DALLAS - The University of Texas Board of Regents plans to issue $401 million of refunding bonds next week for the triple-A rated Permanent University Fund that endows the UT and Texas A&M University systems.

The PUF bonds, which refund all $400 million of outstanding flexible-rate notes, will be issued as variable-rate demand bonds in a weekly mode with swap agreements to achieve synthetically fixed rates.

The board has two separate swap agreements, each for $200.5 million. Morgan Stanley Capital Services Inc. is counterparty under the first agreement, with Royal Bank of Canada as the second.

The system will pay a fixed rate and receive a variable rate equal to the Securities Industry and Financial Markets Association's municipal swap index. Both swaps require the counterparty to post collateral in the event of credit downgrades. The UT System can also end the agreement.

"This is a deal to watch to see how receptive the market is to this type of structure," said Jeffrey Timlin, portfolio manager at Sage Advisory Services in Austin. "I'll be interested to see if it does get done. Who were the buyers? Was it primarily institutional or did the retail come in?"

While the flight to quality will favor issues such as this one, "I think they'd be better off coming to market with a fixed rate, but obviously they have their reasons for doing it this way," Timlin said. "In this market, people tend to shy away from deals like this that are more structured. While liquidity is slowly coming back into the market, investors wonder if this is going to continue or is it going to dry up again."

With backing from the Permanent University Fund, the bonds achieve top short- and long-term credit ratings.

"The long-term rating reflects the substantial pledge of dedicated PUF income for PUF debt service, and the short-term rating reflects the university's provision of self-liquidity in the event of an investor put," said Standard & Poor's credit analyst Susan Carlson.

Fitch Ratings analyst Douglas J. Kilcommons said that the AAA rating "primarily reflects the PUF's vast, highly diversified, investment holdings, which had a market value of $10.3 billion on Aug. 31, 2008, and the expertise of the University of Texas Investment Management Company, which manages the financial assets comprising the PUF investment portfolio."

UT receives about two-thirds of the annual payouts from the PUF, with the A&M System receiving a third. For fiscal year 2007, distributions were about $415 million.

The Texas Constitution also authorizes the UT Board of Regents to issue bonds and notes secured by pledged revenues consisting of up to 50% of the money allocated annually to the board for UT Pan American and UT Brownsville.

In July, the UT regents added $1 billion to the Permanent University Fund through the forward sale of oil and gas reserves. At the time, oil prices were at record levels.

The addition of $1 billion to the PUF was not expected to increase bond issuance significantly, since current indebtedness is only about half of the limit set under the state's constitution. University debt is allowed to rise to 20% of the fund's market value.

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