LOS ANGELES - A financing for several sanitation districts in Orange County, Calif., has extracted some extra savings out of a long-dated interest rate swap by taking the unusual route of using a daily rate in the transaction.
The deal also drew several bidders vying for the long-dated swap, a growing trend in the municipal derivatives market.
Such bidding is common in arranging shorter-dated swaps. But the increasing interest on the part of providers for longer swaps suggests this area also could become "more of a commodity that you bid," said Patti Gorczyca, the financial manager of County Sanitation Districts Nos. 1, 2, 3, 5, 6, 7 and 11 of Orange County.
Gorczyca said the sanitation districts' transaction also helped illustrate the overall value of an interest rate swap.
The Orange County districts arranged the swap in connection with the advance refunding of $46 million certificates of participation. Merrill Lynch & Co. priced the deal Tuesday at a daily rate of 2.55%.
In conjunction with the refunding, Societe Generale entered into a 23-year swap agreement with the districts. Such swaps provide an issuer with a synthetic fixed rate, even though the certificates feature a floating rate.
Societe Generale will also provide liquidity support for the life of the issue. Merrill will act as the remarketing agent for the bonds.
Until this year, AIG Financial Products, the triple-a rated subsidiary of American International Group Inc., was the only significant provider of swaps lasting more than 20 years.
In fact, Orange County used an AIG long-maturity swap on a similar transaction last year.
But earlier this year, Societe Generale began providing similar products. And on several occasions, Morgan Guaranty Trust Co. of New York, a subsidiary of J.P. Morgan & Co., has provided long-maturity swaps, market sources said.
The number of players is expected to continue growing. "There'll be other players, " noted Stephen R. Coma, a Merrill Lynch director who worked on the Orange County deal. "Frankly, it's good for the market. More people will bring greater liquidity and efficiency."
The competition for the swap on the districts' bonds was similar to a competitive negotiated situation, according to officials on the deal. The officials solicited bids from swap providers over a period of several weeks.
Because the deal included such a complex structure, the competition was based not just on the price of the swap but also on the terms and conditions offered by the swap providers.
AIG, Societe Generale, and General Re, an insurance company, participated in the competitive process. an official on the deal said.
From the districts' standpoint, the rate is lower than could be obtained through a straight fixed-rate sale without the swap.
The districts also believe they squeezed more savings out of the transaction by structuring it with the daily rate, rather than with the weekly floating rates often used in such deals. Gorczyca estimates the sanitation districts saved an extra seven basis points by using the daily mode.
Some derivatives professionals who did not work on the deal questioned the savings, however. They asserted that the lower daily interest rate would be offset by the higher cost of resetting and remarketing the securities five times a week.
But the seven basis-point savings take into account all fees on the structure.
Most swaps including a daily reset rate have been linked to short-term note deals.
AIG has not completed any swaps with daily reset rates, according to market sources. But Lehman Brothers officials said they had used this approach previously on a 17-year transaction for another California issuer.
The reset rate on the Orange County deal can be changed to a weekly rate, a commercial paper-like rate, or a fixed rate, at the county's option.
The synthetic fixed-rate structure provided present value savings of slightly more than 4%, compared with an estimated 2.16% savings for a traditional fixed-rate advance refunding structuring, according to an analysis of the deal.
The ill-in true interest cost for the approach with the derivative is about 5.1%. compared with about 5.52% for a traditional refinancing, Gorczyca said.
The certificates carried bond insurance supplied by AMBAC Indemnity Corp. AMBAC also insured the districts' obligation under the terms of the swap.
The certificate sale and swap portion both closed this week. The swap rate, with a net present value of 4.56%, was locked in last month, Gorczyca said.
A Societe Generale official said the swap appealed to his firm because it involved a "highly sophisticated issuer" that is also "an extremely strong credit."