Tax law drives changes to Tennessee bond sale strategy
The state of Tennessee plans to make two changes to market nearly $192 million of general obligation bonds: selling competitively and lowering the savings threshold on a refunding piece due to the Tax Cuts and Jobs Act.
The gilt-edged deal will be issued Wednesday as $155.85 million of tax-exempt new-money bonds and $35.56 million of current refunding bonds.
“We are selling competitively which is something we haven’t done since 2012,” said Sandra Thompson, director of the Office of State & Local Finance.
Thompson said her office has seen an increase in competitive bond sales and some studies have shown that competitive sales can achieve better cost savings. The state has used negotiated sales the last six years due to market volatility.
Both series will be sold via IPREO’s BiDCOMPTM/PARITY competitive bidding system. Hawkins Delafield & Wood LLP is bond counsel.
Another change for the upcoming deal was prompted by the elimination of advance refundings when the Tax Cuts and Jobs Act was signed into law Dec. 22.
That led Tennessee officials to rethink their long-held debt management policy that required a minimum of 4% savings on refundings.
“We decided that doing current refundings we have to have a lower [savings] threshold, and so we lowered that threshold to 3%,” Thompson said.
Being restructured to current refundings will mean less savings, she said, because of the requirement that the bonds must be taken out within 90 days of the call date.
The refunding is expected to generate present value savings of $1.4 million or 3.76% of the refunded par, although the sale is subject to market conditions. The bonds will be issued within existing maturities from 2019 to 2023, and the savings will be taken over the five years.
The new-money bond proceeds will retire $120 million of commercial paper that financed capital improvements and maintenance. The remainder will be used for various university projects as well as to build a new high school for the blind and deaf.
The deal, with maturities from 2019 to 2028, will amortize the debt with level principal and will have a 10-year call date.
“We worked with our financial advisor, PFM, to determine what the market would bear and what investors would like,” Thompson said. “We think they like a 5% coupon and 10-year call date. We feel that’s going to make the bonds very marketable.”
The bonds are rated triple-A by Fitch Ratings, Moody's Investors Service and S&P Global Ratings. All three have stable outlooks.
Fitch analyst Karen Krop said Tennessee's AAA issuer default and GO ratings reflect the state's “very low debt and pension liabilities and a conservative approach to fiscal management.”
“The state by practice builds sizable reserves, including a budgetary reserve to cushion against unexpected volatility and a separate reserve to address unexpected needs in its Medicaid program,” Krop said. “After a sharp contraction in the last downturn, economic gains have been steady during the recovery, driving growth in state revenues and enabling the state to build up reserve balances.”
Fitch said state operating performance has been very strong in recent years, driven by tax collections well in excess of conservative estimates.
Fiscal 2017 tax revenues increased 4.1% on a year-over-year basis exceeding the revenue forecast on which the budget was based, and was led by stronger than anticipated sales tax collections. Tennessee does not have a state income tax.
“We expect continued growth in Tennessee's economy, although the pace may slow with a tightening labor market and as tariffs on key inputs to the state's auto manufacturing sector dampen growth,” Moody’s analyst Marcia Van Wagner said in a March credit update. “Solid job growth has brought the state's unemployment rate to 3.3% in January, below the nation's 4.1% rate.”
Tennessee's pension liabilities will remain relatively low due to a long history of adequate funding and more recent changes that will contain liability growth in the future, according to Moody’s.
The state’s $7.3 billion adjusted net pension liability, based on 2016 data reported in its 2017 financial statements, ranks 5th lowest of the 50 states as a share of the state’s gross domestic product. The state has made 100% of its required pension contribution since inception of the pension system in 1972.
The fiscal 2018 budget is structurally balanced and indicates that the state will continue to strengthen its financial position, according to S&P analyst Oscar Padilla.
“Following a bump in the general fund, reserves were up to $668 million in 2017, and the state has budgeted to transfer $132 million into its rainy day fund bringing the balance up to $800 million, or 5.4% of total appropriation requirements,” Padilla said.
When including an additional projected $226 million from the TennCare [Medicaid] reserve, as well as $1.07 billion in other available funds, total reserves at the end of fiscal 2018 are expected to be $2.1 billion, or nearly 12% of total appropriation requirements.
As of June 30, 2017, the state’s total tax-supported debt was $2.11 billion, including $19.4 million in capital leases and about $193 million of CP, with the balance consisting of GO debt, S&P said.