LOS ANGELES — California will appeal to international investors Thursday when it prices $1.2 billion in taxable general obligation bonds to help fund its $64 billion high-speed rail project.

The bonds are being marketed to international as well as domestic institutional buyers by joint lead managers JPMorgan and Bank of America Merrill Lynch.

The fixed-rated, mandatory put, and floating rate notes offered in three series are designed to appeal to a broad swath of investors as well as keep debt service smooth, said Tim Schaefer, California's deputy treasurer for public finance.

In late March, Sacramento County Superior Court Judge Raymond Cadei set a hearing for Wednesday, the day before the planned bond sale, to hear opponents' arguments for an injunction to halt the bond sale.

California's cap-and-trade revenues help fund its high-speed rail project.
California's cap-and-trade revenues help fund its high-speed rail project. California High-Speed Rail Authority

The bonds are expected to be well-received by the market, according to market participants, despite litigation and construction risk.

“Buyers have to go in with their eyes wide open that there could be litigation,” said Matt Fabian, a partner with Municipal Market Advisors. “It makes sense to structure it this way. There are enough questions surrounding this whole project that the state is smart to pursue maximum flexibility.”

The project has weathered legal challenges and political attacks over the past several years.

The state treasurer’s office said it would not speculate on whether the bond sale could be halted, because it depends on how the judge rules.

“With any large project that has been subjected to the kind of process this has, you take precautions,” Schaefer said. “We believe the state has gone through all the processes required to say the bonds are valid obligations of the state of California.”

The bonds are rated Aa3 by Moody’s Investors Service and AA-minus by both Fitch Ratings and S&P Global — the same as the state’s other GOs. All three rating agencies assign a stable outlook.

“High-speed rail bonds are GOs of the state of California, pure and simple,” said Gabriel Petek, an S&P Global managing director. “Once they issue bonds, they will be treated just like any other GOs with no differentiation and with the state’s full faith and credit.”

The state has done everything to meet the restrictions laid out in the $10 billion bond authorization approved by voters in 2008, Petek said. That included approving a resolution by the high-speed rail finance committee.

“I am aware that there is controversy around the project, but if they fulfill all of the legal qualifications to issue the bonds then they are just a GO,” he said.

While investors should always understand what bond proceeds are being used for, Gurtin also believes that the focus especially for state obligations should be on the legal security being provided by the obligor, said Tom Schuette, partner and co-head of investment research & strategy for Gurtin Municipal Bond Management.

“And in this case, the bonds are straightforward general obligations that are no different legally than any other California GOs,” Schuette said. “The market should not see these as being any riskier than the other bonds that carry the same security.”

The bonds are being sold as taxables because the use of proceeds for high-speed rail will invariably involve the acquisition of assets or construction that would fail the private activity test for Internal Revenue Service purposes, Schaefer said.

The proceeds will fund the 119-mile Central Valley segment of the line planned to run from San Francisco to Los Angeles.

Issuing taxables that include a floating rate note series is a good way for the state to access foreign capital and California is among the municipal issuers with the best appeal for international buyers, because of the well-known name, Fabian said.

“With reasonable prospects of the Fed raising rates, there is more interest in floating rate notes,” Fabian said.

Taxable rates are very close to tax-exempt at the front of the curve, are more easily hedged in a portfolio and the taxable rate structure would be more liquid, Fabian said of broad appeal in the state’s structuring of the series.

That California has been a frequent seller this year isn’t expected to dampen demand.

It has priced $2.8 billion in GOs and $534 million in public works bonds. Plus, Wells Fargo Securities won California’s $603.8 million competitive GO refunding sale last week with a true interest cost of 2.81% -- just a basis point above the next closest losing bidder, Schaefer said.

“There is still ample demand for California paper even with the recent sales, and there is not a ton of supply of shorter taxable paper in the market,” Schuette said. “So the state is selling this into a favorable environment.”

The recent bond sales have not affected the state’s debt burden because the largest sale was a refunding and the state’s debt level as measured by the size of its economy has been declining over the past several years, Petek said.

S&P considers the state’s $75 billion in outstanding debt to be moderately high, but the debt only represents 3.1% of the state’s $2.7 trillion in gross domestic product, Petek said.

California has had a very positive credit story to tell over the past several years, Schaefer said. The legislature has adopted budgets on time, the voters have approved tax extensions and the governor has demonstrated prudence in setting reasonable spending goals for the state, he said.

“The state’s credit quality is performing pretty well,” Petek said. “The budget conditions have continued to improve and they are accumulating additional reserves.”

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