But there were still signs of good market health. Even in a year when the stock market dominated investors' strategies, the marketplace was still able to absorb nearly $226 billion in new bonds. With 13,000 issues coming to market, long-term bonds in 1999 notched their fourth- strong-est year in the decade. "That underscores the resiliency and flexibility of the marketplace to meet needs," notes Micah Green, chief operating officer of the Bond Market Association.
Market watchers at Fitch IBCA, the rating agency, saw a particular trend developing in last year's approach to issuance. More special- purpose entities were created to issue bonds, notes William Streeter, a senior director at Fitch. These one-purpose bonds, which do not have a broad-based government or enterprise standing directly behind them, tend to be higher-risk issues--and that translates into higher premiums issuers had to pay to attract investors.
Two other elements with a growing presence in the 1999 marketplace were securitization and sales of bonds over the Internet. Securitization, with a well-defined source of repayment money behind it, offers the possibility of a stronger rating because it helps decrease the possibility of bankruptcy on the part of the bond issuer, says Alan Anders of the New York City Office of Management and Budget. The city, in fact, was one of the preeminent securitization issuers in 1999: It used tobacco payments to securitize the first-ever tobacco- settlement bonds--an approach that is likely to be copied by several states and localities in the coming year.
Electronically, Pittsburgh again approached the cyber edge with the first direct sale of bonds on the Internet to institutional investors. Clearly, the use of electronic auctions to sell bonds continues to gain believers.
Here's a look at bond deals that were breakthroughs in 1999.
NEW YORK CITY: TOBACCO TIME
New York City was the first jurisdiction in the country to issue bonds linked to the $206 billion settlement that tobacco companies signed in November 1998 with 46 states and Washington, D.C. The city assigned its right to 40 years of settlement revenue to TSASC, a corporation set up just for that purpose. Last November, TSASC offered $709.3 million in bonds, which buyers quickly snapped up.The bond sale proceeds will come in handy. For the last five years, the city has bumped up against a constitutional cap limiting its debt to the value of 10 percent of the acreage in its real-estate tax base. The city's Office of Management and Budget considers it an outdated formula, since real estate now provides only 30 percent of the city's income.
To help assuage its capital budget's hunger pangs, the city had recently sold a $7.5 million bond backed by the city's income tax and secondarily by the sales tax. That went well and made the city want to try another structured financing. The upcoming revenue from the tobacco deal seemed like the ideal opportunity. To make it happen, the city set up the TSASC (TSASC used to stand for Tobacco Settlement Asset Securitization Corp., but now the alphabet-soup version is the legal name) and authorized it to sell a total of $2.8 billion in bonds over the next four years.
The bonds' warm reception in the market might have been due to their unusual, if somewhat complex, setup. First, although the bonds go out 40 years, they are scheduled to be paid off in 30 years. Having bonds paid off earlier than is required tends to be a selling point for investors. Second, anticipating concerns about tobacco companies' financial health--and their long-range ability to honor the settlement--New York established so-called "trapping" triggers: "Every year, we capture enough money to pay debt service, while the overage money will continue to go to the city. We promised that if any one of the major companies gets into serious problems, we will trap even more of the moneys," Anders says.
Bond rating agencies: Duff & Phelps Credit Rating Co., Fitch IBCA, Moody's Investors Service, Standard & Poor's Lead underwriter: Salomon Smith Barney
TULARE COUNTY, CALIFORNIA: TURNING TOBACCO FUNDS INTO A LEGACY
Tulare County, California, also decided to funnel tobacco-settlement money into capital projects, but it took a very different approach than New York City. With securitization prohibited in California, the county instead will use the proceeds of a $45 million bond to establish an endowment--the Millennium Fund--that is intended to grow to at least $60 million. Tobacco-settlement money will be used to help pay off the bond.There were other reasons that the county chose to set up the Millennium Fund. One was to ensure that the settlement revenues not be absorbed into operating budgets, explains Alex Burnett, managing director of Public Financial Management, which worked with the county to design the fund. Also important was to protect the general fund from the inherent uncertainty and timing issues of the settlement. In addition, the county wanted to create what Burnett called "a lasting legacy, some tangible benefit that was measurable and that ultimately would provide a stable source of revenue for capital projects."
In less than three years, the Millennium Fund is designed to no longer count on any contribution from tobacco revenues, so that even if tobacco-settlement revenues fall off dramatically, the fund could pay off the bonds, Burnett says. The county expects to see about $4 million a year come in from the settlement. Money in the fund will be invested in high-grade fixed securities and actively managed.
On May 1, 2000, July 1, 2001, and July 1, 2002, $2.5 million will be paid out to the county from the fund for capital proj-ects. Beginning April 1, 2004, if the value of the Millennium Fund is more than $60 million, the county may request any amount from the fund as long as its value doesn't dip below $60 million.
