Pennsylvania plans to be in the market Monday and Tuesday with a $2.6 billion sale of unemployment compensation revenue bonds. A one-day retail period will precede Tuesday’s institutional pricing.
The Keystone State joins several of its peers that have recently authorized or sold bonds to pay off unemployment fund debt to the federal government.
“States that do so can avoid interest charges, lower the costs for businesses within their borders, delay or smooth increases in payroll tax rates, and in some cases, free up internally borrowable funds,” Standard & Poor’s credit analyst David Hitchcock wrote in a report. “The security structures of these bonds depend upon each state and, in our opinion, can be of varying credit quality.”
Standard & Poor’s and Fitch Ratings both assign AA-plus ratings to the bonds and Moody’s Investors Service rates them Aaa. All three have stable outlooks.
As the recession hit, state unemployment payroll tax revenue fell short of covering jobless benefits being paid out, according to the U.S. Department of Labor. Pennsylvania borrowed roughly $3.9 billion from the federal trust fund to cover unemployment benefits during the recession.
The state’s seasonally adjusted unemployment rate for August was 8.1%, the same as a year earlier and up two-tenths of a percentage point from July.
States with debt due to the federal unemployment trust fund turned to the bond market after the expiration of a federal stimulus provision that made such loans interest free.
Gov. Tom Corbett’s administration paid off the principal debt through a short-term loan from Citibank.
The Pennsylvania Economic Development Financing Authority is issuing the tax-exempt bonds; Tuesday’s fixed-rate pricing consists of $1.4 billion of Series 2012A and $1.16 billion of Series 2012B bonds.
The PEDFA will also price $302 million of Series 2012C variable-rate demand revenue bonds on Oct. 17. PNC Capital Markets LLC is underwriter and remarketing agent, and PNC Bank provided a letter of credit for liquidity support.
Citi is book-runner for Series A and Bank of America Merrill Lynch will handle Series B. The bonds will mature in 2019 and 2023, respectively.
According to a preliminary official statement, 23 banks, including 10 co-managers, and 10 law firms are working on the deal. Saul Ewing LLP of Philadelphia and Eckert Seamans Cherin & Mellott LLC of Pittsburgh are co-bond counsel.
Pennsylvania in June passed a law authorizing the bond sale.
Corbett said at the time that he expects Pennsylvania’s unemployment-compensation fund to be solvent by 2019. The law, known as Act 60, also made changes in unemployment taxes and benefits, including eligibility requirements, that the commonwealth believes will make the fund more sustainable.
According to Moody’s analysts, no additional parity bonds are possible after the Series 2012 except for refunding purposes. Although the state may use bond proceeds to fund compensation benefits, it does not expect to do so.
Securing the bonds is a first lien on an assessment, called the interest factor contribution, on contributing employers that do business in Pennsylvania.
According to the Department of Labor and Industry, Pennsylvania anticipates saving employers up to $100 million in interest payments over seven years through the bond sale.
“These issuances can also be beneficial for state businesses,” Hitchcock said. “If these loans remain outstanding for two consecutive years, private employers that pay unemployment taxes incur a reduction in federal tax credits. This can also hamper the state’s ability to create jobs.”
David Fiorenza, a former chief financial officer for Radnor Township, Pa., sees financial benefits on several fronts.
“The Aaa rating from Moody’s will ensure these bonds will be sold entirely and the savings of interest is long term for Pennsylvania businesses. Pennsylvania will have no trouble selling these bonds. This continues to ensure the governor and his team are taking steps in the right financial direction,” according to Fiorenza, a professor at the Villanova School of Business.
“Other states are taking similar steps as the communication network between the governors and their financial teams are pretty strong in the U.S. The next step will be to make the state’s unemployment compensation program solvent by the end of Gov. Corbett’s second term.”
In a special comment it issued late Thursday, primarily about the credit pressure Pennsylvania’s distressed communities face, Moody’s said the state’s economic downturn was less severe than the nation’s.
Gross state product increased by an average of 0.68% from 2007 to 2011 compared with 0.2% nationally, and unemployment has been consistently lower than the national average.
Moody’s cited health care and higher education growth in metropolitan Philadelphia and Pittsburgh, as well as the rise in casino gambling and natural gas drilling in the state’s Marcellus Shale regions, as mitigating Pennsylvania’s downturn somewhat.
Standard & Poor’s credit analyst John Sugden agreed that Pennsylvania’s diverse statewide economy is a plus.
“Generating pledged revenues from 244,000 employers on a wage base of more than 3.9 million employers is a credit strength,” he said.
Standard & Poor’s said its rating also reflects Pennsylvania’s statutory increases to the taxable wage base that will rise from the first $8,500 of wages in 2013 to the first $10,000 of wages by fiscal 2018, and its first lien on pledged revenues.
Offsetting factors, said the rating agency, include the economically sensitive nature of the pledged revenue stream, and the significant increase in the interest factor rate from 0.2% in 2012 to 1.1% in 2013.
Sugden sees similarities and differences in the states’ deals.
“The unemployment compensation bonds that we have rated have some common features such as a statewide tax pledged to pay the bonds and strong legal provisions,” he said.
“The strengths in Pennsylvania are the first lien on pledged revenues, which are used directly to pay debt service and not used for unemployment benefits, a closed lien and closed flow of funds, which management projects will result in a shorter amortization.”
All three major credit rating agencies also cited Pennsylvania’s 97% tax collection rate.
Laura Porter, a Fitch managing director, said Pennsylvania’s deal structure is similar to comparable bonds sold in Michigan, Illinois and Texas, while Idaho and Colorado had more complicated structures.
“The nature of the pledged tax is very strong strength. We’ve given them all high ratings,” she said.
Fitch rated Michigan’s bonds AAA and Colorado’s at AA. It rated the others AA-plus.
“The difference is that Pennsylvania has cap on the rate, while Michigan and Texas have unlimited rate-setting authority and Illinois a set rate that does not change,” Porter said. “That’s the key distinction. Other than that, the four we’re talking about all have a broad pledged tax with strong collection histories and solid coverage.”
According to Porter, the exposure is to economic performance in the state overall, not just to Pennsylvania’s many pressured cities and towns.
The state has labeled 27 municipalities distressed, according to the Department of Community and Economic Development.
“We’re really looking at a statewide tax. That is clearly separate from general operations,” she said.
Texas, among other states, also issued unemployment bonds during the 2001 recession cycle.