WASHINGTON — In an effort to take advantage of the 35% subsidy rate for Build America Bonds while it lasts, Maryland plans to competitively sell its largest BAB issue to date — $400 million — as well as $200 million of advance refunding bonds on Wednesday.
The transaction by the triple-A rated state, which faces a $2.0 billion fiscal 2011 budget shortfall, may foreshadow other issuers’ attempts to sell large BAB deals before the program expires at the end of the year.
Maryland sought a large BAB portion with this deal to take advantage of the 35% subsidy now because future market conditions and the Obama administration’s proposed 28% subsidy could make BABs less cost-effective in the future, according to Patti Konrad, director of debt management in the state treasurer’s office.
“We decided to do a large issuance of BABs to try to get it in at 35%,” she said.
If the subsidy is reduced to 28%, the state may not be able to issue BABs because of a constitutional requirement that GO bonds amortize within 15 years, Konrad said. The amortization requirement offsets Maryland’s high debt-to-personal-income ratio, Moody’s Investors Service said in a report.
At the 35% subsidy rate, BABs become cost-effective compared to traditional tax-exempt bonds at 10 to 15 years along the yield curve, Konrad said.
The BABs in this deal are expected to mature in 2019 through 2025 and the tax-exempt advance refunding bonds are expected to mature in 2018 through 2022. But if the BAB subsidy is reduced to 28%, then BABs might become cost-effective at 15 to 20 years, she said.
Maryland “might not be a big issuer of BABs in the future,” Konrad said. However, the state’s university system and department of transportation are permitted to issue bonds beyond 15 years and could still benefit from reduced-subsidy BABs, she said.
The state expects to save $6 million with the refunding deal, but Konrad stressed that figure is preliminary. The state saved about $25 million with a refunding deal in December, she said.
Kutak Rock LLP is the bond counsel and Public Financial Management Inc. is the state’s financial adviser for the transaction.
Maryland’s triple-A rating was reaffirmed by Moody’s, Standard & Poor’s, and Fitch Ratings, with stable outlooks, making it one of seven states with that rating from all three agencies.
Gov. Martin O’Malley issued a statement calling the rating “noteworthy” amid the national recession and praising the state’s financial management.
Maryland’s bond proceeds are used on a cash-flow basis and are allotted for projects as needed, usually within six months of issuance. About 60% of Maryland’s GO proceeds pay for education needs.
Last month, O’Malley proposed a fiscal 2011 budget that would close a $2 billion revenue shortfall plus provide about $205 million needed to close the fiscal 2010 budget shortfall.
But the state’s spending could run $2 billion above its projected revenue for the next several years, said Standard & Poor’s lead analyst for Maryland, Richard J. Marino. Maryland budgetary problems are “not unusual” compared with other states, he added.
Personal income tax revenue in Maryland, the general fund’s largest source of revenue, continued to decline in the state’s December revenue forecast. Fiscal 2010 general fund revenue is expected to decline 4.7% and rise 3.0% in fiscal 2011, Fitch said in a rating report.
Maryland had the second-highest debt-to-personal income among the seven gilt-edged states behind Delaware, according to reports from Moody’s and Standard & Poor’s last year based on 2008 data. The median average for the seven states was 2.5% debt-to-personal income.
The state has tapped its revenue stabilization account to help balance the budget, but the rainy-day fund will remain at 5% of revenues in fiscal 2010 and, based on the governor’s budget, in 2011 also, Moody’s said.
One of O’Malley’s proposals to close the budget shortfall calls for the state to transfer $330 million of capital funds to the operating budget and to issue bonds for the capital projects.
The proposal, which needs to be approved by the legislature, will not add to the state’s debt burden, rating analysts said. The state will substitute certain projects for ones that will be delayed or deferred to accommodate bonds, Konrad said.
Maryland has no variable-rate debt or interest-rate swaps outstanding. The state does not expect to issue any short-term debt for cash-flow needs, Konrad said.