Bond rating agencies: Fitch IBCA, Moody's Investors Service Letter of credit: Bayerische Landesbank Girozentrale Lead underwriter: Morgan Stanley Dean Witter
PITTSBURGH: THE CYBER EDGE
In 1998, Pittsburgh was the first jurisdiction to sell an issue online. Now it has another e-first under its belt: In November, it opened up its electronic sale of $56.9 million in general obligation bonds to institutional investors. They responded with enthusiasm, thus broadening the city's bidding base. "We believe we got a better price" than via the more traditional approach, says Finance Director Ellen M. McLean.A total of 195 bidders signed up, although only 45 entered the auction. Of those who entered, a little more than half actually submitted bids. Some were broker-dealers; a majority were institutional investors. In terms of dollar volume, the broker-dealers won $40.8 million of the deal, or 72 percent, while the institutional investors won $16 million, or 28 percent. Pittsburgh accepted bids only for individual maturities rather than for the entire deal. Each maturity received an average of at least eight bids.
Although there were no technical or legislative hurdles to jump, McLean notes there was a lot of "gnashing of teeth by giants of the financial world." Some big broker-dealers reportedly pressured institutional investors not to participate, and the city was warned that such a sale would not bring it the best bid and indeed was jeopardizing taxpayer money.
As a result, a few investors were nervous that the bonds might not be easy to resell in the secondary market. Others talked about possibly forming their own syndicates to buy and sell--foreclosing the need for broker-dealers. At any rate, McLean says the bonds have sold just fine in the secondary market.
Bond rating agencies: Moody's Investors Service, Standard & Poor's Bond insurer: Financial Guaranty Insurance Co.
BROWARD COUNTY, FLORIDA: AN UNDERLYING CHANGE
A simple twist to a well-established bond format solved several problems at once for Broward County, Florida.When it began considering a new issue, the main goal was to help fund a much-needed $330 million expansion of Fort Lauderdale-Hollywood International Airport. Passenger facility charge revenue (the PFC is the per-passenger fee tacked on to most airline tickets) was targeted as a source to tap, but PFCs traditionally are rated a full step below general aviation revenue. That would have meant working with BBB credit, something the county was reluctant to do since it would have entailed paying higher interest rates than officials had in mind. Relying on PFCs also would tie up the revenue and make it impossible to use later on for other capital projects.
So, prodded by consultants, the county went to market in January 1999 with a brand-new type of hybrid: a $126.67 million convertible-lien bond. Until 2012, the issue is secured solely with PFC revenue. Afterward, the underlying security becomes airport system revenues.
This was a variation on the usual tradition of having convertible- lien bonds depend on a so-called triggering event to change the underlying security. The approach, says Phillip Allen, director of finance and administrative services for the county, may be useful to jurisdictions needing to finance projects that do not generate revenues or that generate revenues more slowly early on. A water-sewer bond in Virginia already has followed Broward County's lead and used this structure.
The funds from this bond, plus $63.5 million from a general aviation bond issued at the same time, will provide the wherewithal for new terminals and additional parking. The expansion is important, Allen says, because "we view our airport as a significant economic engine for the county," and demands on it are increasing.
Bond rating agencies: Fitch IBCA, Moody's Investors Service, Standard & Poor's Lead underwriter: Lehman Brothers Consultant: Leigh Fischer Associates Bond insurer: Ambac Assurance Corp.
PORTLAND, OREGON: A DESIRE NAMED STREETCAR
To help redevelop part of its downtown into a new mixed-use neighborhood, Portland, Oregon, is using an old-fashioned tool: streetcars. The new transit system will run a 4-mile loop in the Central City area, north of downtown. The area used to be a warehouse district and train marshaling yard but is on its way to becoming a neighborhood densely packed with more than 5,000 housing units, ranging from subsidized to luxury, plus restaurants and businesses."The streetcar will help with circulation in dense neighborhoods, making it attractive to people looking to live downtown," says Kenneth Rust, director of the city's Bureau of Financial Management. Construction began last spring. The track is in, cars have been ordered and passenger service is scheduled to start next spring. No fare will be charged, and the streetcars will run between 16 and 20 hours a day.
Since the city can't plan on money from fares to cover costs, officials had to figure out how to pay for the $52.1 million project. They put together a package that includes a $29.2 million bond, assessments on property owners, urban renewal bond funds, federal transportation and housing grants--and $2 million from the City Parking Facilities Fund.
While it may seem counterintuitive for municipal parking garages to support a streetcar system, Rust says it actually makes a lot of sense. Demand is overwhelming for parking spaces, and it's very expensive to build downtown. So a proj-ect that will cut down on the number of cars parking downtown is a boon. In fact, while the bonds are secured by the general fund, the money to pay bondholders comes from parking garages and meters. Parking rates even were raised recently to help with the funding.
