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Deal in Focus

Utah Deal Offers Sense of Security

DALLAS — In a deal tailored for risk-averse investors, Utah is planning to offer $635 million of its top-rated, tax-exempt general obligation bonds with maximum maturities of 15 years.

The deal, expected to price via negotiation next week, is one of the largest in the Southwest in a year of shrunken issuance.

“We’ll be participating in it,” said J.T. Thompson, portfolio manager for Aquila Funds’ Tax-Free Fund for Utah. “I anticipate it goes really well. There’s a lot of cash out there for good quality paper.”

Proceeds from the sale will be used chiefly for highway construction and improvements to state universities, according to the state treasurer’s office.

All three rating agencies agree on Utah’s triple-A status and stable outlook.

“According to several ­important economic measures, Utah’s experience through the 'Great Recession’ has lagged and been less severe than the experience observed in some other states,” analyst Gabriel Petek wrote in Standard & Poor’s latest report. “Adding to the stability of the state’s credit is that its revenues are once again in a growth mode and the state has already accommodated the loss of federal stimulus funding in its programmatic service levels.”

Thompson said the investors in Aquila’s Utah fund are people familiar with the state’s conservative ways and live in the state or in states with reciprocal tax exemptions on interest income. The short maturities add an additional layer of comfort.

“There’s a lot of talk about inflation out there that’s got a lot of people concerned,” he added.

JPMorgan and Jefferies & Co. are senior managers on the sale. Co-managers are Bank of America Merrill Lynch, BMO Capital Markets, Barclays Capital, George K. Baum & Co., Goldman, Sachs & Co., Morgan Stanley, Seattle Northwest Securities Corp., and Wells Fargo Securities.

Zions Bank is financial adviser and Chapman & Cutler is bond counsel.

As of last week, triple-A credits yielded 3.7% on the Municipal Market Data curve, up two basis points over the previous week.

Last September, Utah issued a record $1.25 billion that was mostly taxable Build America Bonds. In a case of lucky timing, the issue went to market before investors began moving money out of muni bond funds on a large scale.

Last week, individual investors pulled cash from municipal bond mutual funds for the 29th straight week, according to Lipper FMI.

While the rate of withdrawals appeared to be slowing in early May, the pace has accelerated, with $436 million in net outflows last week, the highest in a month, according to Lipper.

However, because there are few opportunities to buy Utah’s gilt-edged paper, next week’s issue is not likely to linger in the market, fund managers indicated.

“To find extra yield over the past several quarters, the [Utah] fund has taken on more secondary issues and purchased bonds with call risk, which are expected to perform well in a rising rate environment,” Aquila’s fund managers wrote in a report last year.

Despite Utah’s frugal ways, the nation’s weakened economy had a significant impact on the state’s budget in both fiscal 2009 and 2010, analysts said.

In 2009, revenues attributed to the general and education funds were almost $900 million, about 15% less than originally budgeted. Collections of the state’s two largest general revenue sources — sales and personal income taxes — came in well below actual fiscal 2008 levels.

Revenues fell another 8.4% in fiscal 2010 and were 8.1% below the original estimate, with continued weakness in personal income and sales and use taxes.

Fiscal 2010 revenues were 23% lower than those two years earlier.

The state took steps to reduce spending to meet the lower revenue targets, including two across-the-board agency cuts of 4% and 7% in fiscal 2009 and much deeper budget reductions of 16-18% in 2010.

Unlike many states, Utah did not tap its rainy-day fund during fiscal 2009, maintaining the balance at $414 million, or about 9% of fiscal 2009 revenues. The state retained an additional $100 million set-aside, originally intended to be spent on education enrollment growth.

For the 2010 budget year, the state needed to tap the rainy-day fund for $86 million. Federal stimulus funds were also used to close the balance of the gap in fiscal 2009 and 2010.

“The actions taken by the state are consistent with its conservative fiscal management style, with frequent spending reviews and prompt balancing actions,” Fitch Ratings analyst Karen Krop wrote in a report.

While major revenues began growing again in fiscal 2011, the state still faced a gap of $482 million. To balance the budget, lawmakers continued reductions, added $43 million in tobacco taxes, used reserves, and applied an extension of the enhanced federal matching rate for Medicaid.

The budget included further use of the rainy-day fund, withdrawing another $123 million as well as using $103 million, with accumulated earnings, that had been set aside in the student population ­account.

The $209 million remaining in the rainy-day fund represents 4.7% of expected fiscal 2011 revenues. Revenues through April are showing strong growth over last year and are ahead of projections. Personal income tax is up 7.3% and the sales and use tax revenue has risen 12.6%.

The increase in sales tax revenues reflect in part a temporary retention of vehicle-related taxes in the general fund that are usually allocated to transportation, according to Fitch.

Utah’s approach to debt issuance is extremely conservative, relying primarily on GOs. The state does not issue variable-rate debt, use interest rate swaps, or issue short-term or cash-flow notes. Amortization is rapid, as the state has historically limited its bond maturities to seven years, other than for transportation-related bonds, for which it permits 15-year amortization.

“Although debt levels are increasing, particularly with the heavy issuance in recent years of GO bonds for transportation purposes, debt continues to represent a moderate burden on resources,” Krop said.

The upcoming bonds will finance the ongoing expansion of the highway system around Salt Lake City and various construction projects. After this deal, net tax-supported debt of approximately $3.9 billion will equal 4.3% of 2010 personal income, analysts estimate.

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