LOS ANGELES — The University of California is expected to ride its credit strength to low financing costs when it prices $2.8 billion in two revenue bond sales next week.
"The UC system is an extremely strong credit and it's going to get cheap financing," said Michael Ginestro, director of municipal research for Beverly Hills-based Bel Air Investment Advisors LLC.
Ginestro pointed to the UC system's strong balance sheet, good cash flow, and significant demand from the 240,000 students enrolled on its 10 campuses statewide for why he thinks the bonds will be warmly received by the market, even amid heavy supply.
Barclays is the lead manager on both University of California Regents sales, which each involve the same 21-member underwriting syndicate.
Raymond James is co-manager on the two series of limited project revenue bonds: a $1.2 billion tax-exempt 2015 Series I and $440 million taxable 2015 Series J.
Stifel is the co-manager on the two general revenue bond series: the tax-exempt $770 million Series AO and taxable $370 million 2015 Series AP.
A retail order period will be held Tuesday for all series of the bonds. Institutional pricing for both general revenue bond series and the taxable limited project revenue bond will be Wednesday, followed by final pricing Thursday for the $1.2 billion Series I tax-exempt limited project revenue bonds.
The financial team is rounded out with Swap Financial Group, LLC. as the municipal advisor, Orrick, Herrington & Sutcliffe LLP as bond and disclosure counsel and O'Melveny & Myers as underwriter's counsel.
Roughly 80% of the bonds will refund existing debt, according to a Fitch Ratings report. The sale anticipates pricing $260 million in new money GR bonds and $391 million in LPR bonds, according to a slide show attached to the offering documents.
The general revenue bonds will be used to finance or refinance the acquisition, construction or renovation of university facilities on the 10-campus university system. The limited project revenue bonds will finance or refinance athletic, parking, dining, and student and faculty housing.
The limited project revenue bonds received ratings of Aa3, A-minus and AA-minus from Moody's Investors Service, Standard & Poor's and Fitch Ratings, respectively. The general revenue bonds received ratings of Aa2, AA and AA. All assigned stable outlooks.
The strong supply in the market since the beginning of this year, and the deal's timing a week after $1.9 billion of California general obligation bonds, shouldn't hamper demand for the UC system bonds because there is still such strong demand for California paper, market participants said.
The high-net worth California residents who drive retail bond sales are facing several factors this year that should make the state's tax-exempt municipal bonds look particularly good to them, Ginestro said.
Proposition 30, passed by voters in 2012, increased income tax on the state's highest earners, which gives them more incentive to buy munis, Ginestro said. The stock market also has been doing well, providing more incentive to protect income.
"The demand for this paper is going to be there," Ginestro said. "There are so many positive tailwinds for the state right now that will continue to move the state into a better credit position."
He said debt issued by the state, the university system, local school districts and possibly even its local governments looks favorable right now.
Nevertheless, the market is heavy this week from supply including the $1.9 billion California GO deal, said Peyton Studebaker, a managing director at Richmond, Va.-based Caprin Asset Management, LLC.
Supply has been averaging about $8 billion a week in new money sales since the beginning of the year, much more than the same period last year, Studebaker said. Mutual fund inflows were positive coming in around $450 billion last week, he said.
The spreads on the lower-rated deals and secondary trading have widened out a bit, but less so in the high-grade names like UC Regents, he said.
"It is a fairly recognizable name; California demand still tends to be high; and taxes are still weighing on the California investor's mind, particularly from retail investors," he said.
The large refunding component to the UC system's spring sale is typical for what is occurring in the market as issuers try to refinance before the Fed raises interest rates, he said.
The university system also has some headwinds to battle as well, according to S&P analyst Jessica Matsumori.
Despite the AA rating and stable outlook, Matsumori raised a caution flag in her report.
Significant risks remain that will continue to pressure the system for years to come, she said.
Among those pressures are declining operating and balance sheet metrics, growing pension and other postemployment benefit liabilities, significant deferred maintenance needs, and future debt plans, she said.
The UC system had $10.47 billion in general revenue bond debt and $1.97 billion in limited purpose revenue bond debt as of Dec. 31, 2014, according to bond documents.
The rating agency's stable outlook projects out two years. Matsumori said the concerns raised in the report are about longer-term fiscal pressures.
All three rating agencies cited pensions and healthcare as a concern. The system's pensions were 79% funded as of July 1, 2014 compared to 76% a year earlier, according to the slide show. The actuarial pension deficit declined from $10.7 billion as of July 1, 2014 compared to $11.7 billion a year earlier. OPEB liability has grown from $13.2 billion as of July 1, 2013 to $14 billion as of July 1, 2014.
Pressures Matsumori cited include the affordability of healthcare and state support levels in combination with the system's significant capital needs.
"They are trying to figure out how to fund those capital needs, and if there is not as much state support, they will have to figure out how to do it on their own," she said.
California Gov. Jerry Brown and UC President Janet Napolitano have waged a public battle over how much funding the university should receive.
Brown increased the amount of funding to the system in his budget released in January by 5% to $2.99 billion, but it was less than university management had anticipated. The university acceded to his demand last year to not raise tuition. But the UC Regents approved a 5% tuition increase for 2015-16 if they don't receive funding they requested.
Brown's budget included a caveat that the system would only receive the state funding increase if tuition remains flat, non-resident enrollment remains flat and the university system takes steps to constrain costs.
The university president announced recently that she would hold off on tuition increases through the end of this fiscal year.
Typically state funding would not as significant of a factor for the university's bottom line, but the fact that Brown is insisting tuition remain flat now impacts two revenue sources, Matsumori said.
State funding only makes up 9% of the UC system's budget while tuition and student fees are closer to 18%, she said.
Ginestro said his view of the UC system is much more positive than S&P's.
The fundamentals of the UC system trump concerns over pensions, OPEB and the pro forma debt numbers, Ginestro said.
His reasons: the system has 10 different campuses spread throughout the state, and revenue diversity is excellent with significant funding coming from internationally-known research programs and through gift funding and tuition. The university also has an $8 billion endowment pool, he said.
Matsumori also said the management team is very sophisticated and has made impressive strides toward mitigating the pressures.
"Some were created before Napolitano got there, but most recently they created a debt taskforce to look at how to fund capital needs," she said.