CHICAGO - The South Dakota Education Fund Corp. is preparing to enter the market with a $272 million tobacco securitization -- a rare issue for its size in a state that has bucked some of the troubled economic trends that have affected its neighbors.
The deal had been set to go Wednesday, but the underwriters said the sale had been delayed, though they still expected it to sell this week. Market participants said the issue was postponed because of the difficulty in finding investors for the taxable portion of the sale.
The Series 2002A taxable portion of the sale will total $159 million and the Sereis 2002B tax-exempt piece will total $113 million, said Kym Arnone, a senior managing director with Bear, Stearns & Co., the lead manager on the deal.
The debt will be secured solely by the state's share of national tobacco settlement funds.
The bonds are structured using the full-turbo mechanism that speeds up repayment, with 100% of the tobacco settlement revenues dedicated to repay the bonds, Arnone said. The taxable portion of the sale will mature in 2026, and the tax-exempt piece in 2032.
The 2032 maturity will be in line with the projected average life of the payments, but will go out longer than most tobacco deals. Including a taxable piece in the sale allows the state more flexibility in using the proceeds for investments, she said.
The financial adviser on the deal was Dougherty & Co. and bond counsel is Altheimer & Gray.
It remains to be seen how well investors will embrace such a sizeable taxable portion , said Ronald H. Fielding, a senior vice president of OppenheimerFunds Inc. "That's a whole different clientele to buy them."
The smaller tax-exempt portion will go to the national market, he said. And compared to the sale in June of $685 million of tobacco bonds by the Rhode Island Tobacco Settlement Finance Corp., which yielded 6.65%, the South Dakota deal could sell at about 6.5% because it is smaller with only a minority of the bonds being tax-exempt, Fielding said.
More than half of the bonds "will have to go to a whole different market, which has always been quite thin," he said. "It's a matter of who the underwriters have lined up to take them."
In a market where a number of states have used tobacco bonds to shore up state budgets, the deal may not be viewed as one that would price aggressively, said Dianne Sales, vice president at John Hancock Advisors in Boston. However, the bonds carry a different twist that may distinguish them from other such deals, either planned or on the market.
Most tobacco bond structures are designed to pay off the bonds faster prior to maturity. South Dakota officials have said that if market conditions worsened, the state could call the bonds with available funds and pay the bondholders at par rather than using extra funds to buy them on the open market. The language, not normally specified, could be an advantage to investors in a market when interest rates are higher.
"It's an interesting twist," Sales said. "That's not going to make or break the deal."
For the state to buy back the bonds at par, she said, revenues must also be strong. Though that is an unknown, the language may be beneficial for the sale in a competitive market, she said.
"It's a modest encouragement to buy the bonds, and it makes them slightly different than other tobacco bonds out there," she said. Whether she would buy also depended on pricing and cash flow, Sales said.
Standard & Poor's assigned an A rating to the taxable portion and an A to the tax-exempt piece. Moody's Investors Service assigned a Aa3 to the taxables and an A1 to the tax-exempts, according to the bonds documents.
The bonds are being sold through the Educational Enhancement Funding Corp., which has a nine-member board, seven of whom work for the South Dakota Building Authority and two appointed by Gov. Bill Janklow.
The state created the educational fund into which the proceeds will be deposited through a constitutional amendment. The Legislature in 2000 approved the creation of the People's Trust Fund for the deposit of the tobacco settlement funds. Earnings on the investments made through that fund are placed into the People's Interest Fund, which the Legislature can access.
Each year, the Legislature can transfer 4% of the value of the trust fund to the general fund to use for educational enhancement, said Jack Arnold, a senior vice president with Dougherty. That 4% transfer would not be made if the amount invades the principal of the interest fund, he said. The distribution of the funds will begin in 2003.
When he signed the legislation, Janklow questioned the consistency of the funding stream. The state had anticipated $24 million in 2001, but the governor said that amount was subject to change to $21 million or less.
"That's the problem. We don't know what to expect," Janklow said when he issued a statement after signing the legislation. "I know I remain in a very small minority, but I still believe the tobacco companies eventually will declare bankruptcy."
South Dakota is one state that has managed to remain relatively stable as the economy slowed and revenues dropped. The state held no special legislative session and has not relied on cigarette tax increases to shore up the budget -- something other states that have sold tobacco deals have done.
South Dakota used some of its reserves, but still maintains a strong reserve fund, said Curt Everson, director of the Bureau of Finance and Management. Although preliminary numbers show a structural shortfall as the state closes out its books for the year, he said, the shortfall was expected.
"It's pretty much where we thought it would be," he said.
South Dakota has no corporate or individual income tax, so the impact of economic shifts has been different from surrounding states, he said. Sales tax is the main revenue source, he said, and that has remained strong.
"It's not that our economy is in better shape than anybody else's," he said. "We just don't happen to be dependent on as volatile a revenue source as income tax has become."
In addition, though a portion of South Dakota has suffered a drought this year, surrounding states are in the second or third year of drought, he said.
