The New York State Environmental Facilities Corp. plans to market its first bond deal using a new security structure this week. The EFC’s new indenture for state revolving fund projects doesn’t require a reserve fund, something that bonds issued under the old indenture needed.

The EFC expects institutional pricing on $142.5 of tax-exempt bonds will begin on Thursday following a one-day retail order period. The deal will include refunding bonds and new money.

Jefferies & Co. is book-running senior manager on the fixed-rate bonds that will be offered as Series 2010C bonds with serial and term maturities of up to 29 years.

Hawkins, Delafield & Wood LLP is bond counsel and Public Financial Management Inc. is the financial adviser.

The EFC lends money from its revolving fund to local governments or authorities to finance capital water and sewer projects. The bonds are secured by a pledge of local government repayments on their loans, equity in the revolving fund, and reserves from the old indenture that will be released as bonds are refunded.

Chief financial officer James Gebhart said the shift away from a reserve model has been something the issuer began considering in 2005.

“We had so much capital pledged under the 1991 master financing indenture, far more capital than we needed to maintain the triple-A ratings,” he said. “The restructuring puts us in a position where we do not have to have a reserve investment or over-collateralization behind every local government recipient financing that we originate from our bond proceeds.”

Gebhart called the new indenture a “blended-rate” model, which is similar to a cash model in that it does not require pledge reserves. Not needing a certain level of reserves behind every bond transaction will also allow the issuer to loan funds at cost to local governments that don’t qualify for subsidized loans, effectively giving borrowers access to the EFC’s triple-A rating.

The $142.5 million of bonds pricing this week will be secured by a pledge of $320 million of local government principal repayments. The largest borrowers in the pool are Westchester County, Orangetown, and Syracuse.

The initial impetus was to allow the issuer to have more flexibility in the kind of loans it could make to borrowers and to free up capital that was in pledged reserves, Gebhart said.

Bonds issued under the old indenture required reserves that had to be invested in securities that carried the same rating or better than the corporation. In 1991, the indenture was rated double-A by all three rating agencies, but in 1994, it was upgraded to triple-A.

“Meeting the triple-A requirement worked because the providers were active enough in the collateralized investment agreement market,” Gebhart said.

Work on the new indenture was already under way when the financial markets meltdown in 2008 added a new problem.

The EFC generally invested its reserves in guaranteed investment contracts, including one with American International Group Inc and one with Depfa Bank. The credit crunch and the downgrades to AIG and Depfa meant those GICs had to be unwound and replaced with other securities.

“On the investment side, you’d have this issue of what the credit quality is in respect to the equity investments, so that was a bit of a problem for us,” Gebhart said. “The old master financing indenture would no longer work for us.”

The EFC has $1.85 billion of bonds outstanding on its 1991 indenture and about $730 million of reserves pledged to those bonds. Over time those bonds will be refunded under the new indenture and reserves will be released.

The new indenture does not apply to a separate indenture created for financings undertaken on behalf of the New York City Municipal Water Finance Authority.

Fitch Ratings analyst David Livtak said that the EFC is not alone in moving away from a reserve model.

“We’ve seen an increased trend toward 'cash flow [state revolving funds],’ or SRFs using a cash-flow model where the federal capitalization grants and matching funds simply go to make additional loans,” he said. “Because interest rates on investments are so low there’s less value gained from having a large reserve, you don’t get much interest subsidy.”

Fitch rates the EFC’s 2010 master financing indenture at AAA, despite what a rating report characterized as a weaker legal covenant.

“There’s more loans than bonds outstanding,” Livtak said. “That excess is what provides the credit enhancement that allows us to get a triple-A rating.”

Fitch said in its rating report that the EFC is expected to maintain a debt-service coverage ratio sufficient to keep a triple-A rating on the new indenture even though its legal structure only requires a ratio of one time on senior and subordinate debt.

Both Moody’s Investors Service and Standard & Poor’s rate the bonds triple-A with a stable outlook.

The EFC has sold $6.6 billion of new-money revolving fund bonds and $8.22 billion of refunding bonds since 2000, according to Thomson Reuters. The issuer has $7.5 billion of bonds outstanding on all its indentures.

Rick Farrell, executive director of the Council of Infrastructure Financing Authorities, a trade group, said he hasn’t heard of a large-scale move nationally away from the reserve model.

While SRFs have had to deal with lower investment returns, they have also gotten a big bump in federal funds under the American Recovery and Reinvestment Act. Federal capital grants to clean-water programs jumped to $2.1 billion in fiscal 2009 from $689 million in fiscal 2008, Farrell said.

“The federal cap grants to SRFs has basically tripled so there is a lot of money,” Farrell said. “But long term if you’re not able to get a decent return on your investments, I think it has implications for the whole revolving nature of the fund and you may have to go to some other kind of model like New York is.”

In April, when the Kentucky Infrastructure Authority went to market with $208.4 million of bonds in its first-ever leveraged SRF bond deal, it used a cash model.

“Both the reserve-fund model and the cash-flow model are accepted models for issuing bonds — it’s just which meets your circumstances the best,” said KIA executive director John Covington. “We have a very substantial portfolio of loans to serve as security, so it just naturally pointed to a cash-flow model because we have a significant unobligated cash flow coming in.”

The KIA also didn’t have the cash on hand to invest in a reserve fund, Covington said, though it has the option of using that model at a future date.

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