Regional News

U. of Minn. Sets $35M Of BABs

CHICAGO - Barring any significant shift in the yield curve or in investor interest, the University of Minnesota will enter the market as soon as today with $35 million of taxable, general obligation Build America Bonds that officials believe will mark the first public offering of securities under the new federal program.

The university will apply for the direct-pay interest subsidy from the federal government with about $2 million in net present value savings expected, or $100,000 a year, based on current market conditions and the spread between taxable and tax-exempt securities further out on the yield curve. With Treasuries trading far enough below municipals on the long end, that is where the most savings can be achieved by using the program.

The Build America Bonds are part of a larger fixed-rate transaction that totals $85 million and includes $50 million of Series C tax-exempt bonds that will mature serially through 2020 and 2025. The Series D BABs are structured as a term bond with a 2028 maturity, although the finance team cautioned that the final structure is dependent on market conditions and demand.

Under the BAB program authorized in the America Recovery and Reinvestment Act, municipalities can sell taxable bonds and receive a 35% direct interest subsidy in the form of direct payments from the federal government or allow investors in the bonds to claim tax credits worth 35% of interest paid.

The university deal will mark both the first public offering of Build American Bonds and the first BAB sale by a public university.

"We were looking for opportunities in the stimulus package and we had bankers telling us about Build American Bonds and we just happened to be ready to go to market with a financing for about $85 million," the university's chief financial officer, Richard Pfutzenreuter, said in an interview Monday.

The preliminary offering statement is at http://www.muni-source.com/Pages/2009/UofM-090408.htm?d=n.

The University of Minnesota Board of Regents is the formal issuer. The merging broker-dealers Wachovia Securities and Wells Fargo Brokerage Services are co-senior managers. Wells Fargo closed on its acquisition of Wachovia at the end of last year. Although the two firms are still in the process of merging their muni groups, the university's transaction marks its first deal formally as one team. Dorsey & Whitney is bond counsel and Faegre & Bensen LLP is underwriters counsel.

Stevens Point, Wis., last month closed on the sale of $3.65 million of taxable general obligation promissory notes under the BAB program - also applying for the direct-pay subsidy - but that deal was not publicly offered. It more closely resembled a private placement. Wells Fargo submitted the lowest interest rate in a request for proposals conducted by the city.

The university is reserving the right to shift a portion or all of the BAB tranche to tax-exempt should investor appetite be lacking.

"The university is going to do $85 million. Whether the university issues the full $35 million of BABs will depend on the market on the day of pricing," said Nicholas Taylor, a higher education sector banker at Wachovia who is working on the transaction.

Taylor said he expects strong demand but declined to comment on potential buyers. Other market participants have said that potential buyers include foreign investors, pension funds, defined-contribution investors, some trust accounts, and investors who don't stand to benefit from a tax-exemption, such as U.S. banks that are still writing off losses.

The university is including a 10-year call on the BABs, a feature typical on tax-exempt issues, Taylor said, cautioning that the structural decision could change until the time of pricing. A so-called make-whole call is the standard in the corporate finance world. It provides corporations the ability to make the investor whole by paying off the bonds at anytime due to different situations that might arise such as catastrophic events or change in ownership.

The university's deal won't include such a call, which offers investors some protection. It sacrificed another $80,000 in interest rate savings annually by including the traditional 10-year call, but the move was worth it to maintain future flexibility for the issuer.

"It's a new program and in 10 years you don't know what the yield curve will look like," Pfutzenreuter said. "This provides us with more flexibility."

He said he is less worried about the risk that the federal government or Congress would alter the program or subsidies. Treasury officials have tried to quell concerns of some that Congress could halt the payments, saying that the law treats the payments like a tax refund, and that they should be likened to an ongoing permanent appropriation.

Proceeds will finance various capital projects, including a new Medical BioSciences building, a new residence hall and a stadium expansion. The projects span various campuses, including the main Twin Cities campus, the university's Crookston campus and Duluth campus.

The program quickly caught the interest of many issuers earlier this year but most were waiting for the Treasury Department's release of guidance on how issuers are to elect the direct-pay subsidy or tax-credit options and details on how soon issuers can expect payments.

Those initial guidelines were released nearly two weeks ago and a handful of governments are ready to hit the market. The New Jersey Turnpike Authority is readying a $650 million sale for next week that includes $250 million of Build American Bonds and California later this month will include BABs in a $4 billion deal. New York's Metropolitan Transportation Authority is planning a $200 million sale later this month.

In the Midwest, Michigan's Milan Area School District is planning to sell $49 million in Build America Bonds early next week with Raymond James & Co. as underwriter. Stauder, Barch & Associates Inc. is the district's financial adviser, and Thrun Law Firm PC is bond counsel. The district expects to take the 35% interest rate subsidy, as the finance team said so far investors have not shown much interest in the tax credit alternative.

The guidelines provide information on the necessary paperwork that must be submitted to the Internal Revenue Service which will begin accepting forms on May 1 with the interest subsidy payments then being sent out within 45 days from the filing date.

That information "gives a lot of comfort to issuers," said Wachovia's Taylor. He added that the firm has a number of issuers interested in the program, but most have been waiting on the payment details. "That was the big item," he said. "The most important issue now is for issuers to make sure they get their paperwork in after doing a deal."

Pfutzenreuter said applying for the subsidy tied to interest payments will pose an administrative burden, but it's not one the university is complaining too much about given its anticipated savings. "You have to proactively submit the paperwork. Someone will have to do that," he said.

Issuers can elect to qualify their bonds as BABs if they would otherwise qualify for a tax-exemption to finance qualified capital projects and are issued before Jan. 1, 2011. BABs cannot be used for refunding purposes. In creating the program, Congress is aiming to introduce new types of investors to municipal debt that carries significantly lower default rates than corporate debt.

Ahead of the sale, Moody's Investors Service affirmed the university's Aa2 general obligation credit assigned to a total of $1 billion of debt and Standard & Poor's affirmed its AA.

The university's credit strengths include its position as a leading educational and research university in the Big Ten conference with enrollment of more than 58,000 full-time students, and an overall strong balance sheet with total financial resources of $3.5 billion. That figure, however, is expected to decline to $2.5 billion due to investment losses and endowment spending, Moody's wrote. The university saw its research funding grow from federal and private sources to $675 million in fiscal 2008 from $619 million a year earlier.

Challenges include thin unrestricted resources that brings down debt service coverage to below 1% and the school has substantial borrowing plans over the next six years - including another $143 million this year - to begin construction or complete construction on major projects like its new football stadium and four biomedical research facilities. The state is covering about 75% of the nearly $300 million cost of the new stadium for the university's Gophers.

Some borrowing may be delayed depending on the results of the current state legislative session. Gov. Tim Pawlenty's budget for the fiscal 2010-11 biennium would have reduced the university's base appropriation by $156 million but that was restored due to federal stimulus funds. The university relies on state support for about 27% of its operating revenues.

The university has significant floating-rate exposure as about 70% of its debt portfolio is structured as variable-rate demand bonds and commercial paper. Most is swapped to a synthetic fixed-rate with the fair market value of those swaps currently a negative $60 million. The university is not required to post any collateral unless its rating falls below the mid-triple B level.

Caitlin Devitt contributed to this story.



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