Pennsylvania Sets $600M Competitive Sale

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In what would be the largest competitive municipal bond offering since the Lehman Brothers Holdings Inc. bankruptcy in mid-September, Pennsylvania early next month hopes to issue what it has always offered the market - plain-vanilla, fixed-rate bonds.

The state plans to sell on Dec. 9 as much as $600 million of 20-year general obligation debt on Ipreo's Parity electronic bidding platform. Officials are prepared to alter the deal if necessary in response to market conditions by cutting the size of the offering or even moving the sale to a different date.

While selling the bonds through negotiation would allow the state to pre-sell a portion of the debt - an option many issuers that typically sell competitively have been forced to take, given the upheaval in the credit markets - the commonwealth by law must issue its GOs in an open bidding process.

"So that's the only avenue that we have available to us," said Rick Dreher, director of the bureau of revenue, cash flow, and debt in the Budget and Administration Office. "This would be by far the largest competitive deal since the troubles began in September, so we are remaining flexible regarding timing and sizing and the like."

Many issuers this past year have been restructuring auction-rate and variable-rate debt in response to volatile market conditions and dealing with troublesome swaps.

Not Pennsylvania, which has roughly $9.33 billion of total outstanding debt. The Keystone state has no auction-rate debt, no variable-rate bonds, and no derivatives to monitor. Nevertheless, it now faces a troublesome municipal market created, in part, by such nontraditional municipal borrowing.

"Obviously, the concern is where the financial markets are and states like Pennsylvania that have had a very conservative debt issuance policy are kind of caught up in the reaction to some of the more high-flying transactions that have occurred over the past couple of years," Dreher said.

"We didn't get involved in swaps, we didn't get involved in auction-rate securities, variable-rate debt, and obviously no credit default swaps. But yet the whole market has shut down to all market participants, including an issuer like the commonwealth, who I would think from an investor's perspective would be a very stable credit that folks would be interested in owning our paper."

Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, said Pennsylvania's sizable deal could be a good indicator of where the market stands as it slowly comes back from the Lehman bankruptcy. The traditional stability of state-level issuers may outweigh current budget shortfalls and underperforming revenues, he said.

"It's a good test because I think relative to the volatility and the pessimism on the stock market, it is likely to lead some investors to want to go to the areas of natural protection, which would be the GOs and states, even though they have their own vulnerabilities," Ciccarone said.

The $600 million GO deal includes serial maturities from 2009 through 2029, with principal payments increasing gradually every year.

Buchanan Ingersoll & Rooney PC is bond counsel and Public Financial Management Inc. is the financial adviser.

Fitch Ratings and Standard & Poor's rate the commonwealth AA. Moody's Investors Service assigns a Aa2. Analysts said they will release their rating on the upcoming transaction by early December.

Bond proceeds will help support capital improvements throughout the state, including upgrades to public buildings, redevelopment projects, and open space and environmental initiatives. In addition, $200 million of the sale will help finance bridge rehabilitation projects.

While $400 million of debt will be paid off through future general fund revenues, the $200 million used for bridge repair stems from the state's decision to leverage motor vehicle revenues, including gas tax receipts and driver's license fees in order to speed up bridge repair work. In the past, the state has used those revenues to support bridge and roadway improvements on a pay-as-you-go basis.

"Given the slow growth in those revenue sources over the recent past, there was a decision as part of the [fiscal 2009] budget to accelerate our bridge-repair program and there was a decision to debt finance $350 million worth of bridge repairs," Dreher said. "So, we'll continue to fund bridge repair projects on a pay-go basis, but we'll augment our rehabilitation efforts with a one-time infusion of $350 million in bond proceeds. So the $200 million in this issue is more than half of the [fiscal 2009] bridge program which is projected to be issued."

The state plans to increase its borrowing over the next few years to address not only bridge improvements but also water and sewer infrastructure upgrades and expansions. Pennsylvania typically sells $1 billion of debt each year, but will boost that amount slightly over the next two years as it anticipates issuing $1.4 billion of debt in fiscal 2010 and fiscal 2011.

Even with the increase in bonding, Dreher expects debt service costs to account for less than 5% of the state's operating budget. Debt service payments take up 4% of the fiscal 2009 budget.

Along with trying to access the capital market, the commonwealth, like many states, must reduce its current $28 billion budget to offset a $564 million decline in revenues. Gov. Edward Rendell has called for $350 million of spending reductions but officials are also concerned regarding revenue performance for next year.

In addition, Dreher said the administration will release its mid-year financial report on Dec. 9, the same day that the bonds will price. That report will include revenue collections through the end of November.

Market analysts say the transaction may still withstand market volatility and current budget challenges and pointed to the state's low debt levels and a more than $1 billion rainy-day fund.

"I still believe that state GOs are a pretty good sector in the municipal market to be in and therefore I think the deal is actually going to go well ... It is going to be large, so anytime you have a large deal you have to wonder," said Tom Dalpiaz, portfolio manager and first vice president at Advisors Asset Management. "But for a double-A rated state GO ... Pennsylvania's actually in a pretty good position, and similar to many states, it is entering this difficult period, I think, from a position of strength."

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