While the majority of municipal swaps executed so far have been sold on a negotiated basis, issuers are increasingly asking themselves whether competitive bids might not be an attractive alternative.
Representatives of three issuers -- Philadelphia, Connecticut, and the Port Authority of New York and New Jersey -- yesterday explained their reasons for choosing either the negotiated or competitive route on their recent swaps and discussed other major bridges that had to be crossed before signing a deal.
"When Connecticut decided to do it competitively, we as financial advisers weren't sure it was the best way to go," said Robert Lamb, president of Lamont Financial Services Corp. and financial adviser to Connecticut. "As it turns out, they were right."
Earlier this year, Connecticut executed a $ 250 million swap on a competitive basis. A portion of the deal carried maturities as long as 20 years, and, Mr. Lamb sai, he was concerned the market was too small for competitive bids to make a difference.
While officials expected to receive no more than three bids on the deal, seven were offered, and the state was able to realize savings from the process, said Mr. Lamb, during a speech yesterday at a conference on municipal swaps and derivative products that was sponsored by the Institute for International Research.
"The treasurer's office was right in their decision to put this out to the widest audience," he said.
The state was pleased with the results, but, Mr. Lamb said, if he had known how complicated the process was going to be, Lamont would not have charged its standard fee for financial advisory services.
Among the complicating factors, he explained, was that the deal was split into two sections. One section used documentation closely resembling standards swap documents in the corporate sector. But the other half required custom-made documents, adding another layer of intricacy to the deal.
Edward Bell, a public finance specialist for Philadelphia, said the city typically does its general obligation debt competitively, but its $148 million GO swap last year was negotiated because of the special structure needed for the swap. He said, however, the price from Merrill Lynch Capital Markets was a fair representation of the market at the time.
"We went behind Merrill's back" to get quotes from Security Pacific National Bank and BT Securities Corp., Mr. Bell said, explaining that the city wanted to be certain Merrill officials were offering the best price possible. "We found that they were."
The Philadelphia official said the negotiated route has other benefits as well. "The flow of ideas can be choked off it bankers that come to you with ideas are not rewarded with business," Mr. Bell said. "So you walk a tightrope."
Edwin G. McKeever, manager of financing and investment development for the Port Authority, agreed.
Mr. McKeever said firms that bring new ideas or products to the authority are typically rewarded with the deal if those ideas or products are used.
"But our board feels that awarding financial contracts on a competitive basis makes good, sound public policy and sound economic policy, and avoids criticism that can be directed at a negotiated deal," he added.
Beyond whether the deal should come negotiated or competitive, issuers must also grapple with numerous risks associated with swaps that are not part of the normal bond sale process.
One of the most important, according to the swap professionals at yesterday's conference, is counter-party risk -- the risk that the other side of the transaction will be unable to meet the terms of the swap contract at some point in the future.
To guard against such a default, all three issuers said they set minimum standards for the type of firm or bank with which they would agree to work.
Connecticut, rated double-A by both Moody's Investors Service and Standard & Poor's Corp., required its counterparties on the deal to be at least as strong.
"We wanted to make sure that the counterparty was going to be around 10 or 20 years from now," Mr. Lamb said.
The Port Authority, also rated dobble-A, insisted its counterparty be no more than one level below that, or single-A, Mr. McKeever said.
Philadelphia's position was reversed in a sense, since its credit was deteriorating during the time the swap was executed. Its counterparty therefore demanded insurance for the deal with a carrier rated at least double-A.
Mr. Bell said Philadelphia has no plans to do another swap in the near future. But the Port Authority and the state of Connecticut are both considering new deals.
"It is the state's intention to do another one of these puppies probably with the next 12 months," Mr. Lamb said.