New York City finance officials say they have structured Tuesday's general obligation bond deal of about $1 billion by offering investors a debt mix that will allow the issue to sail through an uncertain municipal market.
The bond issue, underwritten by a syndicate group led by Lehman Brothers, continues a trend of city issues featuring a combination of securities designed to lessen the city's reliance on straight GO debt. The deal includes straight tax-exempt general obligations, taxable and derivative products capital appreciation bonds, and variable-rate securities that resemble commercial paper.
"Basically, our overall objective is to raise money at the lowest cost," said Michael W. Geffrard, director of the city's Office of Public Finance. "This type of deal has been a pattern for us. We like to show as many different credits to the Street as possible. That's the way to save money."
But the deal apparently has yet to receive the full support of members of the municipal buy-side community. In a series of interviews, these investors said they were not sure how well the deal will sell. Several, for example, said the city bonds likely will fall victim to higher interest rates and a growing supply of municipal debt that is forcing yields on the long end of the issue to rise above 7%.
City officials, however, say that despite some buy-side concerns, they feel comfortable the deal will not hit the skids. Geffrard said he met with several Boston-based investors last week who said there is a dearth of New York bonds is the market. These investors also said city bonds offer an attractive yield that should bolster the deal, he added.
New York City, the largest municipal issuer in the country, faces a constant battle in meeting its huge capital needs in a market that is not always receptive to the size of its issuance. As a result, city finance officials in recent years have chosen to diversify the mix of GO bonds they sell by using derivatives and other less traditional products.
In Tuesday's deal, which will be the last of the 1992 calendar year, the city will offer about $645 million of fixed-rate tax-free GOs, and then a host of other securities. The issue, market observers said, actually resembles several different deals, each designed to meet a specific city funding need, or investor preference.
The city, for example, will issue at least $85 million of capital appreciation bonds, under its "NYC BONDS" program. City officials have targeted this zero coupon bond program toward the retail investor class.
The city classified about $10 million of these securities as taxable bonds. Darcy Bradbury, the city's deputy comptroller of finance, said the taxable "NYC BONDS" are targeting investors who need to fund IRAs or other retirement accounts that are already tax-exempt.
The issue also features two derivative products proposed by an Oct. 9 meeting with Wall Street investment banks, where city officials asked 10 investment houses to present ideas on various securities to incorporate into the upcoming deal.
The city last week chose two proposals: a $39 million indexed fixed-rate bond offered by First Boston Corp., and a &75 million taxable adjustable-rate bond proposed by Kidder, Peabody & Co.
The indexed, fixed-rate bond marks an attempt by First Boston to help investors hedge their holdings of inverse floaters. Investors buy inverse floaters based on the market view that interest rates will fall. When market rates decline these securities will pay higher interest to the investor.
But when rates rise, as many market analysts predict for the short term, the interest paid on these securities will fall. The First Boston bond hedges against this scenario by pegging the bonds' interest rate during its first five years to the Public Securities Association Swap index. The securities have a 30-year maturity.
As a result, when interest rates rise, so will the interest paid on that investment, offsetting the investor's loss on the inverse floater.
The city, said one investment banker who asked not to be named, takes some risk on the deal if interest rates should spike in coming months or years. But city officials took the position that outweighing this risk is the steepness of the yield curve, which makes variable-rate debt more attractive.
Like the First Boston idea, Kidder Peabody's pitch also involved identifying an investor class suited to buy the product. Kidder Peabody, sources with knowledge of the transaction said, knew that many investors who purchase commercial paper would also invest in a city bond that mimicked this short-term security. The securities will be insured by Financial Guaranty Insurance Co. for the life of the bond, with a liquidity facility supplied by FGIC Securities Purchase Inc.
The $75 million deal is broken into two maturities: $33 million that matures in 2018 and $42 million that matures in 2019. But in an attempt to create a security that resembles commercial paper, Kidder Peabody designed these bonds to be "put" or sold back to the issuer at certain short-term intervals.
This security also allows the city to take advantage of the cost savings associated with variable-rate securities. Bradbury said that with the spot rate of commercial paper trading at about 3.18%, this product should be sold anywhere from five basis points to 15 basis points above that level.