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Deal in Focus

Ohio Plans Budget Relief Deal

CHICAGO — Ohio plans to enter the market next week to refund $271 million of general obligation debt in a transaction that is expected to save the struggling state up to $740 million over the next two years.

It is the first time Ohio has restructured debt in order to achieve budgetary relief, and the deal is one of several one-time measures the state has imposed to address ongoing revenue shortfalls.

The restructuring is a key part of the state’s $52 billion, 2010-2011 budget. It will delay until 2013 interest and principal payments originally scheduled for 2010 and 2011, but is not expected to push out final maturities on the debt.

Nearly 75% of Ohio’s GOs, which total $6.9 billion, amortizes in 10 years, a rate that credit analysts consider one of the state’s top strengths. The upcoming restructuring follows an earlier transaction in which the state refunded $200 million of GO bonds in May to achieve savings.

Meanwhile, legislators last week agreed to close an $850 million shortfall by delaying a planned income tax cut for the next two years. The deal comes after the state Supreme Court ruled in late September that a gaming expansion plan key to balancing the upcoming budget was subject to voter referendum. Last week’s legislative agreement is projected to raise $844 million over the next two years and allow the state to avoid cutting education spending.

The upcoming transaction, currently scheduled for Jan. 5 and 6, will restructure three series of debt that total $271 million. The Ohio Public Facilities Commission will issue the debt. The transaction will push out debt-service payments scheduled for the next two years to 2013 through 2021 on roughly $93.6 million of higher education GOs, $131.6 million of common schools GOs, and $46.2 million of infrastructure improvement GOs. Only cost of issuance will be paid before 2013.

The state now pays interest rates on the debt that range roughly from 3% to 5.25%, according to bond documents.

Bank of America Merrill Lynch is senior underwriter and JPMorgan is co-senior. Seven additional firms round out the underwriting team. Peck, Shaffer & Williams LLP and Lumpkin McCrary LLP are bond counsel. Public Financial Management Inc. is the state’s financial adviser.

Ahead of the sale, Moody’s Investors Service affirmed its Aa2 rating and Standard & Poor’s affirmed its AA-plus rating. Moody’s and Standard & Poor’s revised their outlooks on Ohio to negative in August and September, respectively, citing the state’s reliance on one-time revenue measures and increasing fiscal stress.

Fitch Rating rates Ohio AA with a stable outlook. Fitch and Moody’s both downgraded the state in June.

Like most states, Ohio has struggled with sharply declining revenues over the last year. The deterioration of its manufacturing base and a weakened domestic automobile industry have meant major changes to its  economy, and will likely mean a slower recovery than the rest of the U.S., analysts warn.

To deal with revenue shortfalls, Gov. Ted Strickland in 2009 imposed a number of cuts and relied heavily on a number of non-recurring measures. In addition to the current restructuring, Ohio used $2.4 billion in federal stimulus dollars and drained its entire $1 billion rainy-day fund to deal with current-year and projected deficits in the next biennium. The state also transferred $530 million into its general fund from other funds.

Ohio’s reliance on one-time measures means more risk of recurring deficits in the future — but is not uncommon among states this year, said Fitch analyst Karen Krop, who covers the state.

“The use of one-time shots can create a structural gap going forward that Ohio will have to address,” Krop said. “But we have seen over the last year many of the states have done this kind of debt restructuring, which historically would have been viewed as a negative factor. We don’t consider it a strong debt management practice, but with what’s gone on this year with revenues, we don’t consider it a bad arrow in the quiver.”

Despite Ohio’s problems, its history of prompt action to address budget shortfalls — such as the recent move to delay the income tax cut — is one reason Fitch maintains a stable outlook on the state, Krop said.

“The rating incorporates the expectation that even with revenue declines, the state will balance its budget,” she said. “When a big gap opened up because of the video gaming [ruling], there was an immediate hole in the budget. We expected that they would address this, and in fact they did.”

Another key credit strength is Ohio’s moderate debt burden and relatively rapid amortization schedule, analysts said. The state’s pension plans are “reasonably well funded” and its retiree health care benefits system has substantial assets of $10.7 billion to cover a liability of $29.8 billion, according to Moody’s.

Ohio has entered the market almost every month this year with both new-money and refunding issues. It has at least 10 issues on tap through June 2010, including a sale of $170 million of GOs by the Treasury, and $270 million of major new state infrastructure Garvee bonds in March.

Meanwhile, a proposal to issue $1 billion of bonds to finance a popular jobs program advanced last week when a top Republican Senate leader indicated he would support an effort to put the proposal on the May ballot.

The fate of the Third Frontier bond proposal became a political battle recently in the Legislature, as Democrats, including Strickland, pushed to put the measure on the May ballot while Republicans, who control the Senate, said they were reluctant to take on new debt amid declining revenue.

But last week Senate Republican President Bill Harris said he agreed to work toward putting the issue on the May ballot. The measure needs to pass the Legislature by Feb. 3 to make it on the May ballot.

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