DALLAS – In one of its largest deals in recent years, the Kansas Department of Transportation will issue $400 million of revenue bonds for its "T-Works" highway program.
The bonds are scheduled to price Dec. 2.
This issue is the second of the year for KDOT. The department issued $186 million of refunding bonds in August. With this sale, KDOT will have about $2.1 billion of debt supported by its Highway Fund.
The upcoming deal was increased to $400 million from its planned $300 million in case the financially struggling state transfers money from the highway fund to the state general fund, according to Standard & Poor's.
"Although the KDOT does not have plans to issue additional new money debt during the remainder of the current capital plan running through 2020, substantial future transfers of highway fund money to the general fund could create, in our view, a need for new bonding," Standard & Poor's analyst David Hitchcock wrote.
Keith Bradshaw, KDOT's director of fiscal and asset management, said recent transfers from the State Highway Fund will not impact projects or agency operations.
Pledged revenues run a robust seven times higher than maximum annual debt service, and the bond covenant requires at least 300% coverage, ratings analysts said.
With such strong security, Bradshaw expects a healthy appetite for the bonds in the first full week after Thanksgiving.
"We feel we'll get very good pricing out of this," Bradshaw said. "Historically, KDOT has priced on average 8 to 18 basis points over MMD."
Bookrunner on the deal is Morgan Stanley, led by executive director Bill Mack. Jon Burmeister, managing director of Public Financial Management Inc., is KDOT's financial advisor.
With maturities running from 2025 to 2035, the bonds carry split ratings of triple-A from Standard & Poor's, AA-plus from Fitch Ratings and Aa2 from Moody's Investors Service. Outlooks are stable.
While KDOT carries a separate rating from the state, Moody's factors in the state's fiscal situation, Bradshaw said. Kansas is facing revenue shortfalls after a series of tax cuts by the state legislature at Gov. Sam Brownback's urging.
The Moody's rating "recognizes a legal structure that is not solid enough to completely insulate the bonds from the State of Kansas (issuer rating Aa2 stable), whose practice of transferring transportation funds into its general fund is a key weakness," analyst Dan Seymour wrote in a Nov. 13 rating report.
Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Kansas City, Mo., said investors do pay attention to issues such as the state's pension problems and the revenue shortfall that led to highway fund transfers.
"Kansas has certainly had their fiscal issues and that will certainly be taken into account," said Heckman, who firm has $126 billion under management. "However, there's always been a good reception for KDOT and this should be no different."
Jim Colby, portfolio manager for Van Eck Global, said that the fact that this is a highly rated new money deal from a high-profile issuer in support of major infrastructure should enhance demand for the bonds.
"A deal of this size and particularly this size out of Kansas doesn't come out that often," Colby said. "This is a terrific time for Kansas to be entering the market."
Colby manages six exchange traded funds, three investment grade and three high-yield. While he does not generally acquire bonds in the primary market, some of the KDOT maturities will eventually find their way into his portfolio, he said.
"This deal will, I guarantee you, find its way into national portfolios," he said. "I would certainly have it on my radar screen."
The KDOT bonds will come to market two weeks before the Federal Reserve Bank's Open Market Committee meets to consider raising interest rates. Most muni investors have already factored the higher rates into their strategies, experts said, as the possibility of a rate increase has been discussed for more than two years.
More beneficial for the KDOT deal is a shortage of new money issues in the market. With rates at historic lows, the market has been flooded with refunding deals.
"We think there's been a shortage of supply for about six months," Heckman said. "You strip out the data on issuance and take out refundings, you're going to see that net new supply has been decreasing last three or four years."
Moreover, the indecision over whether to hike rates has kept large piles of investor cash on the sidelines, Heckman said.
"There are some people who are waiting on rates to normalize and they're just sitting on cash as their earning power is eroding," Heckman said. "We've told clients and prospects: 'You've got to get into the market.'"
Although the KDOT bonds are double tax-exempt in Kansas, the Sunflower State does not represent a large retail market, Colby said.
"The income taxes in Kansas are not onerous enough to make this deal significantly important just to Kansas residents," Colby said. "Like investors in several states, they are attracted to the bonds from a pride standpoint as much as anything."
Gov. Brownback's plan to eliminate income taxes in favor of sales taxes could someday have a slight bearing on sales of Kansas bonds within the state.
Kansas lawmakers increased the allocation of state sales tax to the highway fund by about $180 million in fiscal year 2014 and raised its overall state sales tax rate in this year's session.
The new budget slightly decreased allocation of sales tax to the state highway to keep funding level with the previous year.
Transfers from the highway fund to the general fund have not interfered with debt service payments. Such transfers were made in fiscal years 2010-2015, are budgeted for fiscal 2016, and planned for fiscal 2017, analysts said.
State officials have recently proposed making an additional $50 million transfer from the highway fund to the general fund in mid-2016 to meet newly identified budget gaps. The current fiscal 2016 budget anticipates $406.6 million of subordinate transfers out from the state highway fund in total to the general fund.
KDOT funds transportation projects for 9,461 miles of state highways and 5,000 bridges. Vehicles travel 27.5 million miles a day on state highways.
The agency is halfway through the nearly $8 billion "T-Works" transportation program passed by the legislature in 2010.
The 10-year program is designed to create jobs, preserve highway infrastructure, and provide multimodal economic development opportunities across the state.
Ben Cleeves, chief budget officer for KDOT, said that $775 million of the anticipated $1.2 billion of bonds has been issued for T-Works so far.