Long-term bonds--the bonds that finance buildings, bridges and other important pieces of public infrastructure--came in at an all-time high of $358 billion. That was an impressive 25 percent gain over 2001, which had already gone into the record books as a strong year. Not all of that issuance went to new projects: Nearly 30 percent of it was in refinancings, a way for government issuers to tap lower interest rates to decrease the size of their debt payments. Short-term debt--the notes that are often issued to cover cash flow problems--also surged, coming in at $72 billion, a 28 percent increase over the previous year.
Short-term rates are down even more than long-term ones, having dipped below 2 percent for almost two years. Issuers that have borrowed at variable rates have been big winners, says John Nelson, a senior vice president at Moody's Investors Service, a credit rating agency. There is little expectation that rates will jump drastically, which means, Nelson adds, that variable-rate bonds may become more popular among state and local governments.
Given the disillusionment investors had with the stock market and corporate behavior, it is not surprising that many of them rediscovered the safety and stability of muni bonds. Since 1940, municipal bonds have had an extraordinarily low rate of default.
There were less upbeat realities reflected in bond activity. Some of the issuance reflected the fiscal stress being felt in the states. Many of those who had not already done so in 2000 or 2001 rushed to convert future tobacco-settlement payments into cash in hand now. The conversion was a tool of choice to bail out budget shortfalls, says Claire Cohen, a vice chairman of credit rating agency Fitch. There were some slight variations on the deals. Both Missouri and Oregon, for instance, added investor appeal to their tobacco bonds by putting their own credit behind the issues.
Another sign of state fiscal stress was the increased issuance of bonds for projects that normally would have been pay-as-you-go. Alaska, Cohen points out, borrowed "for the first time in forever." There should be more of the same this year, Cohen speculates, as budget problems deepen and state and local governments turn to more forms of deficit financing.
Along with a supersized market last year came some supersized deals. California finally put together and sold--to the tune of $11.3 billion--its long-expected bond to cover what it paid out to make sure homeowners could get electricity during the state's energy crisis of 2001. The size of that bond was exceeded, though, by the $13.5 billion refunding completed by the New York City Metropolitan Transit Authority. These two, plus four others, are the Deals of the Year for 2002--innovative ways in which states and localities borrowed money.
ELECTRIC SHOCK: CALIFORNIA DEPARTMENT OF WATER RESOURCES
California's experiment in electricity deregulation took it on the chin in 2001. Energy prices went through the roof, utility companies lost their creditworthiness and rolling blackouts became a way of life. To keep the lights on, the state stepped in and bought electricity on the utilities' behalf--$10 billion worth. The cash came from the general fund and from a consortium that lent the state the money. Last year, the state sold $11.3 billion in bonds to repay its debt. Rate increases for utility customers are paying off the bond premiums.Given the size of the deal, California made an effort to appeal to the widest marketplace it could, says state Treasurer Philip Angelides. A range of maturities was offered, and both taxable and tax-exempt bonds were sold.
It took a while to bring the bond to market. Although the structure was simple, the deal was being put together in the midst of what Angelides describes as a storm of sorts: Pacific Gas & Electric, one of the utilities involved, had declared bankruptcy and was suing the state. "People had to feel comfortable that the underlying security would be levied, was collectable and would withstand any legal challenge," he says.
In a recent development, the state attorney general's office is asking the Federal Energy Regulatory Commission for refunds of what California calls overcharges and is suing several companies, charging market manipulation, illegal rates and antitrust actions. Any money recovered would help pay off the bond.
PUMPING UP PENSION FUNDS: SAN DIEGO COUNTY
Last year, San Diego County had to face a problem many other localities and states are also dealing with: unfunded liability in pension funds after portfolio investments lost money. The county decided to borrow money to meet the obligations. To get the lowest rate possible on the $750 million deal, officials offered a variety of pension obligation bonds designed to appeal to as many buyers as possible. There was the plain vanilla fixed-interest bond and less traditional auction variety of variable-rate securities. And then there was the $100 million in bonds that were listed on the New York Stock Exchange in October. The lowest denomination was $25."People know they have to hold bonds until maturity. There's no easy way to sell them," explains Bill Kelly, county treasurer. "The challenge becomes what can we do to create retail interest but avoid this hindrance?" The answer was to structure the notes so they look like equity and make them available on the NYSE, where they could be bought and sold easily.
Being listed on a stock exchange is unusual but not unique: The county was preceded by New Jersey and Philadelphia in listing its bonds on the NYSE.
Not only was the product successful, Kelly figures, but it also got San Diego County's name in front of investors so that they will remember it. To get a better picture of those investors, Kelly tracked where they lived: 27 percent of sales were to people who live in the Southeast; 23 percent were sold to New Yorkers; and 14 percent were gobbled up by Southern Californians.
In tough times such as these, the county treasurer says, it's especially important not to focus just on revenues and expenditures. "Don't take a myopic view that only goes from July 1 to June 30. You need to take advantage of assets like credit ratings."
BRIDGE BUILDING: BAY AREA TOLL AUTHORITY
Fifteen years ago, San Francisco Bay Area voters approved raising tolls on bridges to $1, with the money going for two new bridges and widening the San Mateo bridge. The cash accumulated, but no action was taken. Then, in 1998, authority for managing and funding the bridges switched from the state to the Metropolitan Transportation Commission. Officials there began running the numbers to see how much they had and how much was needed. The annual revenue totaled $120 million; construction costs would come to $1.6 billion.To make the numbers work, chief financial officer Brian Mayhew's office came up with a plan to sell $900 million in bonds over five years, assuming interest rates notched down to 5.5 percent. Last year, the rates cooperated, and the Bay Area Toll Authority went to market with a $300 million deal that included $100 million in variable-rate debt, plus one complex--and money-saving--piece: a $200 million forward-starting, credit intermediation swap.
