CHICAGO - Joining the parade of government borrowers looking at Build America Bonds, but with a twist, the city of De Pere, Wis., is asking broker-dealers to submit both tax-exempt and taxable bids on its competitive sale of $2.67 million of general obligation bonds today.
The city, located about five miles south of Green Bay along the Fox River, will accept bids via fax or through Ipreo's PARITY system and broker-dealers can submit a tax-exempt bid, a taxable bid, or both, said Kathleen Aho, president of Springsted Inc., which is serving as financial adviser to De Pere.
The deal includes two tranches of debt that will be bid together - $1.875 million of street improvement bonds and $800,000 of promissory notes. The notes mature over the next 10 years and the bonds carry a final maturity in 2028. The preliminary offering statement is at www.springsted.com/Default.asp?app=salestoday.
If the taxable bid is lower than the low tax-exempt bid after the 35% government subsidy on interest is factored into the overall interest rate costs, the city will declare the bonds under the Build America Bond program and apply for the direct-pay interest subsidy from the federal government.
"This issuer was very interested in the BAB program but wanted to do a competitive transaction and have the option to compare directly the difference between the tax-exempt and taxable rates," Aho said.
Under the BAB program authorized in the America Recovery and Reinvestment Act, municipalities can sell taxable bonds and opt to receive a 35% direct interest subsidy in the form of direct payments from the federal government or allow investors in the bonds to claim tax credits worth 35% of interest paid.
In talking with broker-dealers, Aho said the firm expects good interest on the taxable side, but the city retains the right to pull the sale if the rates are not to its liking.
Foley & Lardner LLP is serving as bond counsel. The firm worked on Stevens Point, Wis.'s sale last month of $3.65 million of taxable general obligation promissory notes under the BAB program. The deal marked the first under the program but it was privately placed with Wells Fargo. Though privately placed, Stevens Point also sought both taxable and tax-exempt rate proposals.
The University of Minnesota and University of Virginia sales last week marked the first publicly offered BAB bonds and the New Jersey Turnpike Authority followed yesterday. California is expected to finalize pricing a deal of at least $4 billion this week.
De Pere has structured the transaction as a traditional municipal bond, including in it a standard 10-year call feature. A so-called make-whole call is the standard in the corporate finance world and the large deals coming up include that feature over a traditional call.
The make-whole call provision allows the issuer to call the bonds but often at some rate set by a specified formula, which can effectively strip away the future economics of a refunding. Issuers that want to preserve their future financial flexibility, like De Pere, are including a traditional call, although it can hurt investor appeal and add to the interest costs.
Some buy-side market participants have raised questions over the accuracy of directly comparing the tax-exempt and taxable rates - with the subsidy factored in - on the yield curve to determine the true worth of the BAB program, since the long-term tax-exempt yields reflect the inclusion of a traditional call.
That's not an issue for De Pere, Aho stressed.
"We are comparing oranges to oranges, because it is the same municipal bond structure with a traditional call feature that is being submitted to the tax-exempt and taxable markets," she said.
Aho said De Pere preferred to maintain its future flexibility. "Calls are very beneficial to issuers to manage their future finances and some are willing to sacrifice the lowest possible interest rate," she said.
That flexibility is all the more important to some governments and market participants given the newness of the program and lingering concerns that the federal government could change it or how subsidies are distributed in the future. Under recently released Treasury guidelines, governments can begin applying for the interest subsidy next month.
Springsted is also working with Oshkosh, Wis., on a similar transaction.
Fitch Ratings affirmed the city's AA rating and Moody's Investors Service affirmed its Aa3 rating ahead of the transaction. Proceeds will pay for street improvements, municipal building and parking lot improvements, equipment and vehicle purchases, and costs of issuance. The city has about $31 million of GO debt.
Fitch attributes the city's rating level to its maintenance of favorable reserve levels above a targeted level of 20 % of expenditures, a growing tax base and population growth, and a moderate debt profile. Though the Brown County region remains one of the state's strongest economically, it's feeling the effects of the recession with slowing growth and a sharp rise of unemployment that in February was 7.8%.
