Bear, Stearns & Co. managing director Nat Singer said he sometimes feels like Bill Murray in Groundhog Day.
Thats because Singer, one of many interest-rate swap experts on hand for The Bond Buyers Fifth Derivatives/Short-Term Finance conference, has spent the better part of the past decade explaining the nuts and bolts of the tax-exempt bond markets most intriguing and fastest growing segments: interest rate swaps and other structured financial products.
These financial products have made it possible for issuers to capture lower interest rates than they might find in the typical cash market for their debt. Issuers that are considering swap transactions have to be versed in the benefits and the risks associated with these engineered financings. As such, market professionals interested in growing the business have been marketing their services through informational and educational panels at events such as yesterdays.
The conference held at the Roosevelt Hotel in midtown Manhattan yesterday and today attracted more than 275 registrants, and more than two dozen issuer officials attended the opening panel. UBS Financial Services Inc. director Ryan Donovan; Citigroup Global Markets Inc. director Jerry Abrahams; Morgan Stanley managing director Seema Mohanty; and Goldman, Sachs & Co. vice president Kemp Lewis joined Singer on the kick-off panel, which was moderated by Steven Klein, a managing director at bond insurer CDC IXIS Financial Guaranty Inc.
An interest-rate swap in its most basic form is simply a contract between an issuer and its counterparty typically a well-capitalized investment banking firm. Under such contracts, issuers market their bonds to investors at a fixed- or floating-rates and then contract, or swap, their interest-rate payments with the chosen counterparty. The issuer then pays the counterparty interest rates that are either set at a specific fixed level by agreement of the parties or tied to a designated index.
Singer outlined the three most common fixed payor swap models: the actual rate swap; the The Bond Market Association or BMA index swap; and the percentage of LIBOR, or London Inter Bank Offering Rate, swap. The issuer in each model sells variable-rate debt and pays its counterparty a synthetic fixed rate, which is less costly to the issuer than interest rates it would be required to pay if selling into the traditional muni market.
These transactions are priced off a swap curve. Singer showed the audience the simple formula behind the deal using maturity-specific data, the current U.S. Treasury rate is added to the LIBOR indexed swap rate, so a five-year Treasury bond yielding 3.80% with an indexed swap spread of 0.45% would produce a LIBOR swap curve of 4.25%, Singer said. To generate the BMA swap curve, the LIBOR curve data would be multiplied by the percentage variation between BMA and LIBOR for the relevant maturity.
Theres no black box here on how to create a swap curve; theres no magic behind it, Singer said.
While synthetic fixed-rate swaps are more valuable on the long end of the curve, UBSs Donovan said synthetic variable-rate swaps are best used to create attractive rates in the middle to short end of the yield curve. These contracts where the issuer sells fixed-rate debt and swaps it for a synthetic floating rate allow issuers to create variable-rate exposure through a contract, which eliminates some traditional variable-rate debt concerns, such as the threat of wider rate spreads due to a deterioration of the issuers credit, or that of its letter of credit provider, Donovan said.
Citigroups Abrahams discussed one of the faster growing segments of the derivatives market the fixed spread basis swap. These swaps can be used in conjunction with existing or primary market fixed-rate debt and the issuer and counterparty each exchange floating rates, he said. An issuer in a typical FSBS deal will pay its counterparty a floating rate based on the BMA index and will receive in return a fixed spread plus a percentage of LIBOR.
All swaps entail a measure of risk, though over the past 10 years, these deals have consistently produced net positive results, Abrahams said.
