CHICAGO — Michigan State University on Thursday will price $205 million of 40-year taxable Build America Bonds for capital projects. The school in May expects to offer a pair of refunding transactions that will restructure some of its variable-rate demand bonds and refund outstanding commercial paper.
Proceeds from the refunding will allow MSU to eliminate some risk in its debt portfolio by lowering the amount of its variable-rate debt and terminating interest-rate swaps. As part of the restructuring, the university could enter into one or more new basis swaps, in which it both pays and receives a variable rate.
Bank of America Merrill Lynch and JPMorgan are underwriters on Thursday’s sale. Miller, Canfield, Paddock and Stone PLC is bond counsel. Sound Capital Management is financial adviser.
One of Michigan’s co-flagship schools, MSU maintains one of the nation’s largest campuses — located in East Lansing — and enjoys diverse and strong revenue sources. But with 91% of its debt portfolio in a variable-rate mode, and 15 interest-rate swaps tied to its debt, the school’s debt exposes it to significant market-related risks, warned credit analysts.
The challenges associated with its debt and swap portfolios, including counterparty risk, termination risk, and basis risk, have prompted Moody’s Investors Service to maintain a negative outlook on the school. Michigan’s economy also poses a challenge for the university, analysts said.
Moody’s gives a Aa2 to the school’s debt, which totals around $850 million. Standard & Poor’s rates it AA with a stable outlook.
Michigan State representatives did not return phone calls seeking comment.
The BABs mature serially between 2044 through 2050. The debt is secured by a pledge of MSU’s general revenue, which includes tuition but not state appropriations. Pledged general revenues totaled more than $1 billion in 2009.
The debt is further secured by a rate covenant that requires the school’s general revenues to total at least 200% of annual debt service.
In May, officials expected to restructure roughly $210 million of variable-rate debt and follow that transaction with the refunding of roughly $127 million of commercial paper notes. The VRDB restructuring would reduce the amount of variable-rate debt in the school’s portfolio to 38%, down from 91%, Moody’s said.
“We note that the substantial variable-rate debt exposure that would remain after the restructuring still exposes Michigan State to dependence on the smooth functioning of the variable-rate debt markets and significant exposure to maintenance of historic behavior of tax-exempt and taxable rates,” Moody’s analyst Laura Sander wrote in a report on the planned transactions.
MSU would also use a portion of the proceeds from the restructuring to pay counterparty fees to allow it to terminate interest-rate swaps associated with the debt and enter into a new basis swap, Moody’s said.
Currently the university has 12 floating-to-fixed-rate swap agreements with four counterparties and three basis swaps tied to a total notional amount of $906.1 million, according to bond documents. Ten of the 12 floating-to-fixed-rate swaps are hedged with three separate basis swaps in which MSU both pays and receives a variable rate of interest.
If the school completes the restructuring, it would reduce by $210 million the amount of debt tied to interest-rate swaps while adding $162 million of debt tied to basis swaps, analysts said. Under the new basis swap, MSU would pay the Securities Industry and Financial Markets Association index rate and receive 67% of the one-month London Interbank Offered Rate plus a spread, according to Moody’s.
MSU also faces challenges tied to the state’s weak economy. The state is expected to continue to trim the amount of aid it gives to the school. State appropriations historically make up 22% of MSU’s operating revenues, Standard & Poor’s said.