New York City finance officials say they will be asking underwriters for their ideas on how the city can save money by issuing derivatives as part of an upcoming sale of general obligation bonds.
As part of the process, city finance officials say they will mail request for proposals today or early next week to firms interested in pitching ideas on derivatives.
The city requires that any product offered by Wall Street provide a minimum yield savings of 10 basis points, and dealers must meet this requirement for the city's $1.3 billion deal, scheduled for pricing on Nov. 9.
In recent years, swaps and other products commonly referred to as derivatives have cut the city's interest expense by million of dollars. The products took advantage of a bull market that brought yields in the municipal market to their lowest point in decades.
But the municipal market's recent sour disposition has several key city finance officials doubting that even the 'best and the brightest that fill Wall Street's derivatives departments can devise a swap or embeddedcap formula that will work under current conditions.
"I think most derivatives work in a bull market and we're not in a bull market," said Michael Geffrard, the city's first deputy comptroller. "We're unlikely to find any out there, but we might find some need for a customized product."
Peter Shapiro, an executive in the municipal products group at Euro Brokers Inc., also said that the city and its underwriters will face difficulties in developing derivatives for the upcoming sale.
Shapiro attributed the problems largely to market uncertainty, rather than bearishness. Derivatives, such as embedded caps, are used by investors as a hedge against higher short-term interest rates.
Embedded caps pay investors additional interest if rates rise above a certain level. But at the moment, there is no firm conviction among investors that rates will continue to rise, Shapiro said.
"Investors will pay extra for these products, but they must have a view of the market," Shapiro said.
City officials say they expect to know what investors will be willing to pay sometime soon, as underwriters talk to their buy-side accounts and submit their proposals to City Hall and the comptroller's office.
Merrill Lynch & Co. is scheduled to serve as senior manager on the city's next bond issue, which will close Nov. 16. Goldman, Sachs & Co.; J.P. Morgan Securities Inc.; and Prudential Inc. will serve as senior manager for the next three deals, in that order, city officials say.
To bolster retail demand for the November transaction, the city for the first time will extend its order period for a week. City officials say they will give retail orders top priority so the top retail bond firms Can have their brokers place bonds with their retail customers.
At the moment, the city plans on issuing $800 million in fixedrate debt, $300 million in tax-exempt variable-rate bonds, and $200 million in taxable bonds.
The inclusion of derivatives is still a question mark. "That's the $64 million question," said one city finance staff member. "This will be the first time we are going out with an RFP for derivatives in this kind of market."
