The New Jersey Economic Development Authority will issue $1.94 billion of refinancing debt Tuesday and Wednesday to switch variable-rate school facilities construction bonds into fixed-rate mode. The bonds are secured by the state’s appropriation pledge.
The transaction will help terminate swaps aligned with the floating-rate debt. Officials aim to reduce the notional amount of derivatives attached to school construction debt by $1.7 billion, still leaving them with $1.9 billion in swaps. That will help decrease the mark-to-market value of the NJEDA swap portfolio to negative $288 million from negative $584 million, according to Fitch Ratings.
Bank of America Merrill Lynch will begin retail pricing on Tuesday followed by institutional pricing on Wednesday. Wolff & Samson PC is bond counsel.
The bonds were originally set to price on Monday and Tuesday. Market conditions prompted the state to hold off on issuing the bonds by one day. In addition, Gov. Chris Christie will present his state of the state address this week.
“The main reason is the market looks better on Tuesday and Wednesday,” said Andrew Pratt, spokesman for the state Treasury Department. “And the other part of this is that the governor’s state of the state speech is Tuesday and we’d rather just delay the institutional investors part of the deal until after the state of the state speech as well.”
Fitch, Standard & Poor’s, and Moody’s Investors Service rate the refinancing double-A minus. The NJEDA has $8.15 billion of outstanding school construction bonds.
The construction bonds have ratings one notch below New Jersey’s general obligation rating since repayment of the construction debt is subject to annual legislative appropriation.
The transaction includes $1.46 billion of tax-exempt Series 2011EE refunding bonds, $244 million of taxable Series 2011FF refunding bonds, and $240 million of tax-exempt Series 2011C SIFMA index notes, according to the preliminary official statement.
The Series 2011C notes will convert variable-rate bonds into floating-rate notes and will mature during the next six years, according to Standard & Poor’s.
“There are no puts on the notes, which are due in fixed maturities and may be refinanced,” a Standard & Poor’s report read.
The large $1.94 billion deal could be a precursor to other refinancing transactions in 2011. If the London Interbank Offered Rate and SIFMA market rates rise as Treasury yields increase, that could prompt issuers to switch to fixed rate and terminate swaps to reduce basis and counterparty risk.
“As the swap market rates rise, issuers’ swaps that they have on their books are less out of the money to the issuer,” said Matt Fabian, managing director of Municipal Market Advisors. “So they have to compensate the counterparty less.”
The one-month Libor is 0.26% compared to 0.23% one year ago, though it rose to 0.34% six months ago, according to Bloomberg LP. The three-month Libor is 0.30%, slightly higher than 0.25% one year ago but lower than the 0.53% rate six months ago.
Such refinancings could add to 2011 volume issuance. While higher borrowing costs may deter states and local issuers from selling new-money debt, refinancing opportunities that offer an exit from swap agreements and the need to renew letters of credit could account for $50 billion of municipal volume in 2011, Fabian said.
“Higher interest rates are going to slow down issuance, except that higher Treasury rates are going to unlock [variable-rate demand obligation] fix-outs because they reduce the termination costs on swaps associated with VRDOs,” Fabian said.
New Jersey officials estimate the refinancing will cost the state a net $18.2 million. Part of the refinancing will generate $277.7 million of savings over the life of the bonds, yet swap termination costs of $295.9 million will generate a net payout of $18.2 million.
The Treasury Department is looking to reduce the state’s $4.14 billion swap portfolio, which includes the school construction derivatives.
Treasurer Andrew Sidamon-Eristoff last month referred to such hedging instruments as “exotic financial engineering.”
Overall, the state is taking on a more conservative approach toward debt issuance.
Christie last week stressed that his proposed $4.4 billion of borrowing to help finance transportation infrastructure would involve a level debt structure in which the state gradually pays off principal on the bonds as opposed to a balloon payment at maturity.
Along with decreasing its practice of hedging against interest rates, the school construction refinancing will eliminate the need for the state to purchase LOC renewals on $1.8 billion of variable-rate debt this year.
Demand for LOCs has increased as fewer banks are offering such liquidity facilities, pushing their costs higher.
In the spring of 2010, the Treasury Department received $1 billion of interest from banks to provide LOCs, with an average price of 118 basis points, according to an NJEDA board memorandum from Dec. 21.
“We’re refinancing now because we have well over $1 billion in bank LOCs to renew this spring and so do many other issuers around the country,” said Jim Petrino, director of the New Jersey Office for Public Finance. “Demand for credit in the months ahead will be overwhelming. This transaction will both reduce our costs and our risks and it will do so at no long-term costs to the taxpayer.”
All three rating agencies viewed the refinancing as a credit positive. Moody’s believes the transaction “favorably impacts the state’s credit profile by reducing exposure to capital market volatility and the need to replace liquidity agreements during 2011, when it is widely held that liquidity agreements will be more difficult to obtain than in the past and will be more expensive.”
New Jersey will have other LOCs expiring this year on its state-supported debt, including $181 million of New Jersey Building Authority bonds in May and June and $297.5 million of New Jersey Transportation Trust Fund debt in December, according to Moody’s.
