Derivatives action last week focused on issuers rather than investors.
With interest rates climbing in an unsettled market, investors have shied away from volatile derivatives. But interest rate swaps were used by issuers trying to lock in low rates while they still can.
In one such deal, the Chelsea (Mass.) Industrial Development Finance Agency yesterday issued $100 million of floating-rate securities reset at a 35-day auction. The transaction featured a long-term swap to lock in a synthetic fixed rate for the issuer.
The fixed rate was 25 to 30 basis points lower than the agency would have received on a straight fixed-rate issue, according to officials at Lehman Brothers. Capital Guaranty Insurance Co. insured the floating-rate securities.
Lehman officials noted that the deal allowed the agency to enter into a long-term swap without requiring a letter of credit or a liquidity facility on the variable-rate bonds.
But variable-rate securities that carry enhancement and put rights trade slightly better than the type of securities used in the Chelsea deal, other derivatives professionals said. With enhancement and put rights, money market funds can buy the securities, increasing demand and lowering yields for issuers.
A lower rate on the floating-rate security would allow the issuer to lock in a lower fixed rate on its swap.
But enhancement can be expensive or even unavailable, especially for a credit linked to a city like Chelsea, which has had severe fiscal problems over the past several years.
And comparisons of the average yields on different types of floating-rate securities can be misleading for specific issues. Lehman officials maintain that their structure is the most cost-effective for many issuers.
The Detroit Metropolitan Wayne County Airport locked in low rates last week using a different structure: a forward swap. The transaction allows the airport to lock in an advance refunding on $123 million of 1986 bonds that could not otherwise be refinanced for several years.
The airport will enter a 12-year swap and issue variable-rate bonds in December 1996. The swap is 70% with Merrill Lynch and 30% with Goldman, Sachs & Co.
The forward swap will create about $12 million in present-value savings, although about one-quarter of that amount will be used to pan an up-front fee on the swap, according to J. Chester Johnson, chairman of Government Finance Associates Inc., the airport's financial adviser.
There was no activity last week in the primary market for embedded derivatives. Some investors say they are still waiting to see a compelling derivative product to allow them to make a bet on rising rates.
"The inverse floater has been great for a few years, but I haven't seen the equivalent knockout for q bear market," one portfolio manager said.
The manager said bonds with embedded caps had proven unreliable, not always trading as holders had expected.
Wall Street officials said they had a variety of products for bearish investors who did not want to buy embedded cap bonds.
Some step-up bond structures, for example, pay investors considerably more interest if rates rise.
