Not all firms offering municipal derivative products are created equal, and issuers say they are becoming increasingly aware of the traits that separate one from another.
Whether the distinction is credit quality, commitment to derivatives, or strong client relationships, talks with several issuers found a growing awareness of the different reputations of companies' derivatives units.
Officials at the Salt River Project in Arizona, for example, are looking for a firm to handle an upcoming swap, and say the cliques that are emerging among providers affect the selection process.
Bear Stearns & Co. has underwritten the project's last several bond deals, but the company is "not a top candidate" for the swap program because it is not among the elite derivative providers, explained Anastasia Song, an analyst in the project's treasury office.
BT Securities, on the other hand, has decided to stress derivatives over traditional underwriting, and that commitment puts them on the short list, she said.
"We're looking for dealers that have experience, particularly because we don't," Ms. Song explained.
Credit quality is high on the priority list of the Salt River Project and of most other issuers contacted. For years, bankers offering derivative products have stressed that counterparty credit is even more important on derivatives than with standard underwriting, because the derivatives relationship can last decades instead of just the few months needed to prepare and sell a bond issue.
The emphasis on credit quality is apparently paying off for firms like J.P. Morgan Securities Inc., which has a triple-A rating "and never lets you forget it," as one issuer put it.
Another issuer who said he is concerned about credit quality agreed that firms like J.P. Morgan stand out. But Smith Barney, Harris Upham & Co. has also caught his attention, because the firm has joined forces in a loose alliance for swap business with triple-A rated AIG Financial Products Corp.
Smith Barney and AIG have also made a name for themselves among issuers by taking on particularly long-dated swaps, including 30-year deals, while most of the rest of the industry limits itself to maturities of 10 year or less.
Merrill Lynch & Co. has not yet brought its triple-A subsidiary on line for municipals, but the firm is still considered "the first name in the municipal swap business," because of its pioneering of municipal swaps in the mid-1980s and the fact that it has handled the majority of municipal swaps ever since, Ms. Song said.
Longstanding relationships, a staple of underwriters' strategies to keep business flowing, also play a role when issuers select a derivatives provider. Goldman Sachs & Co. handles the Salt River Project's $350 million commercial paper program, "so they're in the running" for the swap project as well, Ms. Song said.
The Salt River Project's perception of the various strengths and weaknesses of derivatives providers reflects an understanding of the traits that firms have tried to market over the past several years, apparently with some success.
But some bankers express concern that less sophisticated issuers still do not understand the importance of their counterparty in derivatives transactions, especially interest rate swaps.
One banker, who is in frequent contact with issuers interested in municipal swaps, said knowledgeable derivatives users split the industry into two groups: companies that have a commitment to derivatives, and those that do not.
"Some firms can just walk away from derivatives because they can walk away from municipals without hurting their regular business," he said, pointing to the 1987 exit of Salomon Brothers from the municipal market. "There are a wide variety of providers who may be doing responsible business today, but don't feel a responsibility to this pool of clients."
The banker said issuers who do not recognize the distinction are contributing to the "emerging problem" of transactions that are being done for quick results in the short-term without regard for potential long-term complications.
In addition to firms' reputations, the particular fiscal situation of an issuer plays a role in how it perceives derivatives providers.
Howard Sanders, assistant deputy treasurer for Massachusetts, said a strong reputation in the derivatives area might not be as important for a credit like his state. Massachusetts uses derivatives, but is more concerned with its relationship with investors and the rating agencies as it emerges from credit troubles.
"I'm not sure if it really makes a difference or not if you have that kind of experience," Mr. Sanders said. "Given the commonwealth's needs over the past few years, we haven't focused on using firms with specific expertise in exotic products because we're more worried about getting back to an A rating than getting 10 basis points on a Ribsaver," he said, referring to Lehman Brothers' inverse floater product.
Firms like BT Securities and Citicorp Securities, which have placed their emphasis on derivatives over traditional underwriting business, are fighting the perception among issuers that derivatives are on the exotic fringe of the market.
Martin Ted Mayden, managing director of municipal derivatives at BT Securities, said that perception is diminishing, and stressed that despite an emphasis on derivatives, the bank maintains a strong underwriting department as well and sees derivative products as "a tool in the toolbox."
"We're focusing on the derivatives business and we have a fullfledged municipal capability to support that effort." Mr. Mayden said. "Traditional and derivative capabilities enhance our ability to provide unbiased advice."
Glen R. Sergeon, managing director of Citicorp's municipal finance division, said issuers are somewhat confused about how to interpret the bank's emphasis on derivatives, but he is working to clarify that.
"Just because we have a derivatives focus doesn't mean there aren't a variety of things we can do for an issuer," Mr. Sergeon said. "The reason these products are viable and vibrant is that their prudent use saves money. If an issuer wants to save money, he needs access, and access through a nonprovider is a contradiction."
He said the bank's strategy of placing derivatives at the forefront of its efforts sets it apart from others. But one major issuer said that tactic has drawbacks.
"Many times for derivatives to work they've got to fit into entire financing package," said the source, who is treasurer of a large bond-issuing authority that has used derivative products in the past. "It would be harder for an outside firm to come in and have a grasp of the total picture" if they do not also handle the authority's normal bond financings.
Mr. Mayden said that would be a problem for any firm trying to convince an issuer to switch allegiances, not just firms that emphasize derivatives.