Massachusetts decided yesterday not to include derivatives on its $240 million competitive note issue, although six firms submitted bids that included swaps.
The state announced that firms could bid for up to half of the issue with a synthetic fixed-rate structure.
The bids included floating-rate notes reset weekly at the Public Securities Association swap index rate and a corresponding swap to lock in a fixed rate for the state.
Massachusetts issued a memorandum on Monday listing 16 firms that were "prequalified" as acceptable swap counterparties.
But the state also required savings of 10 or more basis points on the derivative bids versus fixed-rate bids. None of the underwriters was able to hit the state's saving target using the PSA note and swap structure. In fact, the best swap bid was eight basis points higher than the winning fixed-rate bid, a Massachusetts official said.
New Jersey plans to sell a competitive deal next month using similar rules, market sources said.
Money market funds, the primary purchasers of the PSA notes, can consider the securities as having a seven-day maturity even though the notes are not backed by a put option and liquidity support. More common variable-rate demand obligations require liquidity support, which can be expensive for issuers, and are generally not offered in competitive deals.
CS First Boston won the competitive issue, pricing the notes with a fixed rate and a net interest cost of 2.684%. The notes were reoffered to yield 2.65%.
New York City priced a $672 million issue yesterday without derivatives, although the city received numerous proposals. "There is a lot of market uncertainty and the city has been accommodating in the past -- a lot have been sold," an official on the deal said.
Underwriters reported continuing interest in forward swap transactions last week. Issuers can use forward swap agreements to lock in current low rates and refinance bonds that cannot be advance refunded.
While most of the large transactions have involved airport-related bonds, other issuers are also interested in forward swaps.
South Carolina Public Service Authority is considering a five-year forward transaction, market sources said. The authority would agree to issue 20-year bonds and enter a swap of the same maturity in 1998. Societe Generale and AIG Financial Products, the two leading providers of long-term municipal swaps, are in the running for the forward swap.
Hospitals, universities. and other 501(c)(3) issuers are good candidates for forward swaps, according to Sheldon Sussman, senior vice president at Lehman Brothers. Issuers precluded from advance refunding bonds a second time also are considering forward swaps, Sussman said.
The swap yield curve has flattened as the gap between short-term and long-term swap rates has shrunk. The flatter swap curve lowers the premium an issuer has to pay to enter a forward swap.
For example, one issuer considered a for-ward swap last week to issue floating-rate bonds and enter a 20-year swap in five years, market sources said. The issuer could lock in a synthetic fixed rate of 5.55% on the transaction. The rate includes a premium of about 50 basis points for the five-year delay.
The same issuer, at present, could issue ordinary fixed-rate debt for about the same rate, but is precluded from advance refunding its outstanding bonds.
In other news, the use of menus in preliminary official statements continued last week. Two deals included menus of possible derivative structures, although both issuers were sold as plain-vanilla bonds.
Illinois Health Facilities Authority sold $113 million of revenue bonds without any derivatives. A preliminary official statement said the authority was considering issuing auction rate securities with corresponding inverse floating-rate securities.
