BOSTON -- The Massachusetts Water Resources Authority took a major step last week toward entering the commercial paper market.

Last week, the board of directors of the MWRA voted to allow the authority's chief executive officer, chief financial officer, and treasurer to begin a process that could end the authority's presence in the derivatives market.

The board voted to allow the authority to begin a full or partial reversal of two interest rate swap agreements with counterparty Merrill Lynch & Co. that have been in place since 1990.

The board's approval was unanimous, and the authorization to reverse the swaps will remain in place until the end of March 1995.

Reversing the swaps will protect the authority against rising short-term interest rates, said Barbara Gottschalk, chief financial officer of the MWRA. It should also help the planned commercial paper program, she said, because rating officials will include the swaps when rating the paper.

"As we get further into a commercial paper program, there is only a limited amount of short-term debt that we can have," Gottschalk said. "We want to have the maximum amount of flexibility when we size the deal."

The swaps would be counted as part of the authority's short-term portfolio.

The authority is planning an initial offering of commercial paper of as much as $350 million.

The swap agreements between the authority and Merrill have, according to officials at the MWRA, earned the authority $14 million. The swaps were scheduled to be in place through 2000.

"The authorization will allow us to either reverse the swaps or enter into a counterswap with another party," said Gottschalk. "We went to the board because we wanted to be protected against rising interest rates."

Gottschalk said that although the swaps continue to be profitable for the authority, rising short-term interest rates have reduced the authority's return.

Under the swap agreements, the authority agreed to pay Merrill Lynch interest on the principal amount of the swaps at a variable rate based upon a short-term interest rate index.

One swap pays Merrill based on the J.J. Kenny mid-grade index, minus 1.1%. The second swap is based on the same index, minus 1.25%.

On the other side of the swaps, the authority receives payments from Merrill Lynch based upon the principal amount of the swaps at a fixed rate of 7.56%.

In the MWRA's staff summary, obtained by The Bond Buyer, the board was warned that if interest rates continue to rise, the swaps could become a liability for the authority.

The swaps were designed to act as a hedge for the other short-term investments in the authority's portfolio. But as short-term rates have risen, the need for the hedge has decreased, Gottschalk said.

If the swap reversal takes place, it will also erase one of the authority's last ties to former financial adviser Mark S. Ferber.

Ferber, who served as the authority's financial adviser for more than 10 years, initiated the two swaps with Merrill Lynch in 1990.

Although the swaps benefited the authority, an undisclosed contract between Ferber and Merrill. Lynch raised questions about whether the authority was getting the best financial advice from Ferber.

Over a three-year period, Ferber, then a partner at Lazard Freres & Co., was paid a retainer of $2.8 million by Merrill Lynch for help in establishing Merrill in the swaps market.

Ferber's and Merrill Lynch's attorneys have denied that the contract had anything to do with MWRA business.

Nonetheless, the authority dismissed Ferber last year after it learned of the terms of the contract.

Ferber, who was also fired from his subsequent position as co-chairman of First Albany Corp., is the subject of several federal and state investigations.

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