CHICAGO - In its third use of a derivative product this year, Chicago will sell $206 million of variable-rate general obligation bonds today in a deal tailored to capture low rates on the long end of the yield curve.
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Banc One Capital Markets Inc. is the senior manager and the swap counterparty on the synthetic floating- to fixed-rated swap embedded in the deal. Mesirow Financial served as financial adviser. Lloyd's of London is providing a letter of credit. Proceeds of the transaction will pay for neighborhood infrastructure projects.
The transaction is part of a larger GO issue that included both a fixed-rate and floating-rate component. The city priced the $55 million fixed-rate piece about two weeks ago and will close on it today. The fixed-rate portion included short to intermediate maturities, while the maturities on the series scheduled to price today begin in 2017 and extend out 35 years.
Chicago, which is hesitant to take on much variable-rate exposure, will pay a fixed rate of 3.57%, according to deputy city comptroller Brian King. The rate is lower than the city would have captured by issuing long-term fixed-rate bonds because the spreads between fixed rate and synthetic fixed rates is wider than normal in the current market.
"The synthetics are more efficient on the long end so the issuer gets to capture the full value of the low interest rates" in the municipal market, said Gene Saffold, national head of public finance at Banc One.
Institutional buyers are reticent to buy long maturities that pay rates well below 5%. That forces issuers to pay a premium on long bonds in the straight fixed-rate market.
The variable rate will be tied to the London Interbank Offered Rate, or Libor, which changes monthly. By tying its payments to the Libor, which is a rate from the taxable bond market, as opposed to a municipal market based on The Bond Market Association rates, Chicago received a better synthetic fixed rate valued at about 10 basis points. The better price for the city is based on the fact that the city assumes the risk of any potential impact on the bonds in the event Congress changes tax laws.
Chicago has little floating debt outstanding and typically has limited that type of debt to short-term borrowing and revenue-backed issues. "The strategy was to get the lower rate on variable-rate bonds but to protect the city from the exposure," said Comptroller Tarique Malhance. The deal marks Chicago's first transaction since Malhance was elevated to the post of comptroller, the office that manages city bond deals.
The city has embraced swaps in recent months like other typically conservative and often plain-vanilla issuers across the country seeking to capture lower interest rates without taking on too much variable rate exposure.
Chicago included a swap in a $116 million sales tax refunding earlier this year that was not going to work as a straight fixed-rate refunding because of negative arbitrage.
The city also entered into a synthetic fixed- to variable-rate swap with counterparty Bear, Stearns & Co. on its $150 million 1998 parking garage bond issue. That deal was struck in an effort to generate up-front payments for the city that could help it cover debt service on the bonds since parking revenues have so far fallen short. Chicago also has two other swaps in place on tax-increment financing bond issues.
