SAN FRANCISCO — California is planning its first offering of green bonds next week as a $200 million portion of its $2.3 billion general obligation bond sale.
Green bonds, dedicated to funding sustainable and environmentally beneficial projects, are a relatively new segment of the bond market, with the first municipal issuance sold last year by Massachusetts.
This year, green bonds have been growing in popularity, with total sales reaching $20 billion in just the first half of 2014, according to estimates from Bank of America. That amount includes all sectors of the bond market, not only municipal debt.
"We wanted to give investors a way to buy bonds they know will be used exclusively to finance projects that improve and protect the environment," said Tom Dresslar, a spokesman for California State Treasurer Bill Lockyer.
The projects that could receive green bond proceeds were approved in 2006 under Proposition 84, which authorized $5.4 billion of GO bonds to fund water-related projects, and Proposition 1B, which authorized around $20 billion of GOs for transportation.
While the green bonds are dedicated to environmental projects, they are otherwise structured identically to the other GO bonds to be sold next week.
"As I understand it, they are GOs and payments come out of the same general fund all GOs are paid from," said Marilyn Cohen, founder of Envision Capital Management in Los Angeles. "Other than a marketing hook I don't understand the differentiation, other than the funds are supposed to go to a specific green project."
In general, the market tends to look at the security of bonds, and not the use of proceeds, said Matt Fabian, a managing director at Municipal Market Advisors. In this case, the bonds will be sold largely on the strength of California's GO pledge.
However, selling "green bonds" does offer certain benefits to issuers.
In theory, a green bond finances environmentally efficient government services, which should garner savings and reduce the overall cost of government operations, Fabian said. It can also help increase demand for municipal debt.
"By giving them green status, it may open them up to socially responsible investors, so they get a broader class of investors," Fabian said. "In this current market, having more investors doesn't really matter, but in a thinner market, that green distinction could be more meaningful."
The current municipal market is not lacking in investor demand, as new issuance has remained low. Municipal primary issuance through August dropped 12.4% from the same time period in 2013, to $203 billion.
By starting to issue green bonds now, Fabian said, municipal issuers can set precedents and develop a program for the future. That way, when there isn't as much demand for new bonds, a "green bond" distinction could be helpful.
"It's a way to build incremental demand, even if right now, there's more than enough traditional demand," he said.
Green bonds have been offered in other areas of the market, including corporate and asset-backed funds, but there have only been a handful of green bonds in the municipal sector.
In 2013, Massachusetts sold its first issuance of "green bond" debt. The state sold $100 million as part of a $670 million GO bond sale. Proceeds went toward financing projects to support open spaces as well as environmental clean-up efforts at various sites.
The state, rated Aa1 by Moody's Investors Service and AA-plus by both Standard & Poor's and Fitch Ratings,
Massachusetts was inspired by a similar program from the World Bank, which has issued more than $3.5 billion in green bonds since 2008.
Other muni green bond issuances include a $213 million issuance from the New York Environmental Facilities Corp. and a $300 million issuance from the DC Water and Sewer Authority, both issued in June.
It's a sector that investors are likely to be hearing more of in the years ahead, said Michael Pietronico, chief executive officer at Miller Tabak Asset Management.
He added that Miller Tabak would approve green bonds that carry the issuer's GO pledge, if the credit fundamentals are strong overall.
"We suspect that if the deal is attractively priced, it will see significant demand due to the overall shortage of bonds available in 2014," Pietronico said.
Next week's California deal will also include $940 million of new money GO construction bonds that will fund various infrastructure projects and pay off outstanding GO commercial paper notes.
Another $950 million of GO bonds are being issued to refunding outstanding debt. Dresslar said the state does not provide pre-sale estimates of net present value savings for refundings.
The remaining $200 million will be mandatory put bonds, which will also fund various state projects and pay commercial paper notes as they mature. Projects to be financed include those under the 2006 transportation bond measure, as well as the Safe, Reliable High-Speed Passenger Train Bond Act for the 21st Century.
The High-Speed Train bond measure, approved by voters in 2008, authorized funding for a high-speed rail system project to connect Los Angeles and San Francisco. The project has been tied up in litigation from opponents challenging it on environmental grounds as well as the legality of bond sales for the project.
Dresslar said proceeds from the bonds will be used for projects authorized under the bond act that are not in dispute in the litigation.
The funds will be used for local connectivity projects to link local rail systems with the future high speed rail line.
"Using proceeds to fund connectivity projects is distinct from using bonds to finance construction of the actual HSR system," Dresslar said.
The mandatory tender put will be, depending on market conditions at the time of sale, between three to ten years.
A failed remarketing on the put date will not result in an event of default, but a stepped-up interest rate.
California's GO bond law allows the state to issue variable rate debt up to 20% of the aggregate amount of long-term GO bonds outstanding. The state has about $3.5 billion in variable rate debt as of July 1, which includes fixed rate bonds with mandatory tenders.
The state's total amount of GO debt outstanding is around $76 billion. Total GO debt with mandatory tenders is around $450 million.
"We're selling [the mandatory put bonds] for a couple of reasons," Dresslar said. "One, they give us a way to diversify what we offer to investors. And, two, they allow us do business at the short end of the yield curve without incurring the expense of obtaining credit enhancement."
The bonds are scheduled to price on Tuesday with Wells Fargo and Citi as joint senior managers. Bank of America Merrill Lynch is joint senior manager for the green bonds.
Orrick, Herrington & Sutcliffe LLP is bond counsel and Public Resources Advisory Group is financial advisor.
Dresslar said the maturity structure will be determined at the time of the sale.
California's GO bonds are rated Aa3 by Moody's, and A1 by both Standard & Poor's and Fitch Ratings. Moody's and Fitch assign stable outlooks, while Standard & Poor's has a positive outlook.
"The positive outlook reflects our view that California's credit quality could strengthen within our two-year outlook horizon, resulting in an upgrade," said Standard & Poor's credit analyst David Hitchcock said in the credit report.
He added that the state ended fiscal 2014 in its strongest fiscal position of the past decade.
In June,
"It isn't just investor enthusiasm," Fabian said of California's financial progress. "It's authentic and fundamental improvement in the state's structural budget balance."
The improvement can be seen in the state's credit spreads, which have significantly narrowed in recent years.
So far this year the spreads between the rate on a California GO bond and a triple-A rated bond have come down to 5 basis points from 29 basis points in five-year maturities, and to 23 basis points from 56 basis points in 10-year maturities, according to Thomson Reuters.
Earlier this month, the state reported receiving a record-low yield on its $2.8 billion sale of revenue anticipation notes. The bonds were sold competitively with a weighted average net interest cost of 0.107%.
The state is planning an additional GO bond sale in November-also to fund various capital projects and repay commercial paper notes.
