Connecticut this week kicks off institutional pricing for its long-awaited $2 billion taxable general obligation pension deal - the largest bond issuance the state has ever conducted.
"We've been planning this issue for the last couple of years," state Treasurer Denise L. Nappier said in an interview last week in New York City. "A combination of good planning and a little bit of luck says that we should go now. We're in a current low-interest rate environment for taxable issues."
The proceeds will be used to help close a $6.9 billion gap in the Connecticut Teachers' Retirement Fund.
A week-long retail order period took place last week, with Bear, Stearns & Co., JPMorgan, and Merrill Lynch & Co. leading the syndicate.
A $1.6 billion series of current interest bonds includes maturities from 2014 through 2028, with a term bond in 2032. Yields offered as of Friday ranged from 4.20% in 2014 to 5.20% in 2025, priced at par. A $400 million series of capital appreciation bonds maturing from 2014 through 2025 was not being offered during the retail order period.
Nappier announced in January that Bear Stearns and Merrill Lynch would work together as lead book-runner and co-book-runner for the deal. These firms have also led pension obligation bond transactions for Illinois, Oregon, and Puerto Rico.
Citi, Lehman Brothers, M.R. Beal & Co., Morgan Stanley, Ramirez & Co., Siebert Brandford Shank & Co., and UBS Securities LLC are co-senior managers. Over 20 co-managing underwriters are also included in the deal.
Public Resources Advisory Group and P.G. Corbin & Co. are financial advisers on the transaction. Day Pitney LLP and Lewis & Munday are co-bond counsel.
After JPMorgan announced plans to buy Bear Stearns about a month ago, the treasurer's office "elevated them up a notch" to lead book-runner with Bear, Nappier said. Despite Bear Stearns' financial woes, Nappier said she feels confident working with the firm as it has the backing of JPMorgan.
"It was a strong team from day one, and we did that intentionally," Nappier said. "So from day one, we put together a syndicate group to make sure that we had the strength ... if something happened to one of our consultants."
During the state's 2007 legislative session, Nappier and Rep. James A. Amann, both Democrats, proposed the sale of up to $2 billion of bonds to help close the shortfall in the Teachers' Retirement Fund. The bill required the state make the actuarially required payments into the TRF each year. Republican Gov. M. Jodi Rell last August signed the legislation into law.
"I'm very excited that we were able to get the legislative body and the governor to agree that we not only need to address the immediate issue of stopping the uncontrollable growth of the unfunded liability, but we need to put in place a discipline that would prevent [the state] from going back to the habits of old," Nappier said.
Connecticut has not historically contributed 100% of its actuarial requirements. But since 2006, Rell has fully funded the TRF. Under Nappier's legislation, fully funding the TRF going forward is required.
The legislation does give the state relief from payments in an "extreme emergency," but it can never result in the funding ratio of the pension going below what was achieved at the time that the bond proceeds were deposited into the TRF. Currently, Connecticut's fund is about 60% funded.
Bear Stearns prepared an analysis estimating that the funded ratio in Connecticut's TRF would immediately rise to about 70% after the bonds are issued. The actuarial accrued liability should be fully funded at the final maturity of the bonds due to the state making 100% of the actuarial required contributions, or ARC, each year.
The legislation allowed up to $2 billion of bonds with a maximum maturity of 25 years. If the state gets a 5.6% interest rate, debt service cost over 25 years was estimated to be $4.54 billion. But the $6.9 billion unfunded liability is currently charged at 8.5%, so replacing $2 billion of that with an interest rate of 5.6% could save the state about $2.76 billion.
Connecticut has to maintain an 8.5% growth rate on the fund itself in order to exceed interest payments on the unfunded liability. Since 1991, it has done better than that, averaging 10% despite downturns in the market in 2001 and 2002. Fiscal 2007, ending June 30 of that year, had a return of 17.34%, Nappier said.
Since the pension obligation bonds are taxable, officials expect to sell a good portion of the debt overseas. Nappier said when the POB bill was still going through the legislative process, the first calls were from interested international banks in Europe.
The week-long retail order period also allowed the state to market the bonds to thousands of individual investors, and teachers in particular. Nappier's office sent a direct mailing to 90,000 teachers, active and retired, to let them know Connecticut was going to market and how they could purchase the bonds. The treasurer's office also ran a radio advertisement.
"The marketing campaign has been quite comprehensive - unprecedented for the state," Nappier said.
She added that the state also had a "comprehensive institutional investor road show" with presentations from her, assistant treasurer for debt management Sarah K. Sanders, and Rell's budget office. Nappier and Sanders had one-on-one meetings with investors and brokers in New York last week. The state also launched a Web site, www.buyCTbonds.com, that also gives access to the preliminary official statement for the POB deal.
Nappier believes that the issue will attract a great deal of interest world-wide and locally. "The market is quite favorable for a high-quality issue for anyone seeking to capture that kind of security in this volatile market," she said.
Fitch Ratings and Standard & Poor's rate the bonds AA, while Moody's Investors Service assigns the debt its Aa3 rating. Connecticut also received a global scale rating of Aaa from Moody's.
"Connecticut was the first public issuer to seek and receive a corporate global rating [in 2003], so we recognized years ago the tremendous benefit of having that rating as it was more than likely to be higher than the municipal rating," Nappier said.
The treasurer believes a change in the way rating agencies assign municipal bond ratings is needed. She was one of about a dozen state treasurers, as well as other public finance leaders, who on March 4 signed a letter by California Treasurer Bill Lockyer addressed to Fitch, Moody's, and Standard & Poor's questioning municipal ratings.
"I think there should be fairness and uniformity in the view of the credit quality of the issuers and the government and corporate ratings," Nappier said.
While Connecticut had to pay Moody's for its corporate rating in 2003, the agency changed its policy this time around and made it free with the municipal rating for the state.
In addition to the $2 billion POB deal, the state also plans to refinance at the same time, but in a separate issue, $50 million of its taxable GO auction-rate securities. While its auction-rate debt is only resetting at interest rates of about 5%, the treasurer's office thinks it's a good time to refinance the debt. It is also planning to refinance $121 million of clean water revenue auction-rate bonds in either June or July. While the state only has about $183.5 million of auction-rate securities in its $14 billion debt portfolio, it is still trying to be proactive.
"Relatively speaking, when you look at what we have versus our peers, we were very prudent in our use of auction-rate bonds," Nappier said. "And we did lock them in, so we're not dealing with runaway rates here that are double digits."
The pension obligation bond deal comes after years of planning and maneuvering through many legal steps. The Teachers' Retirement Fund provides benefits for any teacher, principal, supervisor, or superintendent in the public school system of Connecticut, and it currently has 62,990 active and former members accruing benefits, and 28,042 retired members. Since Connecticut does not contribute to Social Security on behalf of teachers, the TRF is the only employer-sponsored source of retirement income for Connecticut teachers.
"It's been a long journey to get to this point of working to secure the future retirement benefits for our teachers," Nappier said. "This issue is historic, it's critically needed, it's well-time, and it's worthy of investor consideration."