The "forward-starting" part means that the agreement was signed last May, but the exchange of the variable-rate bonds didn't happen until this past March. And the "credit-intermediation swap" part means that instead of swapping variable-rate bonds for a fixed-rate payment with a bunch of counterparties, BATA contracted with only one entity-- Ambac--which simultaneously gave pieces of the deal to Salomon Smith Barney, Morgan Stanley and J.P. Morgan, firms that had been selected by the toll authority to participate. BATA will pay Ambac 4.13 percent for 35 years; Ambac will pay BATA the variable rate for 35 years; BATA will pay the bondholders. As a result, average debt cost over the 35- year life of the transaction will be 4 percent. "The structure is working beyond anything we envisioned," Mayhew says.
In a sense, the deal actually was simpler than many swaps from the issuer's point of view, since the toll authority only had to put together one contract. And Ambac required no collateral in case the bonds are downgraded later on, which was another advantage. "We got all the safety and security we wanted," Mayhew says.
Now the Carquinez bridge is underway and is scheduled to be completed by the end of the year. It will be the first suspension bridge built in the United States in nearly 40 years. The rest of the money will go to the San Mateo bridge and rehabilitation projects.
A TAXING ISSUE: NEW YORK STATE
The $225 million personal income tax bond issued last April by New York--the first major issuance of such a bond at the state level-- inaugurated the state's new approach to debt: From now on, it will sell no bonds based on appropriations. Instead, all bonds must be revenue-backed.In the case of personal income tax bonds, 25 percent of all income tax paid to the state is set aside in a separate fund to cover debt service. The money used to go directly into the general fund; typically, New York pulls in about $23 billion a year in income tax.
Once the fund makes its monthly debt payments and sets aside a targeted amount of money for reserves, the income-tax collections start flowing into the general fund. This approach has reassured rating agencies and bondholders. They were also reassured three years ago to know that, as part of its effort to improve its handling of debt, the state had committed to issuing bonds totaling no more than 4 percent of personal income tax receipts annually. The PIT is a logical move in this same direction.
Five state entities may issue PIT bonds, including the dormitory authority (which covers a variety of higher education purposes), the thruway authority, the housing finance agency and the development authority. By December, they had issued a total of $1.8 billion in debt and the bonds came to market on a more organized schedule than the state had been able to achieve before. With fewer bonds going to market, issuance costs are down, and state bonds aren't competing with each other.
New York officials say they expect the structure to hold up well regardless of the economic environment.
CLEANING UP OHIO: STATE OF OHIO
Cleaning up brownfields is expensive. Ohio voters agreed in 2000 to pay for a chunk of that task by tapping into the state's profits on liquor sales. Ohio sets the prices and controls the sale of liquor, excluding beer and wine, and has been using the revenue for economic development and to feed the general fund. What voters signed off on was a proposal to issue $200 million in bonds over four years, $50 million each year, and use a portion of liquor-sale profits to pay them off. Annual liquor sales most recently totaled $498 million, with a net profit of $139 million.The first deal went to market last October. The bonds were long-term, fixed-interest.
To apply to use money from the bond, a township, city, county, port authority or conservancy district fills out a form that goes to whichever one of 19 state public works districts it is in. The district forwards what it judges to be the six best applications to the Clean Ohio Council, which reviews and ranks all the cleanup applications it receives. The council was set up specifically for this purpose and has 13 members, appointed by the governor.
The council funds the top-ranking applications each year until it runs out of money. Last year there were 22 applications; 16 were funded. When the cleanup is completed, each site should be what James Manuel, director of the state's urban development office, calls "shovel ready." He adds that the program has leveraged $43 million in outside remediation dollars for brownfield cleanup.
The state has also set aside $10 million from the bond to help smaller, less well-off communities take some of the preliminary steps necessary to prepare for a brownfield cleanup. A typical need is to assess the site for types of contamination and the source.
BIGGEST OF THE BIG: NEW YORK METROPOLITAN TRANSIT AUTHORITY
There were no precedents for a deal as mammoth as the New York Metropolitan Transit Authority's $13.5 billion refunding. One concern MTA had was bringing that big a bond to the market all at once: If it did so, the market might not be able to absorb so much debt. Not only that, it might be more cost effective to divide and sell. Accordingly, what MTA did was to create four main credits with a total of 18 deals and take six months to bring it to market deal by deal.While the bond sales took months, the creation of the refunding deal took years of work rewriting bond resolutions and setting up a new credit structure with more flexibility to take advantage of new products and no restrictive covenants. "Our credit structure was inefficient," says finance director Kim Paparello, noting unnecessary artificial divisions such as commuter bonds and transit bonds. Legal revisions then had to inch their way through the legislature to permit MTA to issue new types of debt not allowed under its old bond resolutions. "We wiped the slate clean," Paparello says.
Another change is that reserve funds no longer are required, freeing up $1 billion. That, plus the more efficient structure, has added a total of $3.5 billion in issuing capability for the transit agency's capital programs.
