Utilization of an improved forward delivery bond to enhance interest rate management.

• Author: Bohlen, Bruce D.
• Position: Includes related article

In its search for an ideal hedging technique, the Port Authority of New York and New Jersey developed a forward bond that resembled a standard bond issue, with the only difference being that the transaction involved an unusually long delay between sale and closing.

Editor's note: Each year the Government Finance Officers Association awards its prestigious Award for Excellence to recognize outstanding contributions in the field of government finance. This article describes the 1993 winning entry in the capital financing and debt administration category.

The Port Authority of New York and New Jersey, like most issuers, has tried to take maximum advantage of the historically low interest rates that the municipal market has experienced during the past two years by refunding its highest coupon debt. The authority was able to do many transactions as current refundings because the seven- or 10-year call protection on those bonds had expired. Several of its issues, however, including those with the highest interest rates, were not yet callable and because of tax implications could not be advance refunded. This situation led to the authority's interest in and ultimate issuance of an improved forward delivery bond--the subject of this article. To set the framework for the discussion, some background on the Port Authority and its finances, as well as a detailed discussion of its forward delivery bond, follow.

The Port Authority of New York and New Jersey is a bistate agency, established in 1921, charged with the responsibility for planning, constructing, operating and maintaining transportation, commercial and trade facilities in the port district, an area roughly 25 miles in all directions from the Statue of Liberty. It operates and maintains three major airports, two tunnels, four bridges, the World Trade Center, port facilities, an interstate light rail system and various other facilities in New York and New Jersey. Much like a private business, it must rely on the revenues generated by its facilities to pay its operating and maintenance expenses and debt service. It receives no operating subsidies from either the State of New York, the State of New Jersey or the federal government. The authority raises the necessary funds for the improvement, construction or acquisition of its facilities on the basis of its proven revenue generating ability, its substantial reserve funds and its sound credit standing. The Port Authority is a capital-intensive agency that has invested more than $9 billion in the development of its facilities and has more than $4 billion of indebtedness currently outstanding related to this investment. As a public agency with an important impact on the cost of moving people and goods throughout the New York/New Jersey region, the authority must be highly sensitive to the cost structure of its facilities. As a result, the efficiency with which it can finance its capital improvements, as well as refinance outstanding debt during times of low interest rates, is critically important.

As a frequent, consistent issuer of debt, the authority has issued debt in both high and low interest rate environments over the years and was subjected to the extraordinarily high interest rates of the early to mid-1980s. While the agency did many things during that period to ameliorate the effect of those high long-term rates, such as instituting a tax-exempt commercial paper program and issuing one- to three-year notes to access the shorter end of the yield curve, some long-term debt was issued, most of which provided seven- to 10-year call protection in accordance with market requirements.

Searching for the Ideal Hedge

In the late 1980s, interest rates began to approach levels that seemed to make the refunding of the high coupon debt issued in the early 1980s very attractive. The Port Authority faced very imposing obstacles, however. It could not refinance this debt on a current basis because the bonds were not yet callable. It could not refund on an "advance refunding" basis because the bonds were classified as "private activity" debt under the 1986 tax law and thus were not legally eligible to be advance refunded. The authority issues debt on a consolidated basis, meaning its bonds are secured by the revenues of all of its facilities and the proceeds can be spent on any of those facilities. Since the issues in...