Regional News

California’s $3 Billion ERB Deal

SAN FRANCISCO — California plans one of the biggest long-term tax-exempt bond offerings of the year next week, $3 billion of sales tax-backed economic recovery bonds in a deal created to restructure the state’s outstanding deficit bonds to account for unexpected weakness in sales tax revenue.

Structuring details were scanty yesterday morning, other than a preliminary official statement outlining preliminary plans for a $2.6 billion fixed-rate Series 2009A and a $400 million floating-rate Series 2009B.

Voters approved up to $15 billion of deficit bonds in 2004 to help the state clean up the mess from the budget crisis that followed the dot-com bust.

The bonds are backed with a dedicated quarter-cent sales tax, plus the state’s full faith and credit, a structure that allowed the initial deal to garner low double-A and high single-A ratings when the state’s general obligation ratings were at triple-B levels.

California sold $10.9 billion from the authorization in 2004, and things went swimmingly at first. The quarter-cent sales tax provided so much coverage that the primary debt-management challenge appeared to be figuring out which bonds to retire early.

The state retired about $3.5 billion of ERBs in advance of scheduled maturity dates, according to the preliminary official statement for next week’s deal.

But economic and budget realities interrupted the storybook tale. The state’s economy weakened, pushing the state budget back into deficit, and Gov. Arnold Schwarzenegger decided to tap the remainder of the bond authorization, resulting in the issuance of $3.2 billion of new deficit bonds in February 2008.

There are now more than $8.2 billion of ERBs outstanding, according to the POS.

The recession also took a huge bite out of sales tax revenue, pushing debt service coverage on the sales tax-backed bonds into unexpectedly low ranges.

California’s taxable sales for fiscal 2009, which ended June 30, were down 13.5% from 2008, and more than 15% from 2007, according to he POS.

That resulted in two draws on a reserve account for the outstanding economic recovery bonds, both later replenished.

All three major credit-rating agencies dropped the economic recovery bonds to the state’s GO rating — BBB from Fitch Ratings, Baa1 from Moody’s Investors Service, and A from Standard & Poor’s.

The new bond issue is meant to bring the debt service schedule in line with reduced sales tax projections, and all three rating agencies believe it will work — Moody’s gave the new issue a three-notch bump to A1, Fitch gave it a three-notch boost to A, and Standard & Poor’s raised it one notch to A-plus.

“The A1 rating is a reflection of the increased coverage of debt service provided by the refunding structure, which is expected to provide at least 1.3 times coverage of debt service in each year based on conservative revenue forecasts,” according to the Moody’s report by analyst Emily Raimes.

“On balance, we view the improved coverage ratios expected from the restructuring as doing more to strengthen the credit quality of the ERBs than the risk of additional economic softness does to weaken it,” Standard & Poor’s analyst Gabriel Petek wrote.

All three rating agencies said they planned to upgrade the outstanding ERBs if next week’s deal proceeds as planned.

There is a caveat, according to the Standard & Poor’s report.

“We note that the final ratings may differ from the preliminary ratings to the extent that the actual results of the bond sale differ from the state’s plans, particularly if investor demand for the bond offering is insufficient to affect the changes to the structure as envisioned by the state,” ­Petek wrote.

California will be bringing the third-largest tax-exempt deal of the year to market after what Bank of America Merrill Lynch Global Research analyst Philip J. Fischer described in his weekly report Monday as an “orderly, if somewhat painful, correction to months of muni outperformance.”

The restructuring deal should provide good news to holders of the outstanding debt.

The POS lists 33 Cusips that the state plans to refund, with call dates between 2010 and 2014.

“Some of the bonds went from high yield to low yield over course of the morning because they figured out which ones would be refunded,” said Alexander Anderson, a private client portfolio manager at Los Angeles-based Envision Capital Management Inc.

Barclays Capital and Citi are joint book-runners. Institutional pricing is scheduled Thursday following a two-day retail order period.



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