Minority- and woman-owned firms are making some inroads into the lucrative municipal derivatives market, but they have a long way to go before becoming regular participants.
Connecticut's recent appointment of Boston-based Innova Securities as a swap adviser on its upcoming $800 million to $1 billion issue marks one of the few times a minority- or woman-owned firm has acted in that capacity.
Small firms, including those owned by women and minorities, have been mostly left on the sidelines as the volume of tax-exempt derivatives and interest rate swaps has grown, derivatives experts say.
"Generally speaking, few minority firms have been appointed on derivatives deals," a public finance official at one of the 10 largest minority-owned firms said. "More and more what you find is, not just with the minority firms but across the board, people are fighting to break into that part of the business."
Artemis Group, a prominent woman-owned firm, advises clients on the use of derivatives, but does not provide proprietary products or swaps itself. "We can give objective advice to our clients," said Robin Wiessmann, a principal at the firm. "Any firm in the municipal marketplace will have to be knowledgeable. This is the big growth area."
The major players in the derivatives field have large amounts of capital available, numerous clients engaged in swapping, and hightech systems to track the business. With the proper pieces in place, the firms can act as swap counterparties, taking the opposite side from an issuer in a trade of cash flows.
But even large firms without the capacity to act as counterparties can and do participate in swap deals.
PaineWebber Inc. and Donaldson Lufkin & Jenrette Securities Corp., for example, arrange swaps for their clients while acting as senior managers on bond offerings. The firms solicit competitive bids for swap counterparties.
Tracking the leading providers of municipal swaps is difficult. Securities Data Co., a leading provider of municipal market information, does not track swap advisers or counterparties. And sometimes the firms providing swap-related services are not disclosed.
While minority- and woman-owned firms are routinely included in underwriting syndicates, relatively few issuers have decided to give them a role in swaps.
Possibly the first issuer to include such a firm as a swap adviser was the District of Columbia. District officials asked Merrill Lynch & Co. to include minority-owned firms Pryor, McClendon, Counts & Co. and WR Lazard Laidlaw & Mead as swap advisers on its $230 million swap in March 1992.
"Derivatives and swaps in municipals are important new product areas," said Courtney Knight, managing director for public finance at Pryor McClendon. Although the firm has not completed work on another swap since the District of Columbia deal, "we look forward to more involvement in that area," he said.
"It's a logical extension," a public finance official at another minority firm said.
Innova, a minority-owned firm, and Lehman Brothers will structure an interest rate swap on $300 million to $350 million of the Connecticut issue. The swap will lock in a synthetic fixed rate for the state on floating-rate bonds.
"Their role comes directly from the treasurer's interest in helping minority firms get educated and get access to all aspects of the bond business," said Benson R. Cohn, debt management director for the office of state Treasurer Joseph P. Suggs.
The firms and the state have not determined the exact roles and responsibilities for the swap, officials said.
Benjamin Blakney, president of Innova, said his firm suggested the swap in an oral presentation to the state. Blakney was the treasurer of Philadelphia in 1990 when the city entered into a $148. million swap.
Innova has been a co-manager on nine municipal issues totaling $1.68 billion so far this year, according to Securities Data. Last year, the firm served as a co-manager on 18 deals totaling $991 million, and in 1991 the firm was a co-manager on three issues totaling $541 million. The firm has yet to be a senior manager on any deal, according to Securities Data.
Not everyone on Wall Street is happy about the inclusion of minority- and woman-owned tirms on derivative and swap deals. These firms appear to be running into the same criticisms and obstacles that they encountered when they entered the municipal industry - that they lacked the experience, staff, and capital to operate in the industry.
Today, though, many of those firms have achieved higher rankings as underwriters, including as senior managers, and have become specialists in a variety of financings, including certificates of participation.
"There are many, many situations where people who have no swap desk get hired to broker, agent or execute a swap, and that can be frustrating to those of us in the [swap] dealer community," one swap professional said.
But the professional said he did not object to experienced firms that lack swap capabilities, including woman- and minority-owned firms, asking for bids on their swap-based deals. "If you are a good underwriting firm and you know what's going on, that's very different from someone who doesn't understand swaps at all."
Compensating minority- and woman-owned firms for work on swaps can also be controversial. On most recent swap transactions, the swap provider is not paid an upfront fee for arranging the swap. Instead, the provider builds in the fee by adjusting the spread between the two cash flows that are being exchanged.
For example, if a firm agrees to pay an issuer a floating rate based on the PSA Swap Index, the issuer agrees to pay the firm a fixed-rate close to what it would pay on its fixed-rate bonds. But the provider bumps up the fixed rate slightly as compensation for arranging and executing the swap. The fixed rate is still lower than the issuer would pay on its bonds.
But if a minority- or woman-owned firm is included on a swap and the fee is built into the swap, there is no ready cash available to pay the firm for its advisory work.
Merrill Lynch was paid just over $2 million up front for its work on the District of Columbia swap, according to documents released by the city. The firm declined to comment on Pryor's compensation. A Pryor official said he could not recall how the firm was compensated.
Since then, up-front fees have attracted some unfavorable attention. Last month, Philadelphia Treasurer Kathleen Engebretson told a meeting of the Government Finance Officers Association in Vancouver, British Columbia, that a swap done by the city in 1990 was now losing money, in part because of a $1.5 million up-front fee paid to Merrill Lynch.
Merrill Lynch officials could not be reached for comment.
In some cases an up-front fee may be acceptable and, in other cases, there are alternatives, derivatives professionals noted. The issuer could compensate the minority- or woman-owned firm directly with a separate fee for helping to structure the swap. Or a firm could be compensated for being an underwriter on the bonds being sold in connection with the swap.
"Issuers should be careful when structuring a swap about making or receiving an up-front payment," swap consultant Leslie Rahl warned. "It can make a lot of sense, but it depends on the nature and magnitude of the transaction."How Innova Stacks UpTop minority- and women-ownedsenior managers, 1993 to date Principal amount (millions) 1 Reinoso & Co. $560.8 2 Grigsby Brandford & Co. 439.3 3 Pryor, McClendon, Counts 255.2 & Co. 4 Artemis Capital Group Inc. 185.0 5 M.R. Beal & Co. 168.5 6 Llama Co. 118.5 7 Apex Securities Inc. 55.8 8 WR Lazard & Co. 54.7 9 First American Municipals Inc. 22.710 PHN Capital Funding Inc. 16.2