Derivatives activity sagged last week when issuance dried up in the primary market.

But with rates climbing, underwriters expect continued activity in interest rate swaps and forward deals.

Forward swap transactions have become popular in recent weeks with issuers who cannot advance refund debt and fear that rates will continue rising.

In a forward swap, the issuer agrees now to a deal that occurs in several years. When the contract date arrives, the issuer sells floating-rate bonds and enters an interest rate swap to lock in a synthetic fixed rate.

The rate on the forward swap is set at current low rates plus a premium designed to allow the swap provider to hedge against any shift in rates during the forward period.

An issuer could also enter a simpler, forward delivery contract. That kind of deal calls for the issuer to sell fixed-rate bonds several years from now at today's rates plus a premium.

The forward swap transaction can lock in a lower fixed rate for some issuers, however.

While the rising rates encourage forward transactions, the accompanying market volatility hurts primary market derivative issuance in two ways.

Since fewer deals are priced, there are fewer opportunities to add structured securities. "My pipeline was full, but as the big refunding deals have fallen off the calendar, things have dried up," one derivatives professional said.

And with rates moving around, underwriters selling derivatives have a harder time figuring out what yield will provide savings of at least 10 basis points above fixed-rate bonds, a common requirement of issuers.

"It's nice to talk about saving 10 through spot, but you have to know what spot is," another professional said.

Last Thursday's $262 million issue for Housing New York Corp. did not contain derivatives, although market players said the issuer considered selling floating-rate securities and corresponding inverse floating-rate securities. Instead, however, the deal was priced entirely as fixed-rate bonds.

Two weeks ago, the Metropolitan Nashville Airport sold $53.4 million of insured variable-rate notes due in 2019. The airport saved 20 basis points over a conventional structure by entering a long-term swap with Societe Generale to create an "all-in" synthetic fixed rate of 4.865%.

In the secondary market, Moody's Investors Service rated eight new derivatives issues during the week of Nov. 15.

Secondary-market derivatives are created when underwriters purchase ordinary bonds in the secondary market, place the bonds in a trust or partnership, and then issue private securities structured as derivatives from the trust or partnership.

The secondary activity indicates "that there is some demand for certain specific names," one derivatives professional said. If an investor wants a derivative from a specific issuer, an underwriter can find ordinary bonds from that issuer in the secondary market, even if no new issues are priced.

Two of the secondary market issues were structured as variable-rate tender option bonds carrying liquidity support from Morgan Guaranty Trust Company of New York.

Six of the secondary market issues were structured as puttable floating-rate securities and corresponding inverse floating-rate securities.

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