $640 million issue of O'Hare International bonds could include derivatives. Goldman Sachs will act as senior manager on the deal, expected to be priced at the end of this week or early next week.
A preliminary official statement for the O'Hare issue said it may include auction-based floating-rate notes and corresponding inverse floating-rate securities.
An upcoming refunding issue for Valdez, Alaska, will not include language allowing the issuer to sell its right to call the bonds. Including so-called detachable call language creates some tax-related anxieties for investors.
Valdez sent out preliminary official statements, dated Oct. 6, that included the call language, but then decided to remove it. Without the language, more investors are willing to consider buying the bonds, market sources said.
When Valdez sold an issue containing detachable call language in August, investors demanded a five-basis-point premium to compensate for tax uncertainties. Goldman Sachs will act as senior manager on the upcoming offering.
