ORLANDO, Fla. -- Kentucky's debt manager predicts increased issuance of non-dollar-denominated taxable municipal bonds, but warns borrowers to be aware of the limitations of this type of debt.
"I think we will see more of these financings because they can be an efficient and effective means of accessing taxable funds, providing interest-rate savings and broader market access," James Ramsey, executive director of the state's Office of Financial Management, said here Monday at the annual convention of the Government Finance Officers Association.
"But while there are clear opportunities for savings, issuers should recognize that they may face limitations in using the proceeds of these borrowings and may encounter unexpected costs," he added.
Mr. Ramsey said some valuable lessons can be found in the March 1989 sale by the Kentucky Development Finance Authority of 10 billion yen of taxable bonds.
The development authority was the first municipal issuer in the nation to sell a non-dollar, taxable bond issue, Kentucky officials say. The $77.7 million of proceeds generated by the deal have been used to finance loans to industries in Kentucky.
Mr. Ramsey said the authority realized a savings of about 30 basis points over what it could have obtained through a comparable domestic borrowing. He attributed this to the fact that the sharp differential between interest rates charged in the Japanese and American credit markets more than offset the cost of swaps that protect against possible currency exchange and interest rate risks.
But Mr. Ramsey said the currency swap necessary to protect the authority from the fluctuations in value between the dollar and yen has limited the flexibility of the authority's loan program. The swaps protect the issuer from interest rate and currency losses by allowing it to exchange, for a fee, its yen-denominated debt service payments for dollar-denominated payments.
Mr. Ramsey said that because the swap must be unwound to obtain cash for lending, which is a time-consuming process, the authority has found it can only offer loans every six months. This same constraint makes it impossible to offer loans amortized on a monthly basis, previously a typical feature of the authority's economic development lendings.
He also said the officials who have actually lent the bond proceeds did not understand the complexity of the deal because they were not sufficiently involved in its original structuring.
"All these factors hurt the marketing of the loans, and this has been a big problem for us," he said.
Issuance costs were greater than they would have been in the United States on a comparable deal, Mr. Ramsey said, because of the need to hire both a Japanese and an American law firm. He also said a Japanese commission bank as well as lead underwriter were necessary.
The authority has so far lent out only $37.7 million, or 48.5%, of the $77.7 million of original proceeds, Mr. Ramsey said. It is committed to five additional borrowers totaling $10.6 million and has loan proposals pending for the remaining proceeds, he said.
But despite the limitations, Mr. Ramsey said he considers the program a success and said the authority would consider another such borrowing.
"It did not solve all of [the Kentucky Development Finance Authority's] problems, but rather offered KDFA another tool in its economic development arsenal," he said. "Also, we learned a great deal about the swap market, and we have been able to use that information, both on the asset and liability side of the state's balance sheet. And we believe that it did improve the financial community's perception of Kentucky."
In addition, he applauded New York City's efforts to arrange a yen-denominated bond issue. New York City hopes to sell about $100 million of yen-denominated securities in September.
Another speaker at the Government Finance Officers Association's meeting, Gerry Lawson, a Canadian municipal debt manager, also offered practical advice to municipal issuers considering selling non-domestic debt. Mr. Lawson, commissioner of finance at the Regional Municipality of Hamilton-Wentworth in Ontario, Canada, said his local government has completed four overseas financings since 1985 totaling about $300 million.
Mr. Lawson urged issuers mulling such deals to choose good lead underwriters who know the investment community in the target country. He also said that European and Japanese investors prefer well-known issuers with a double-or triple-A rating.
In addition, Mr. Lawson said that overseas borrowers favor issuers that structure deals to accommodate market preferences and that are willing to support their deals in the secondary market.
"A borrower who willingly buys his issue on an ongoing basis will establish a good set of contacts in the secondary market," he said, "and this will improve the credit when future issues are considered."
The Canadian official said the issuer selling non-domestic debt can make money from the swap portion of the deal.
"In fact, the swap portion of an international borrowing can often add icing to the deal as profits are available there too," he said.
He said his municipality has saved between 1/8 to 1/4 percentage point over what would have been the available rate in Canada.