For the past year, New York City finance officials have billed a planned sale of taxable yen-denominated bonds as a sophisticated attempt to lower borrowing costs by stretching the city's investor base to foreign lands.
In recent weeks, however, city officials working on the potential $150 million issue have acknowledged they are also using the transaction to meet an equally important financing goal - to issue more variable-rate debt.
City officials, who originally planned to create a fixed-rate liability, say they have recently designed the yen deal as a floating-rate transaction for a number of reasons.
Under current market conditions, they say, variable-rate securities can help the city save money because interest rates on the short end of the yield curve are much lower than long-term rates.
In addition, the officials say they want to sell more floating-rate debt - as opposed to fixed-rate debt - because it would better match the interest rates the city is earning on some of its short-term investments.
The officials say they now have a mismatch of interest rates on some investments made by the city. For example, one official said, New York City has about $ 550 million of outstanding variable-rate debt compared to an average of $1 billion of outstanding short-term investments that are subject to daily, weekly, or monthly interest-rate fluctuations.
Due to this investment mix, a decline in short-term interest rates will cause the city to lose almost twice as much interest earnings on its investments than it gains from lower debt service on its variable-rate securities, according to the official.
"We decided to do this as a floating-rate deal because there was a potential to save more money," said Roger L. Anderson. bureau chief for debt management at the city comptroller's office. "Variable rates are lower than fixed rates. But the city also needs to issue more floating-rate debt" as part of its debt management policy. Under the terms of the deal, expected this month, the city will sell floating-rate bonds based on the London interbank offered rate to a newly created, not-for-profit corporation, the New York City Samurai Funding Corp.
At the same time, the corporation will sell Yen-denominated "Samurai" bonds to Japanese investors. The Samurai bonds will have maturities ranging from seven to 12 years. The city will make floating-rate interest and principal payments to the corporation.
The corporation, in order to make debt service payments to Japanese investors, will use a counterparty to swap the floating interest and principal payments made by the city in dollars into fixed-rate yen. A counterparty will also be used to swap the yen proceeds into dollars.
The corporation, which did not need the approval of the state or the city council, was established because local finance law prohibits the city from issuing bonds other than those denominated in dollars.
Staffers in the office of New York City Comptroller Elizabeth Holtzman said the yen deal, which could be the forerunner of other foreign-denominated city bond issues, could save the city between $1million and $3 million over the life of the bonds.
Anderson said the savings are based on a comparison of hypothetical floating-rate securities sold to investors in the United States.
The variable-rate offering will be set on the Libor rate plus as much as 130 basis points, city officials said.
When compared to issuance of dollar-denominated, fixed-rate debt, the deal could save the city substantially more money over the life of the variable-rate issue, Anderson said.
Assuming current interest rates hold steady, the deal could produce savings of up to $50 million over 12 years, Anderson said. He said Libor is at historic lows and may be set to rise.
But even if Libor does spike, the city is almost fully hedged because it has $1 billion in short-term assets that will also benefit from higher short-term interest rates, Anderson said.
New York City, which in 1991 received state legislative authority to issue floating-rate bonds, faces several significant hurdles in increasing its floating-rate exposure.
In recent years, the city has encountered difficulty obtaining letters of credit, which are needed to sell most variable-rate bonds.
Last month, city finance officials said they reached agreements with a new syndicate of banks to provide letters of credit for $350 million of floating-rate debt.
But some banks are hesitant to provide LOCs to New York City, given its credit history, budget woes, and complexity of its debt load.
Another obstacle is the interpretation of the local finance law by Brown & Wood, the city's bond counsel, said Homer D. Schaaf, a partner there.
