Analyzing and Evaluating Tax-Exempt Indexed Floaters: Investor and Issuer Perspectives
Yingchen Li Executive Director JPMorgan Securities
Increasing issuance of indexed bonds is a new trend in the municipal market. All indexed bonds are long-term variable rate bonds that passively reset based on the reference indexes. Common reference indexes include three-month LIBOR, BMA 7-Day Index, and the 5- or 10-year CMS (constant maturity swap rates). The first such bond is the Detroit Sewer Disp Revenue Floater sold on 12/14/2006. The bond pays a quarterly floating coupon of 67% × 3-month LIBOR + 60 basis points and matures on 7/1/2032.
Although relatively new for investors, LIBOR-indexed floaters are equivalent to synthetic floating structures from the issuer’s perspective. Suppose an issuer has a fixed coupon bond outstanding and receives 67% of LIBOR swap of the same maturity. The net position for the issuer is a synthetically floating rate position which is equivalent to a LIBOR-indexed floater.
The synthetic floating activities of issuers used to be concentrated within the 10-year maturity and mostly BMA based. From this point of view, LIBOR-indexed floaters represent the issuer’s push toward LIBOR-BASED synthetic floating in the longer part of the curve.
BREAKEVEN EQUATION FOR THE ISSUER
Most of the index bonds sold so far are LIBOR-indexed floaters paying a coupon of the form 67% × 3ML + Fixed spread, where 3ML means 3-month LIBOR. We would like to derive a breakeven ...