Several dozen issuers have used municipal forwards to refund high-coupon debt since the product debuted in 1989, but some are now finding they would have fared better simply biding their time.
Tampa Electric Co., for example, signed a $25 million municipal forward two years ago, securing 1989 interest rates on a deal that came to market last week. But according to quotes from Delphis Hanover Corp. and other market pricing sources, if Tampa Electric had simply waited until last week and done the deal without a forward, the rate would have been between 60 and 100 basis points lower.
The idea was to use a forward to lock in 1989 rates for the future deal, as an alternative to an advance refunding. Federal law prohibits advanced refundings for pollution control bonds.
Two years ago, Tampa signed a contract, arranged by Goldman Sachs & Co., to pay investors 7 7/8% when the bonds were sold in 1991. But current rates proved to be much lower.
Tampa officials say they are happy with the results: The refunded bonds carried coupons as high as 11 7/8%, and the utility was able to "guarantee" a 400 basis point savings two years ago, rather than wait and risk a rise in interest rates at the first call date earlier this month.
But some market professionals say there are better ways to get the same results without leaving so much money on the table.
Joseph S. Fichera, associate director of corporate finance at Bear, Stearns & Co., said he believes bond repurchase plans using tender offers can garner even more debt service savings than forward delivery products, without the risks associated with waiting months or years for the transaction to take place.
In a tender offer, issuers attempt to contact as many bondholders as possible and offer to buy back their bonds. Once the bonds are redeemed, a new bond issue is sold at the prevailing rates, effectively advance refunding the debt before the first call date.
The strategy typically utilizes a dutch auction technique in which bondholders submit bids reflecting the price at which they would be willing to sell their bonds back to the company. The company then selects a price it is willing to pay and offers that price to bondholders that submitted bids at or below that level.
In March, Southern California Edison Co. became the first tax-free issuer to utilize the dutch auction technique, with nearly 50% of bondholders responding and $105 million of the $239 million in outstanding bonds repurchased and refinanced.
Yesterday, Bear Stearns announced a second taker -- the Illinois Power Co., which said it hopes to refinance a large portion of a $316 million issue carrying coupons as high as 11 5/8%.
And the idea is catching on with other firms. Officials at Oglethorpe Power Corp. in Atlanta have announced their intentions for a tender offer of their own, probably handled by Smith Barney, Harris Upham & Co., as part of a massive plan to refinance $860 million in outstanding debt.
W. Leo Payne, vice president of finance at Oglethorpe, said the refinancing process will be handled in several stages, utilizing forward delivery products, forward swap contracts, and the tender offer.
The utility hopes to use a tender process to eliminate at least $200 million of the total, Mr. Payne said, with forwards and forward swaps playing a role in another $400 million portion. The rest, depending on how the early stages of the process go , could be held until the first call dates, he said.
In 1989, Oglethorpe signed a forward delivery contract for about $92 million of bonds, deliverable in 1992. But Mr. Payne said the remaining $860 million of outstanding debt could not have been handled entirely that way.
Pointing out that only a little over $1 billion of municipal forwards have been executed in the history of the product, he said handling the entire deal that way would virtually double the size of the market with just one issue. "That's too much for the market to digest," Mr. Payne said.
While the tender plan might be expensive at the onset, it will be tried before the other products, because "it gets us the biggest bang for the buck and brings in savings in 1991," Mr. Payne said. "That's versus a forward which will not generate savings until a year or two or three out."
D. Jeffrey Penney, a vice president at First Boston Corp., said tender offers can sometimes be an appropriate choice over a forward. But he said a careful examiniation of cash-flow differences must tbe undertaken to determine whether the premium for an early tender is outweighed by the premium issuers must pay for a forward delivery product.
But he said the basic advantage of the forward is the certainty of locking in interest rates, and cleaning up the entire issue with one deal. Tender offers generally only persuade a portion of bondholders to turn in their bonds.
"Many times a known interest rate at a certain level is bettern than an unknown," Mr. Penney said. He said issuers like Tampa Electric are not complaining when their forwards are delivered during periods when prevailing interest rates are lower, because they are satisfied with the security of guaranteed rates.
Mr. Fichera, however, warned that despite how they are marketed, forwards are not "guarantees" of a certain rate. Rather, he said they are merely a bet on where interest rates are headed, and hinge on the presumption that circumstances will still permit the issuance of bonds on the agreed upon delivery date, and that investors will honor their side of the contract.
Among the factors that might prevent the bonds from being sold after the contract is signed are potential changes in state and federal law further restricting the amount and kind of private-activity bonds that can be sold.
If that happened, the issuer would be exposed to market risk and would have to forego the savings that would have been captured by a repurchase arrangement.
Tax implications are another question mark associated with forwards, according to Market sources. Tax opinions for the deals typically include language warning that the opinion applies only "assuming there is not change in state or federal law" between the time of the contract and the date of the bond issue.
Mr. Penney said concerns about these risks should not be enough to dissuade issuers from using forwards. "These bonds are delivering exactly at the rates at which they were priced," he stressed.
As an added layer of security for many of the deals, investors are required to put up collateral to guarantee they will come through with their promised investment. And Mr. Penney said First Boston even offers insurance against changes in tax laws that could scuttle a deal after a contract is signed.
"But nobody's wanted it," he said. "It's perceived as a non-issue."
Most market professionals seemed to agree there is a place for many different kinds of alternatives to advance refundings, as long as issuers understand fully the risks and benefits before signing up.
"If you want to take the bet on a forward, it may be a good bet," Mr. Fichera said. "But don't think of it as anything but a bet."