LOS ANGELES — California's positive credit trends are expected to help generate solid demand when the California State Public Works Board prices $254 million in lease-revenue bonds Oct. 16.
The state's general obligation bonds, rated single-A by two of the ratings agencies, are being priced into the market at double-A, said Craig Brothers, senior portfolio manager of fixed income for Beverly Hills-based Bel Air Investment Advisors.
Although Bel Air owns some of the State Public Works Board bonds, Brothers said he doubts it will be a buyer in the upcoming sale, because of anticipated pricing.
"A rating upgrade is baked in," Brothers said. "They are being traded like a double-A credit."
Brothers said the lease-revenue bonds, rated a notch lower, are trading in lock-step with the state's general obligation bonds. The current 10-year spot is trading at 25 to 30 basis points to Municipal Market Data's benchmark taxable triple-A GO scale. It's a stark contrast with 2009-10 when the state's bonds were trading between 175 and 200 basis points off the high grade scale, he said.
"It has been a huge outperformer," Brothers said. "That same trade (from 2009-10) doesn't exist. There is no fear now, no shortage of buyers, and this is a much smaller issuance."
The bonds will be sold in three tranches: a $110.3 million series 2014D to fund correctional facility projects, a $78.4 million series 2014 E for capital projects, and $65.2 million series 2014F to refund bonds issued for a Pleasant Valley State Prison project.
The bonds are being issued by the SPWB acting through the Department of Corrections and Rehabilitation for the 2014D and 2014F bonds and the Judicial Council and Department of State Hospitals for the 2014E bonds.
Barclays is bookrunner. Stradling Yocca Carlson & Rauth is bond counsel.
A retail order period is scheduled Oct. 15 before the Oct. 16 pricing.
Fitch Ratings and Standard & Poor's both assigned the bonds A-minus ratings ahead of the sale in ratings reports released Oct. 2 and Oct. 6, respectively. The outlooks were stable and positive from Fitch and S&P, respectively. Both ratings are one notch below the ratings for the state's GO bonds.
"The ratings are based on our view of the state's credit quality and SPWB's receipt of the participating state agencies' pledged annual lease payments for use of the various assets under each lease agreement," said S&P analyst David Hitchcock.
Moody's Investors Service rates the Public Works Board bonds A1, a notch below its Aa1 California GO rating.
The State Public Works Board has approximately $10.4B of similarly secured lease revenue debt outstanding, according to Moody's.
The A1 rating reflects strong legal mechanisms for lease payments in spite of some abatement risk, the weaker security provided by lease revenue bonds relative to the state's general obligation debt, and the credit standing of the State of California," Moody's analysts wrote.
The bonds benefit from access to the SPWB's $162 million master indenture reserve, Fitch analysts said.
The proceeds from the current series will provide $130 million toward jail projects in San Diego and Madera and help fund a $47 million courthouse in Red Bluff and a $30 million kitchen project at the Napa State Hospital, said Tom Dresslar, a spokesman for California Treasurer Bill Lockyer.
The improvement in the state's ratings over the past several years has resulted in increased interest from out-of-state buyers who wouldn't look at California bonds in the years following the nation's economic crash, Brothers said.
"They are definitely bringing in buyers, outside of the state, who were afraid of the credit two or three years ago," he said.
California voters approved Proposition 30 in November 2012 to increase sales and income taxes for several years to prevent cuts to the education budget. Since the measure passed, spreads on California's GO bond yields have contracted against MMD's generic triple-A municipal bond, Brothers said.
Prior to the passage of Proposition 30, "you couldn't sell the state's bonds to money managers outside of California," Brothers said.
The lease revenue bonds are expected to generate a great deal of investor interest, according to Peyton Studebaker, managing director with Richmond, Va.-based Caprin Asset Management.
Demand is expected to continue to outpace supply in the municipal bond markets into mid-October. The market is anticipating that the relative decline in new California bond issuance since 2008-09 is anticipated to continue.
The state reported in its 2014 Debt Affordability Report that it planned to issue around $3.3 billion of new general obligation bonds and $539 million of lease revenue bonds in fiscal 2016. That represents a steep drop from 2008-09 when GO bond issuance totaled $15.5 billion.
This year's total GO bond issuance is expected to be around $5.2 billion. The state plans to issue another $280 million of SPWB lease revenue bonds on Nov. 6, Dresslar said.
JPMorgan is senior manager for that deal.
In November, the state also plans another GO sale, but the amount and exact date have yet to be determined, Dresslar said.
That deal will be sold competitively.
"Overall municipal supply continues to run at very manageable levels with 2014 setting up to be another year of net negative issuance," Studebaker said.
Year-to-date California issuance totals approximately $30 billion compared to $37 billion through the same period last year - a decline of roughly 18%, he said.
"The supply decline coupled with improving state credit fundamentals is fueling eager demand for California debt," he said. "The fact that the state's residents are the country's most heavily taxed only increases new California loans' appeal even further."
The state never tries to guess what the market reception will be on the bonds, Dresslar said. "We just try to get the best deal for the taxpayer that we can," he said.
"Obviously, the state's improved financial management has strengthened its standing in the market," he said.
Hawkins Delafield & Wood LLP is underwriters counsel. KNN Public Finance is financial advisor on the deal. Nixon Peabody LLP is disclosure counsel to the Public Works Board, and Orrick, Herrington & Sutcliffe LLP and Stradling Yocca are co-disclosure counsel for the state government.
