CHICAGO – Just two weeks after receiving clearance from the state Supreme Court, Minnesota will hit the market Wednesday with its $654 million tobacco refunding that marks its first formal use of an appropriation pledge.
Proceeds will refund the state’s $757 million tobacco securitization that sold last November to help the state wipe out a budget deficit. Net present value savings are estimated at $77 million or about 10%.
The transaction includes a taxable series for $55 million maturing in 2014 and 2015. It will retire a taxable piece included in the original transaction. The deal next week also includes a tax-exempt series for $599 million maturing between 2015 and 2030 with possible term bonds.
Barclays Capital is the bookrunning senior manager with Bank of America Merrill Lynch and RBC Capital Markets serving as co-seniors and another five firms rounding out the underwriting team. Kutak Rock LLP is bond counsel and Dorsey & Whitney LLP is underwriters’ counsel. Public Financial Management Inc. is advisor on the deal.
Fitch Ratings and Standard & Poor’s rated the bonds AA, one notch lower than the state’s AA-plus general obligation rating due to the risk of non-appropriation which would cancel the bonds.
"In our view, Minnesota has strong financial management policies and a solid track record of making budget adjustments in a timely manner," said Standard & Poor's analyst Henry Henderson. “This will be an important credit consideration in the next several years, in our opinion, given the state's diminished financial flexibility.”
Fitch said the state’s rebounding economy has helped offset the negative impact on the state’s balance sheet of its past reliance on one-time revenues such as the tobacco bond proceeds and reserves.
Market participants said investor scrutiny would focus on the state’s financial position not the soundness of tobacco payments even though tobacco payments will be used to repay the debt. “The tobacco issue becomes the problem of the Minnesota taxpayers,” said Matt Fabian, managing director at Municipal Market Advisors.
The 2011 legislation authorizing the state’s use of an appropriation pledge on bonds leveraging its tobacco settlement funds required that the Department of Management and Budget seek a validation from the state’s high court.
The validation was required after Attorney General Lori Swanson raised concerns over the legality of the credit, taking the position that the bonds represented public debt and were subject to strict limits on the use of proceeds that bans the use of debt to balance the budget.
Lawyers for MMB struck the position that an appropriation pledge does not constitute a public debt under the state’s definition because of the Legislature’s ability to withhold its appropriation which would in turn cancel the debt.
In need of the proceeds last year to balance its books, the state went ahead with a tobacco securitization as it undertook the validation process. The 2011 bonds included an extraordinary optional redemption feature that allows the state to redeem the bonds with appropriation-backed refunding bonds by a deadline of Dec. 1.
Swanson’s office argued that the bonds constitute a public debt and represented an attempt by the state to bypass rules that don’t permit the use of public debt to balance the budget. MMB lawyers countered that the bonds did not constitute a public debt because they lacked a pledge of the state’s full faith and credit and taxing powers.
Debt service is paid based on a continuing appropriation but the Legislature retains the ability to cancel payments at any time and debt service is subject to the governor’s unallotment powers when revenues falter. The court in its majority opinion sided with MMB.
“The risk of legislative repeal of the appropriation is inherent in appropriation-backed debt and reflected in the rating below that of the state's GO,” Fitch said. “In addition, Fitch notes that despite historical use of executive unallotment powers by the state, debt service has not been affected.”
The state has never issued direct appropriation bonds but it has supported agency debt with an annual appropriation of funding under a master lease equipment financing program and certificates of participation. An annual appropriation also goes to the University of Minnesota for its new football stadium.
The driving factor behind the state’s refunding plans is a reduction in interest costs. The tobacco securities carry a true interest cost of 4.79% and carried credit ratings in the high triple-B and single-A category. In addition to lump-sum initial payments, the state receives annual payments that have ranged from $102 million in 1998 to $169 million in 2010.
The state lost its triple-A ratings in large part for relying on one-shots like the tobacco bonds to balance the budget last year as a result of gridlock between Gov. Mark Dayton, a member of the state’s Democrat-Farmer-Labor Party, and Republicans who controlled the legislature.
Dayton had sought an increase in the income tax on top earners to help balance the fiscal 2012-13 budget, but Republicans balked and a 20-day government shutdown ensued.
On Tuesday, voters gave Democrats the legislature majority and some have speculated that taxes could be headed up. Fabian said there’s not been much evidence, however, that in-state income tax rate changes have much impact on the prices for state paper.
