CHICAGO — Ohio is bringing $175 million of general obligation bonds to market beginning on Wednesday in the first of two borrowings to finance highway capital improvement projects across the state.
The second deal, set for mid-November, will consist of $200 million of grant anticipation revenue bonds. The Garvee deal comes after Fitch Ratings downgraded a swath of Garvee debt last month, including Ohio.
Moody’s Investors Service’s recently put $10 billion of Garvee bonds, including Ohio’s, on review for downgrade. Standard & Poor’s put out a report this week saying it believes Garvees are stable but — like Fitch and Moody’s — noted significant uncertainty surrounding the federal revenue stream that backs the debt.
Moody’s said it plans to resolve its ratings action within 30 to 60 days after its Sept. 25 announcement, a timeline that could coincide with Ohio’s deal, set for the week of Nov. 12. But Ohio officials say the state has no plans at this time to postpone the deal or add a back-up pledge, believing its Garvees are among the most conservative in the market.
This week’s GO deal features $175 million of highway capital project bonds backed by the state’s gas tax. The debt features ratings of AAA from Standard & Poor’s, AA-plus from Fitch and Aa1 from Moody’s. Fitch and Moody’s base their ratings largely on the state’s credit, while Standard & Poor’s incorporates the pledge of gas tax and strong coverage levels of more than five times.
“This is the highest-rated debt that the state issues, and it’s one of our premiere credits,” said Seth Metcalf, chief financial officer and general counsel for the Ohio Treasurer, which is issuing the debt. “The gas tax-backed bonds provide a nice diversity for investors. There’s a lot of Ohio GO debt out there, and the highway bonds are the only gas-tax-backed credit that the state of Ohio issues.”
The state hopes to take advantage of the market’s high demand and historically low rates. The finance team would have considered refunding bonds, but most of its transportation debt is not callable and so negative arbitrage would cut too deeply into the economic savings, according to Metcalf.
The debt also carries the full-faith-and-credit pledge of Ohio, which is enjoying an improving economy and fiscal 2013 revenues that are coming in at nearly 7% higher than projected.
“Right now the appetite for everything has been pretty robust,” said Matt Dalton, chief executive officer of Belle Haven Investments. The transaction includes a retail order period on Wednesday before the team opens it up to institutional buyers Thursday. Ohio has a strong history of selling to retail buyers, and hopes to see the same level of participation again this week.
“It’s a great market for issuers, but tough for buyers, especially mom-and-pop buyers looking for better yields,” Metcalf said.
Dalton, who represents retail buyers, said demand will likely be there despite low yields. “I was with a group of 20 investors yesterday, and they are afraid of the equity market, and they just continue to ask questions about good munis,” he said. “Everyday somebody capitulates and says, ‘I’m not going to get 4%, I’m going to get 3%,’” he said. “At some point, everybody’s in the pool. I call it the capitulation effect.”
In fiscal 2012, Ohio collected $2.6 billion of highway user receipts. The state’s most recent highway user-receipt GO deal was in October, 2010, and included one series of taxable Build America Bonds. The true interest cost for that offering was 2.16%.
The bonds mature in 15 years, in keeping with the state’s generally rapid amortization schedule on most of its debt.
Wells Fargo Securities is the senior book-running manager on the deal. Fifth Third Securities Inc., Huntington Investment Co. KeyBanc Capital Markets Inc., PNC Capital Markets LLC and Piper Jaffray & Co. are also on the team.
Public Financial Management Inc. is financial advisor and Tucker Ellis LLP is bond counsel.
Proceeds will finance various highway capital projects over the next 18 to 24 months as part of the Ohio Department of Transportation’s budget.
Ohio’s $200 million Garvee deal, its first such offering since late 2010, is slated for the week of Nov. 12.
Bank of America Merrill Lynch is the senior manager, and the state is still finalizing the rest of the team, Metcalf said. Acacia Financial Group Inc. is financial advisor.
Grant anticipation revenue vehicle bonds are secured by Federal Highway Administration reimbursements to the Ohio Department of Transportation. For investors, the key risk is — and always has been — the uncertainty surrounding the federal revenue source.
Federal fuel taxes fund the aid, but have not been raised enough to pay for spending since 2008, Moody’s noted.
Investor risk rose over the summer when Congress passed a $105 billion, two-year transportation highway bill that uses general fund transfers to cover shortfalls in the highway trust fund, according to Fitch and Moody’s.
The two-year time frame, which is shorter than previous bills, as well as the reliance on general fund transfers, combined with a recent Congressional Budget Office report that projected the highway trust fund would become insolvent in 2015, have all raised the risk of Garvee bond funding, according to rating analysts.
The use of federal general-fund dollars means the program could be subject to the sequestration process if it takes place next January, according to Moody’s analysts.
Ohio was one of 11 issuers whose Garvee bonds were downgraded by Fitch, which cut its rating to A-plus from AA-minus.
“Fitch’s assessment of the strength of the federal program has been revised to mid-range from strong, a direct result of the uncertainty around federal policy,” the agency said in the downgrade report. “As this attribute is a key driver for Garvee bond ratings, it is the agency’s view that the increased uncertainty is not consistent with ratings in the ‘AA’ category.”
For Ohio, the risks surrounding Garvee bonds are not enough to make the state consider postponing the deal or adding bondholder protections, such as an additional pledge, as some states do.
“Ohio has one of the most conservative Garvee structures out there,” said Metcalf, touting the bonds’ five-times debt-service coverage ratio, which he said is the highest among all the states. Ohio also amortizes nearly all of its Garvee debt within 10 years, which helps reduce reauthorization risk.
“In the past couple of years, the market seems to have gotten a little desensitized to the sporadic reauthorizations,” he said, a reference to the series of short-term extensions of the former highway law before the new one was crafted. “Uncertainty in the Garvee world has been the new normal for a couple years now.”
Metcalf noted that spreads on the secondary market among Garvee bonds shows that investors link Garvee bonds to a state’s credit, so higher-rated states’ Garvees tend to trade slightly higher than lower-rated states, something Metcalf calls it the “halo effect.”
“One would think that they would trade pretty uniformly in the secondary market, but we’ve seen differences,” he said. “I think investor education could help to narrow that spread.”
Metcalf said that Ohio may not hire Fitch to rate the upcoming Garvee deal, adding that he’s heard that several states have already dropped the rating agency after the Garvee downgrades. “We’ll be talking to our finance team about it,” he said.
Ohio currently has roughly $950 million of outstanding Garvee debt. The state has $8.2 billion of outstanding GO bonds. Moody’s rates the state Aa1 with a stable outlook. Fitch and Standard & Poor’s rate it AA-plus with a stable outlook.