Derivatives activity picked up significantly over the last week. Issues included embedded derivatives, and the Texas Turnpike Authority weighed a forward swap deal.
Yesterday's New York City deal included one embedded derivative product. The $656 million deal managed by Prudential Securities Inc. included derivatives structured by Goldman, Sachs & Co. for $22 million of the 1996 maturity.
The city was able to lock in a synthetic fixed rate of 4.00% by issuing a new type of variable-rate derivative, called Binary LIBOR notes, and entering a swap with Goldman Sachs. The spot rate for city notes due in 1996 is 4.10%, said officials with Goldman Sachs.
The note pays the holder a fixed rate of 5.1 5% until Dec. 1, 1994. After that, if the 3-month London interbank offered rate is at or below 4.50%, the notes will continue to pay 5.15%. But if the Libor is above 4.50%, the notes will not pay any interest until maturity. The Libor rate is about 3.50% today.
Aaron Gurwitz, vice president and head of municipal capital markets at Goldman Sachs, said the yield to maturity of the notes would be 5.15% if the Libor is below the threshold, or 1.89% if the Libor is above the threshold.
"The yield curve is pricing in 100 basis points of tightening by the Federal Reserve over the next year, and the market expects short rates to rise 100 basis points," Gurwitz said. "Our forecast is that no tightening is likely by the end of next year."
New York City considered several other derivative structures, but none achieved sufficient savings, according to Roger Anderson, bureau chief for debt management for the city.
The Texas Turnpike Authority recentl reviewed proposals for a $100 million to $200 million forward deal to lock in a synthetic fixed rate for outstanding debt that cannot be advance-refunded. The outstanding bonds were issued in 1982 and were advance-refunded in 1985 and 1989. Under existing tax law, they cannot be advance-refunded again and are not callable until 1998.
A turnpike official said the authority's board will meet later this month to decide whether or not to proceed with the forward swap. No swap provider has been selected yet, although the authority has narrowed the field to eight firms after 23 firms responded to a request for proposals.
Because the bonds are not callable until 1998, the forward premium would cover four or five years - a long time in the forward market.
One official working on the deal said the authority would have to pay 150 to 200 basis points as a premium on the synthetic rate it locks in to account for the long forward period. Since the coupons on the outstanding bonds are as high as 7.125%, the deal could still create savings at current rates.
The San Jose Redevelopment Authority sold $674 million of tax allocation bonds last Wednesday, including about $73 million of derivative products.
Merrill Lynch & Co. managed the issue and structured bonds in the 2012, 2013, and 2014 maturities as floating rate securities and corresponding inverse floating rate securities.
The first two maturities carried bond insurance from Municipal Bond Investors Assurance Corp. and were rated triple-A by Standard & Poor's Corp., Fitch Investors Service Inc.. and Moody's Investors Service. The 2022 maturity was not insured and carried A ratings from all three rating agencies.
New Jersey's $1.3 billion note sale last Wednesday was a smashing success for the state, but less so for derivatives dealers. The state allowed bidders to structure the notes as fixed-rate notes, variable-rate demand obligations with put rights and liquidity backing, or as index-linked floating rate notes without liquidity backing.
New Jersey received bids totaling $11.25 billion for the offering, but all of the eight winning bids included fixed-rate structures.
CS First Boston ended up with $500 million of the notes, but all priced at fixed rates of 2.2340% and 2.2685%.
The firm also bid for $400 million of the notes at 2.3334% structured as variable-rate demand obligations. The CS First Boston bid was the lowest bid including a swap, but was 3/4 of a basis point over the highest bid of 2.3260% accepted by the state.
Smith Barney Shearson bid for $250 million of the notes structured as index-linked floating rate notes with a swap. Donaldson, Lufkin & Jenrette Securities Corp. bid for $250 million of the notes structured as index-linked notes. Kidder, Peabody & Co. bid for $260 million of notes structured as index-linked notes.
