A century from now, an environmental infrastructure project in the nation's capital will have diverted billions of gallons of storm water and sewer overflow from polluting the area's waterways.
Today, the institutional investors who bought the taxable century bonds issued to finance that endeavor are relying on the sustainability of the 16-mile long tunnel to provide them with 100 years of income — and extra yield — over the expected life of the project.
The $350 million D.C. offering of senior-lien revenue bonds was issued on July 10 by the District of Columbia Water & Sewer Authority.
The final maturity in 2114 was priced at par to yield 4.81% — 145 basis points over the taxable Treasury curve at the time.
Walt Disney Co. and Coca Cola pioneered the use of century bonds in the taxable market back in 1993. More recently, however, the 100-year structure has made its way to the muni market as mostly higher education and healthcare institutions have warmed to the concept of gaining century-long cost savings, experts said.
"By selling taxable century bonds these institutions maintain flexibility going forward in terms of use of proceeds, while locking in historically-low financing rates for 100 years," said Nat Singer, managing director at Swap Financial Products in an email last week.
While the structure remains rare in the municipal market, Mikhail Foux, a municipal strategist at Citigroup Global Markets in New York, said taxable century bonds have become a post-financial crisis phenomenon as issuers have taken advantage of locking into historically low yields for a lifespan of 100 years.
"We saw a substantial number of deals being printed in the last three to four years, and they have been very well accepted" largely by institutional investors, Foux said.
The D.C. sale was oversubscribed by $650 million and was the first sale of a taxable century bond by a water and sewer utility. It was also the first independently-certified green bond sold in the United States, according to the authority's website.
Ohio State University, meanwhile, issued $500 million of taxable century bond debt in mid-September with a 2114 maturity that carried a 5% coupon and was priced to yield 4.85% -- 170 basis points higher than the 30-year Treasury scale at the time.
The university's previous $500 million issue sold in 2011 was the first century bond offering for a public university.
"As the higher education sector is faced increasingly with private use considerations, which impact their ability to sell tax-exempt debt, century bonds provide an alternative means of financing," Singer said.
On the buy-side, the bonds are most attractive to asset-liability managers, who are hard-pressed to find duration products in the fixed-income market and want the extra yield to offset the risk of extending 70 additional years on the yield curve beyond the traditional 30-year structure, according to Brian Rehling, chief fixed income strategist Wells Fargo Advisors in St. Louis, Mo.
Pension funds and insurance companies can use the century bonds to offset their long-term obligations and liabilities, Rehling said.
"These buyers have very long-lived liabilities and constantly struggle to purchase matching long-lived assets," Singer agreed.
"Century bonds provide a unique opportunity for these buyers to acquire core assets which offset their perennial asset/liability mismatch," he said. "In addition, the yield pick-up is attractive considering the fact that the duration increase -- a measure of the price sensitivity of the bond given a change in market yields -- is only marginally higher than that of a 30-year bond," Singer added.
The D.C. deal — which was chosen as The Bond Buyer's 2014 "Deal of the Year" winner in the Northeast region -- is viewed as a precedent-setting model for municipalities across the country with similar long-term environmental infrastructure needs.
The authority has typically issued 30- to 35-year tax-exempt municipal bonds to fund its capital improvement projects, but this year used a financing strategy "that both matches the lifespan of our assets with their funding stream and that presents an equitable charge to our ratepayers," Mark Kim, D.C. CFO, said in the release.
Investor confidence in an issuer or specific project, such as the D.C. tunnel — which is expected to perform for at least 100 years -- can be a selling point, sources said.
"You wouldn't want to buy century bonds from an untested issuer or an issuer that can't make the case about the need for its service well into the future," said Patrick Early, chief municipal analyst at Wells Fargo Advisors.
He said cities, for example, would get better reception from selling century bonds than a tech startup.
"You can make the case for continued longevity of some health care institutions as well," Early said, pointing to a $400 million taxable sale in early September by the 94-year-old Cleveland Clinic — its first century bond sale -- that will fund expansions to its cancer center and growth of its Florida operations.
The 2114 maturity was priced with a 5% coupon and a 4.83% yield — a 170 basis-point spread to that day's triple-A 5% scale, according to Municipal Market Data.
While taxable century bond deals like D.C.'s have recently gained in popularity among select municipal issuers, they are less likely to become a household name in the municipal market due to their longer than usual lifespan and limited liquidity in the secondary market, muni experts said.
That's because risks outweigh the rewards for retail investors who are still the largest holders of bonds in the $3.7 trillion municipal market.
"A fairly obvious risk of any long dated bond is the sensitivity to rising rates," Early said. "That risk is even more pronounced in a 100-year structure.
Rehling agreed that the century bonds pose "tremendous interest rate risk" -- not to mention being issued by very high quality institutions that have to maintain that quality standard over 100 years. "There is not a tremendous amount of liquidity since this is not going to be a product that trades much," Rehling added.
Overall, Rehling and Early said they don't see a tremendous amount of demand for century bonds in general.
"When there is particular demand in the market and interest rates are very low it looks attractive to the issuer," Rehling said. "While you will continue to see it here and there — especially if interest rates remain low — I don't expect this to become a standard practice in pricing deals."
Early said century bonds are so rare that when one surfaces, financial advisors often wonder if the 100-year maturity date is a typo.
"With the relative newness of the structure, our desk rarely sees this type of bond and even more rarely is the desk asked to find them for a specific client portfolio," Early said.
In addition, Early doubts that century bonds add much diversity to an investor's portfolio.
"The type of issuer now using this structure is very well represented already in more traditional structures," Early said.
However, Foux believes century bonds will continue to see demand and will remain on the radar screen for the foreseeable future — even if the Federal Reserve starts tightening as expected.
"If rates stay at current levels or go slightly higher you will see these deals more," he said. "We need to see substantially higher long-term rates for 100-year bonds to become less viable, which in my opinion is not going to happen for some time."
Institutional demand, he said, could be curtailed by a market correction, or other volatility, that can cause century bonds to underperform and be less liquid.
He said century bonds are typically issued at denominations of at least $250 million or higher to be considered by the institutional index investors who commonly purchase the bonds.
While spreads between a 30-year maturity and a 100-year century bond have been as tight as 30 basis points, Foux said he believes the spread should generally be at least 50 basis points for investors to realize fair value.
Despite all the debate over century bonds, ultimately, the decision to hold century bonds depends on investors' comfort level with the ultra-long debt, experts said.
Early said one argument for retail investors holding century bonds is the ability to lock in a particular rate and income stream for an extended period of time.
"An investor wants to have a strong level of confidence in the issuer's ability to stay in business through whatever economic cycles the next hundred years might bring," Early said.
