New York is known for setting trends, not jumping on the bandwagon late. But the state took a wait-and-see approach for its first Build America Bonds, coming this week as part of a $1.24 billion personal income tax bond issue to be sold by the Dormitory Authority of the State of New York.
More than half those bonds, $710 million, will come to market as taxable BABs, according to the preliminary official statement. About $395 million are expected to be tax-exempt, and $135 million will be traditional taxable debt. The final mix could change, depending on investor demand.
The bond proceeds will be used primarily for capital projects on State University of New York and City University of New York campuses.
The deal will be the third BAB sale in the state, following a $750 million deal from the Metropolitan Transportation Authority in April and a $14 million deal by Oneida County last month. Issuers of BABs receive a 35% subsidy from the U.S. Treasury Department on their interest costs.
The state waited to get into the BAB market, which was created this year under the American Recovery and Reinvestment Act, because officials wanted to see any kinks get smoothed out first, said Dominic Colafati, the state's chief budget examiner.
"We usually don't see a lot of advantage in being the first mover on these things," Colafati said. "We wanted to see what the market reaction was and hopefully any efficiencies and confusions that might be there would be worked out before we would think about getting into the market."
Colafati said the state hopes to save more than 50 basis points with the taxable BABs over tax-exempts. While a dollar savings amount can't be calculated until after the deal prices, he said he hopes the BABs, which are subject to being called at a make-whole redemption price, will result in about $100 million of savings.
"We want to make sure when we go out with our BAB sale that the true interest cost of the sale is going to provide us savings relative to what we could have achieved in the tax-exempt market," said Colafati. "Really, beyond a break-even analysis, I think what we're looking for is to be compensated for what we say our call value is."
Merrill Lynch & Co. is the senior managing book-runner on the BABs. Goldman, Sachs & Co. and Loop Capital Markets LLC are co-senior managers. The bonds will be sold with maturities from 13 or 14 years out to 30 years.
Sidley Austin LLP is bond counsel on all the series.
Merrill Lynch will solicit investor interest today and determine a pricing scale based on a spread to Treasuries. Tomorrow, the bank will release a formal pricing scale and take orders for the bonds from institutional investors.
M.R. Beal & Co. is book-running lead manager on the tax-exempt Series 2009D and taxable Series 2009E. Morgan Stanley is co-lead manager.
A retail order period will begin on the tax-exempt bonds today with institutional pricing on both tax-exempt and taxable beginning tomorrow. The tax-exempt bonds are expected to have shorter maturities, out to 13 or 14 years and the taxable Series 2009E bonds are expected to have a 10-year maturity, but the final structure hadn't been set on Friday. New York's so-called PIT bonds are its primary financing vehicle and are sold through five public authorities: DASNY, the Empire State Development Corp., the New York State Thruway Authority, the New York State Environmental Facilities Corp., and the New York State Housing Finance Agency.
The state, which has about $51 billion of debt outstanding, expects to market $5.9 billion of bonds in the current fiscal year, of which more than two-thirds will be PIT. The state has sold $14.52 billion of new money bonds on the PIT credit since it was introduced in 2002, according to Thomson Reuters.
The debt is backed by a pledge, subject to appropriation, of 25% of state personal income tax receipts. In the event the Legislature fails to appropriate adequate funds to service the debt, the state comptroller is required to transfer funds from the state's general funds to cover the obligation.
State tax revenues have fallen dramatically since the fiscal year began on April 1. Last month, Gov. David Paterson announced that a $2.1 billion deficit had opened up in the current fiscal year, just four months after the state passed a $131.9 billion budget.
The economic downturn has hammered income tax revenue, which fell $584 million below projections in the first quarter of the fiscal year to $7.7 billion, which in turn is $4.2 billion lower than the first quarter of fiscal 2009. State wages are projected to decline by 4.8% in calendar year 2009, the largest decline since the state began keeping records in 1975. The declines come despite a temporary tax increase on the wealthiest earners, some of whom work in the financial services sector, which has been hit hard by the credit crunch and recession.
Paterson and Lieut. Gov. Richard Ravitch are working on a plan due next month to address the state's long- and short-term fiscal problems.
New York's fiscal stress hasn't shown up in the PIT bond ratings. Standard & Poor's last week affirmed its AAA for the credit and Fitch Ratings its AA-minus.
"The AA-minus rating incorporates variability in the revenue system and the financial services dependence, and the stable outlook assumes they'll address the $2.1 billion [gap] in the same way they addressed the problems over the course of fiscal 2009 and close the gap in fiscal 2010," said Fitch analyst Laura Porter. "Even though there is significant PIT softening, it's bolstered by the fact that they have temporary rate increases ... there's no concern the personal income tax would not be sufficient."
Standard & Poor's analyst Robin Prunty said the state's decline in personal income tax receipts would be much worse were it not for the tax increase on high earners.
"They have revised the personal income tax downward but even with that, you're still looking at coverage in excess of six times," Prunty said.
Moody's Investors Service does not rate recent PIT issues.
The state was in the market on Wednesday last week with a smaller PIT deal sold through the New York State HFA that comprised $97 million of tax-exempt bonds and $103 million of taxable bonds. The tax-exempt series priced to yield 5.10% on a 30-year 5% coupon, which was 46 basis points higher than Municipal Market Data's triple-A general obligation yield curve on that day. On the short end, the deal yielded 0.81% on an 18-month 2% coupon. The taxable series priced at 4.91% on a 10-year bond, which was 120 basis points over U.S. Treasury yields.
The state's fiscal situation has given pause to Evan Rourke, portfolio manager at Eaton Vance, who said the investment management firm is unlikely to participate in the deal.
"We think there's more risk in the credit at the moment than the market's pricing in so we've been kind of leery of holding PIT debt in general," Rourke said. "Not that we think there's a default [risk] ... we just feel that the trading spreads at the moment don't justify taking on those bonds."
Joe Darcy, senior portfolio manager at Dreyfus Corp., said he has concerns about how the economy could affect the liquidity of PIT bonds in the secondary market.
"I don't think the integrity of the credit is in question," Darcy said. "While the credit structure you own is impeccable, its performance characteristics may be challenged by that market environment."
Despite those concerns, Darcy said he thought the deal would be a win-win for the state because the federal subsidy on the BABs would reduce its borrowing costs, while demand for tax-exempt paper in the face of reduced supply would push down interest rates on the tax-exempt series.
"The Build America Bond deal in New York is going to attract attention because there continues to be attention from traditional taxable investors in this comparative credit municipal vehicle that comes at relatively wide spreads in comparison to that credit characteristic," Darcy said. Interest could be tempered due to lingering concerns over liquidity for BABs in the secondary market compared to other taxable debt, he said.
"The attention and some interest that has come into the BAB market begins to wane when they face the liquidity challenges that municipals sometimes operate with," he said.
