The Handbook of Municipal Bonds

CASE STUDY 19

Massachusetts Sells LIBOR Index General Obligation Bonds with an Interest Rate Swap

Sylvan G. Feldstein, Ph.D. Director, Investment Department Guardian Life Insurance Company of America

 

Patrick Landers Assistant Treasurer Commonwealth of Massachusetts

 

 

 

This case study describes a new type of long-term bond issue that came into vogue in the early part of 2007 in the tax-exempt municipal bond market. It is a form of a structured note called LIBOR index bonds. What is unique about it is that the coupon payment to investors is reset every quarter and established in a formula based on LIBOR, the London Interbank Offered Rates for U.S. dollar deposits. Prior to this new structure, tax-exempt floating rates were determined by a remarketing or auction process. This structure already exists in the corporate markets and is known as a floating-rate note (FRN).

In May 2007, the Commonwealth of Massachusetts sold $1,046,710,000 of general obligation bonds. What was innovative about this issue was that approximately two-thirds came as LIBOR index bonds with term bonds of (1) $65,750,000 due on November 1, 2018; (2) $31,665,000 due on November 1, 2020; (3) $348,380,000 due on November 1, 2025; and (4) $400,000,000 due on May 1, 2037. The rest of the bond issue came as fixed rate serial bonds. Half of the bond proceeds were used for refunding outstanding issues and half of the bond proceeds were for new money. The bonds have call features and sinking funds.

The authors were assisted ...