BRADENTON, Fla. — Kentucky reaped more savings than anticipated in Wednesday's $468 million taxable note sale in which underwriters created a new index-eligible term bond structure to entice investors who typically aren't interested in maturities less than 10 years.

The deal — featuring a final maturity in 2020 and an eight-year term bond comprising most of the debt — was oversubscribed more than two times and received more than $1 billion in orders.

The vast majority came from institutional investors, including many who buy Build America Bonds and other intermediate taxable bonds, according to the senior managing underwriter, JPMorgan.

Underwriters said the new structure could have significant implications for BABs, which were introduced last year as part of the federal stimulus program. So far, most BAB deals have been structured as 20- to 30-year bonds for investors such as pension funds.

The Kentucky Asset/Liability Commission, which by law must sell notes with maturities of 10 years or less, sold the transaction to refinance loans the state obtained since 2005 from the Kentucky Teacher's Retirement System Pension Fund to pay for teacher's medical insurance. The 10-year pension fund loans carried interest rates of 7.5%.

"We did better than we expected," said Jonathan Miller, secretary of the state Finance and Administration Cabinet. "The overall rate, including fees, was 3.304% and as a result we will save $87.7 million over the life of the 10 years."

Just last week the savings was projected to be around $70 million.

The transaction was structured with a make-whole call provision at a Treasury rate plus 25 basis points.

It sold as $47.27 million maturing in 2011 with a 0.84% coupon, $56.35 million in 2012 with a 1.49% coupon, $329.58 million in 2018 with a 3.16% coupon, $25.79 million in 2019 with a 4.10% coupon, and $8.56 million in 2020 with a 4.2% coupon.

The underwriters said the unique structure was devised to overcome the challenge of selling a large taxable deal in the short end of the yield curve.

The index-eligible $329.5 million term note maturing in 2018 is expected to have an average life of 4.95 years with mandatory pro-rata redemption language based on the sinking fund, said Peter Clarke, the senior underwriter on the transaction and vice chairman of public finance at JPMorgan.

"We believe this is the first benchmark-size sinking fund bond priced to the average life inside of 10 years," he said.

One challenge was overcoming investors' concerns about redemption features, which historically are done by lot and can result in uncertainty of duration.

Ahead of the sale, underwriters educated more than 100 investors about how the pro-rata redemption structure creates certainty around cash flows.

The other key factor was having a large enough term bond for inclusion in a global bond index.

That was important because the performance of many portfolio managers is measured against such an index so many of them try to duplicate it by buying index-eligible bonds, according to James Lansing, manager of debt capital markets.

"That was critical for the issue to get proper execution and for us to attract sufficient interest," he said. "It dramatically broadened the investor base than a serial structure would have attracted."

The underwriters believe the structure can be replicated in taxable BAB transactions.

To date, most BABs have sold with a bifurcated structure of tax-exempt bonds inside of eight years and BABs on the longer end of the curve.

That strategy could change now with the short-term structure created in Kentucky's deal.

"We've got a sophisticated investor base that's very interested in buying index-eligible, taxable bonds inside the 10-year maturity," Lansing said. "The structure really carried the day and at the end the investor was satisfied as was the issuer — it was a win-win for both sides."

Gov. Steve Beshear said the sale solved two vexing problems as the state deals with the poor economy.

"I am very pleased with the significant savings to the general fund resulting from the refinancing of these loans," he said. "The sale of these bonds will bring a great deal of relief to the thousands of Kentuckians who depend on [the teacher's retirement system] for their health insurance and who have been anxious for the commonwealth to rectify this precarious situation."

Last week's notes were rated AA-minus by Fitch Ratings, Aa2 by Moody's Investors Service, and A-plus by Standard & Poor's.

Others in the syndicate were Citi, Edward D. Jones & Co., First Kentucky Securities Corp., J.J.B. Hilliard, W.L. Lyons LLC, Morgan Keegan & Co., Morgan Stanley, PNC Capital Markets LLC, Ross, Sinclaire & Associates, and Stifel, Nicolaus & Co.

Kutak Rock LLP was bond counsel. Peck, Shaffer & Williams LLP was underwriters' counsel.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.