LOS ANGELES — An elephant-sized issuer is preparing to enter the swaps arena, but it will be tiptoeing slowly. Faced with plans for a sizable increase in debt issuance, the California treasurer’s office is preparing a swap program, deputy treasurer Paul Rosenstiel said here yesterday at The Bond Buyer’s National Municipal Derivatives Institute. In 2006, state lawmakers approved a bill authorizing the treasurer to use derivatives in connection with general obligation bonds authorized from 2006 onward. Not coincidentally, California voters approved $43 billion of GOs in 2006, with Gov. Arnold Schwarzenegger pushing a program to ask for another $29 billion of GO authorization by 2010.That means the state’s outstanding GO debt, currently below $40 billion, is projected to top $100 billion during the coming decade, and its annual debt service, currently at about $3.5 billion, is expected to pass $10 billion, Rosenstiel said. “It’s a big jump, especially in a state where we continue to have trouble with our budget,” he said. “We look at swaps as being able to help us achieve a lower cost of funds.” Derivatives will also help California diversify its buyer base, a response to worries that traditional buyers and insurers will run into capacity constraints, Rosenstiel said. The treasurer’s office is preparing a swap policy it expects to adopt this year. “Probably within the year we’ll be doing some swaps,” he said. “The first ones are going to be kind of dry runs. While we’ll probably begin to use swaps soon, we’ll probably build our program slowly.”In six years, the overall derivatives market has grown from $63 trillion outstanding to $325 trillion, said conference chair Craig Underwood, president of Bond Logistix LLC. “Most people would agree growth in the municipal derivatives sector is at least as strong as the whole derivatives sector,” he said. Panelist Peter Block, a Standard & Poor’s director, said he’s noted similar growth managing the rating agency’s derivatives team. “We estimate about 20% of issuers in the municipal market have entered into swaps,” he said.Panelist Marcia Maurer, chief financial officer of the Sacramento County Sanitation District Finance Authority, exemplifies the growing municipal market acceptance of derivatives. Her agency, which has about $1.5 billion of debt outstanding, entered its first swap in 2003 and now has five swaps. Issuers considering swaps should begin developing a swap policy, according to Maurer. “Opportunities will come up and it’s nice to have your swap policy in place and ready to go,” she said. Maurer said it’s important to make sure the execution of the swaps is monitored, because big banks can make mistakes, as she learned first hand. “It’s important to have someone reviewing those payments,” she said. “I can’t emphasize that enough, especially when you’re dealing with the back office.” Issuers are becoming more and more sophisticated in the way they view the derivatives market, with a better ability to measure relative risks and rewards, Underwood said. One problem, however, is that new derivative products are proliferating faster than the tools to analyze them, he said. There are also challenges in adapting derivative products to the federal tax issues unique to the municipal market, according to Underwood. “As new products arise, we’ve seen lots of challenges making sure the documentation fits the peculiarities of the muni world,” he said.