Rating agency: Moody's Investors Service Lead underwriter: Merrill Lynch
WISCONSIN: OPTIONAL DEADLINES
In 1999, Wisconsin became the first jurisdiction to try out a new form of short-term financing called extendable commercial notes. It's an alternative to traditional commercial paper.The state issued two ECNs in short order, one for $50 million and one for $75 million. Unlike commercial paper, ECNs, a Goldman Sachs product, offer the issuer the option of extending the maturity date beyond the original one. That way, a borrower buys time if the notes can't be remarketed or paid off--without any hassle or negative reflection on its credit.
In addition to providing deadline flexibility, ECNs also generate savings by eliminating the need for a line of credit. Instead, investors take on a little extra risk, and for that they are subject to a higher interest rate.
For the issuer, however, there are administrative savings since there's no need to expend time and energy in renewing lines and letters of credit, says Frank Hoadley, Wisconsin's capital finance director. In addition, Hoadley adds, spikes in short-term interest rates mean that issuers on average probably pay less interest by keeping some notes on the shorter end of the yield curve.
As with commercial paper, the maturity varies from 1 to 270 days. If Wisconsin chooses to extend the maturity date, it has up to 90 additional days, and the state is already mulling ways to win legal permission to make its extension longer.
Although the state continues to issue traditional commercial paper, Hoadley expects to see Wisconsin use ECNs more and more. He cites several reasons besides savings to turn to ECNs. Letters and lines of credit, he says, typically "are laden with outs" for the bank. "In other words, the time you need the liquidity will probably coincide with the event that triggers an out for the provider," he says. And there are no longer many providers around. There were 25 just three years ago, but today there are fewer than half that many. With less competition, fees tend to be higher.
Bond rating agencies: Fitch IBCA, Moody's Investors Service, Standard & Poor's
DOUGLAS COUNTY, COLORADO: MAKING ROOM FOR CHARTER SCHOOLS
Charter schools nationwide face a number of challenges, and one of the most basic is finding a facility. Last year, for the first time ever, a municipal bond was sold to help a charter school construct its own building. The Colorado Educational & Cultural Facilities Authority, in fact, issued three such bonds in quick succession. The first one evaluated by the rating agencies was for Core Knowledge Charter School in Douglas County, just south of Denver. "Our district is the fastest- growing in Colorado," says Bill Reimer, chief operating officer for the school district. Potential space for a building for the charter school is limited because expansion in the commercial sector is exploding, making land expensive. "It's a real dilemma to get facilities at a cost-effective price," Reimer says.Although it took changes in state legislation to allow it, the district may now issue bonds, with the proceeds going to a nonprofit foundation formed for charter schools. The foundation builds a facility, and the charter school then leases it. The lease is structured to cover debt payments and pay off investors. Meanwhile, the school district gives the charter school a per-pupil figure of $5,000 annually, the same amount the district budgets for each public school student. Lease payments are largely made out of the per-pupil stipend.
The proceeds of a $2.8 million bond will build a 26,000-square-foot school on six acres. It will house the 297 Core Knowledge students in kindergarten through eighth grade. A $3.65 million bond was sold for another of the six charter schools in the county, and a $2.5 million bond will help the Jefferson Academy build in Jefferson County.
Bill Dougherty of underwriter Kirkpatrick Pettis says that he expects to see a number of similar bonds in other states. "Really what it takes is someone in the financial establishment to take an interest."
Bond rating agency: Standard & Poor's Lead underwriter: Kirkpatrick Pettis
MASSACHUSETTS: WATER, WATER EVERYWHERE
To help localities abide by the Clean Water Act, state revolving funds have been making loans for more than a decade. The money goes to build wastewater and sewer facilities. More recently, revolving funds also were set up to help with the Drinking Water Act.Massachusetts realized that by combining financing for both programs, it could be more efficient and earn better credit for the newer program. In addition, the state convinced the federal Environmental Protection Agency that it made sense to offer localities the option of a 30-year loan instead of being limited to loans for no longer than 20 years. Thus, last October the Massachusetts Water Pollution Abatement Trust sold $271 million in bonds, with the proceeds financing both types of projects and available for the longer term--a first.
Federal legislation had been in place since 1997 to permit this kind of cross-collateralization, but extending the loan term was another story. Getting permission to do that required almost two years of negotiations with regional and national EPAofficials. They were concerned that the change might not be legal and also that it might reduce the state's ability to fund projects because its money would come back in more slowly, says Jeff Stearns, deputy treasurer for debt management for the state.
But Massachusetts officials satisfied EPA that the change was within the spirit and letter of the law. They also made changes in their financing parameters to make sure the money would recycle. The negotiations were a hard thing for the EPA people to do, Stearns says. "To their credit they didn't give up." And now several Massachusetts communities are the beneficiaries. Given the option, some communities have chosen the 20-year timetable and some the 30-year.
Rating agency: Standard & Poor's
