Pennsylvania still doesn't have a final budget for fiscal 2010 but the Keystone State hopes to get nearly $30 million in interest savings with a $689.6 million advance refunding deal set for tomorrow.
The transaction will price competitively and proceeds will refinance outstanding general obligation bonds to reduce interest costs while maintaining the same maturities.
Though Democratic Gov. Edward Rendell signed an $11 billion "bridge budget" on Aug. 5 to cover payroll costs, keep essential services running, and pay debt service, his proposed $26 billion fiscal 2010 budget has yet to pass the legislature. It now sits in conference committee.
The heart of the impasse deals with additional revenue. Rendell and other Democratic lawmakers believe the fiscal 2010 budget needs new or additional revenue to balance the budget along with spending cuts while Republicans contend the state must live within its means and reduce expenditures further to match sluggish revenues. Democrats control the House and GOP members control the Senate.
Fiscal 2010 began July 1. Pennsylvania officials anticipate the market will still be receptive to a GO refunding and participants said that while the timing may not be ideal, investor interest will still be there for the commonwealth based on its conservative borrowing history.
"I don't think that Pennsylvania will be punished nearly as much as, say, Illinois and California have, because the supply level in Pennsylvania has been very moderate overall and the reputation of that state from a fiscal perspective is on a much more solid ground than say, for instance, California," said Michael Pietronico, chief executive officer at Miller Tabak Asset Management. "It may amount to five or six basis points at most, but nothing that's going to be a significant long-term [issue] for the state - there just isn't enough supply."
Rick Dreher, director of the bureau of revenue, cash flow, and debt in the Budget and Administration Office, said the state is confident that investors will participate in the refunding deal despite the budget stalemate.
"I hope the refunding would be received in the same manner as prior commonwealth issues," Dreher said. "We've had very attractive rates in the last several issues."
JPMorgan was the winning bidder on Pennsylvania's last refunding, a deal for $155.7 million. That sale priced on May 19, with bonds maturing in 2009 yielding 0.30% with a 2% coupon and debt maturing in 2014 yielding 1.92% with a 4% coupon.
Public Financial Management Inc. is the financial adviser for this week's offering. Cozen O'Conner is bond counsel.
Fitch Ratings and Standard & Poor's give the refunding sale their AA rating, with a stable outlook. Moody's Investors Service said it will release its rating on the transaction today.
Pennsylvania has $8.6 billion of total net outstanding debt. The state will pay $1.04 billion of debt-service costs in fiscal 2010.
While Fitch and Standard & Poor's mention the state's lack of a fiscal 2010 budget in their recent analysis of the credit, both rating agencies said they will continue to monitor the budget stalemate and cite the $11 billion approved spending as support for the state's most immediate needs.
The sale will advance refund all or a portion of 14 prior bond series sold from 2000 to 2008. The transaction is set to generate net present-value savings of nearly $30 million, according to Dreher.
Issuers are facing negative arbitrage on advance refinancings as escrow accounts are offering lower interest rates. Dreher said Pennsylvania plans to invest the bond proceeds in Treasury bonds instead of Treasury state and local government series securities, or SLGS, to achieve interest rates closer to what the state will pay in interest on tomorrow's refunding deal.
"The concern isn't so much keeping it under that, it's how much underwater the escrow's going to be and trying to mitigate that negative arbitrage," Dreher said.
The fiscal 2010 budget standoff also delays approval of the state's capital debt act for this year. Pennsylvania anticipates issuing $2.32 billion of new-money debt in fiscal 2010, for major projects such as the expansion of the Pennsylvania Convention Center in Philadelphia and construction of four new state prisons, among other infrastructure developments. That $2.32 billion amount is slightly higher than the $1.91 billion that the commonwealth sold in fiscal 2009. Pennsylvania cannot issue any new-money GO bonds until lawmakers approve the fiscal 2010 borrowing plan.
Dreher said the state can wait to issue those bonds, but if the budget impasse continues into November or December some projects could be put on hold.
"Clearly if we get into a very protracted budget impasse then yes, we will have projects that are going to have to be shut down because of a lack of ability to pay the contracts," he said. "But I don't anticipate that until much later into the fall."
While the state plans to boost its GO debt levels in the coming years, Standard and Poor's believes it can absorb the additional borrowing.
"Pennsylvania's debt profile is favorable in our opinion. In the next five years, however, commonwealth management intends to issue substantially more GO debt than it retires, boosting the commonwealth's tax-supported debt by about 40% from fiscal year-end 2008 levels," according to a Standard and Poor's report. "In our view, debt per capita and debt to personal income are very low at $748 and 1.9%, respectively. We also saw debt services, as a percent of general fund revenues, as low at 3.3% in fiscal 2008."
To bring additional liquidity, the state plans to sell tax and revenue anticipation notes this year, the first time Pennsylvania will offer short-term debt since 1998. The recession has eroded the state's cash reserves, prompting the commonwealth to look towards Trans for additional liquidity.
Dreher said the amount of Trans and the timing of the deal depend upon what the final fiscal 2010 budget looks like. A budget that includes new or additional revenue would necessitate a short-term sale of roughly $300 million to $400 million in February, while a spending plan that does not include a tax hike would require a Tran deal of $1 billion or more around November.
The state is also keeping an eye on pension costs that are expected to increase in fiscal 2013. In May, Dreher projected the state's pension contribution to increase by $1 billion to $1.2 billion in fiscal 2013. Now, due to poor investment performance, that estimate could rise by roughly $300 million.
"I would be ball-parking it, but I would say $200 to $300 million higher, at a minimum," Dreher said.
Officials have not discussed pension bonds in detail, he said. Such borrowing would require legislative approval, as the state's current borrowing capabilities do not include pension debt.