New Jersey plans to sell $1.3 billion of short-term notes today, using a competitive structure in which firms can bid on the deal as either fixed-rate notes, standard variable-rate demand notes, notes pegged to an index, or a mixture of the three.
The two variable-rate portions will require swaps to offset the state's exposure to interest rate fluctuations.
The variable-rate demand obligations will have a put feature and carry a standby purchase agreement from Swiss Bank and Credit Suisse.
The synthetic fixed-rate note structure tied to an index was first used by California in July and then by New York City in October, with each pegged to the Public Securities Association's swap index. But neither of those deals was sold competitively.
Massachusetts offered underwriters the PSA note structure as an option in a competitive deal last month, but the offering was sold entirely as fixed-rate notes when the rates offered on that portion proved more favorable than the variable-rate structured tied to a swap.
Despite what one state official called a "smorgasbord" of choices available to firms bidding on the New Jersey note deal, market sources say it is possible that today's issue might also come entirely at a fixed rate. Lately, yields available through the swap market suggest that the derivative structures might not generate savings comparable to those from a fixed-rate deal.
The combination of variable-rate bonds and an interest rate swap can frequently create a synthetic fixed rate lower than an issuer would get by selling ordinary, fixed-rate debt.
In last month's Massachusetts offering, the state set a savings target of 10 basis points to justify using the derivatives structure. But CS First Boston's bid of 2.684% on the $250 million deal was considerably lower than that of any of the bids that included derivatives.
New Jersey has not set a minimum savings target for its deal. Up to $250 million of the deal can be structured as indexed notes, but they will not carry put rights or liquidity enhancement. Robert Lurie, New Jersey's director of public finance, said the state will accept bids only for the entire $250 million of indexed notes.
The series B, or variable-rate demand note portion, can be sold in increments of $200. million, up to $1 billion, Lurie said.
The fixed-rate portion has no maximum bid restrictions, and will be sold in increments of $25 million. Lurie said the smaller size is designed to give small firms, including minority- and woman-owned firms, access to the deal. But he said he still expects firms with lower rates of capitalization to participate in the deal through syndicates.
The use of the three different structures in a competitive deal is unique, market sources said. "We have seen a few competitive deals including derivatives, but the ability to use any of three structures is a new twist," said a derivatives professional familiar with the deal.
In May, Osseo School District, Minn., used a competitive offering to sell $47 million of derivatives. The district was the first to use a true competitive structure that included derivatives.
Although no major competitive sales are scheduled for the remainder of 1993, market sources said they expect to see the index-linked note structure frequently in 1994.
The structure is best suited for high-quality, well-known issuers, professionals said. The notes must have a final maturity of less than 397 days and cannot have a maximum rate to qualify for money market funds.
Under current securities laws, tax-exempt money market funds may not purchase any securities with a final maturity longer than 397 days. The funds must also maintain an average maturity of 90 days.
Since the index-linked notes are usually reset weekly and do not have a maximum rate, the funds can count the securities as having a seven-day maturity, which helps them lower the funds' overall average maturity.
New Jersey announced earlier this week that 12 firms had prequalified to bid on the swap portions of the deal: Bank of America; Citibank, N.A.; Credit Suisse Financial Products; First National Bank of Chicago; Goldman, Sachs & Co.; Lehman Brothers Holdings Inc.; Merrill Lynch Capital Services; Morgan Stanley Capital Services Inc.; Nationsbank; Sanwa Bank Limited; Sumitomo Bank Capital Markets Inc.; and UBS Securities Inc.