DALLAS - Despite investors' growing aversion to complex derivatives in the muni market, the University of Texas System plans to issue $680 million of variable-rate revenue bonds swapped to a synthetic fixed-rate next month.
The UT system expects the mid-March deal to have strong appeal because of its triple-A ratings and the university's ability to provide its own liquidity.
"I think most of the turmoil is around auction-rate paper," said Terry Hull, director of finance for the system. "We've kind of seen the opposite effect with the flight to quality."
UT is not new to the swap market. The system has two floating-to-fixed rate swap agreements worth $310 million to fix the interest obligations on previous bonds.
Though agreeing that a blue-chip credit like the UT System will have no trouble finding buyers for its bonds, Jeffrey Timlin, vice president and portfolio manager for Sage Advisory Services in Austin, said the university will still be "paying a penalty for other people's mistakes."
"While it's a triple-A rated security, there's a stink in the marketplace about this kind of paper," Timlin said. "People are saying, 'I don't care that it's triple-A, I don't want anything like that.' In this sense, it's a matter of behavioral finance."
Senior managers on the upcoming deal are JPMorgan and Lehman Brothers, with the university acting as its own financial adviser.
The bonds issued under UT's revenue financing system are expected to be issued in weekly variable-rate mode, and the system plans to use floating- to fixed-rate swaps to hedge the bonds.
The university will pay a fixed rate and receive a variable rate based on the SIFMA swap index under the agreement with JPMorgan Chase and Morgan Stanley Capital Services.
Either counterparty may end the swap if the rating of the other falls below investment grade. The two counterparties must post collateral under certain circumstances, but the system is not required to post collateral and has the right of optional termination. The system expects to enter into additional floating- to fixed-rate swaps to fully hedge the bonds.
The deal wins top marks from all three rating agencies.
"Given the system's liquidity position and financial management practices, Moody's is comfortable with the risks associated with these agreements at the Aaa rating level," Moody's Investors Service analysts Laura C. Sander, Karen Dulitz, and John C. Nelson wrote in a report.
"The AAA rating is supported by UT's diversified revenues, consistently strong financial performance, manageable, though potentially growing, debt burden, and experienced management team," Fitch Ratings analysts noted. "While UT's fall 2007 enrollment (194,199 students) grew at only a modest rate (1.9%) from the prior fall semester, tuition and fee revenue generated by enrollment represents only 10% of UT's total revenues."
The UT system's top income sources include hospital revenues (24%), sponsored programs, largely funded by the federal government (19%), state appropriations (15%), and investment income (16%).
Standard & Poor's says that UT is among only three public university systems in the nation to receive its AAA rating. While the system's debt has almost doubled in recent years to about $5 billion, with more coming as part of an ambitious capital plan, UT remains well positioned academically and financially, analysts note.
Proceeds from the sale will be used to refinance $462 million of commercial paper, refund $35 million of outstanding revenue bonds and to finance $182 million of campus improvements across the statewide system.
UT is among the largest university systems in the world, with nine academic institutions and six health institutions contributing to an operating base of over $10 billion.
With the original Austin campus as its hub, the system is governed by a board of regents that oversees all the facilities. Campuses are located in Arlington, Brownsville, Dallas, Edinburg, El Paso, Midland-Odessa, San Antonio, and Tyler. The medical schools and hospitals are in Dallas, Galveston, Houston, San Antonio, and Tyler.
The system is currently considering the possibility of building a medical school in Austin, an issue that has been a political hot potato in the past.
The most likely scenario for building a medical branch in Austin would involve an extension of the UT Southwestern Medical School in Dallas, Dr. Kenneth Shine, head of the UT medical schools told reporters last week.
Waco economist M. Ray Perryman was commissioned by the Greater Austin Chamber of Commerce to do an analysis of what a medical school would mean for the Austin area. The report said that the new branch would generate $2.38 billion a year and create 19,307 jobs. The school would also provide $11 billion worth of medical benefits to the community, the report said.
The UT System regents also supervise the Permanent University Fund that backs the system's other major bond program. The system has $1.2 billion of PUF debt outstanding.
At a meeting on Feb. 7, the regents increased the distribution rate for the PUF from 4.75% to 5%, based on rising returns from the system's oil and gas properties in West Texas. The last time the board adjusted the payout to the university was in 2001 when it was raised from 4.5% to 4.75%.
The Texas Constitution of 1876 established the PUF through the appropriation of land grants along with an additional million acres. Another state grant of a million acres was made in 1883. PUF lands, located primarily in West Texas, are managed to produce two income streams: one from oil, gas and mineral interests and the other from surface interests, such as grazing.
PUF income can only be used for the payment of principal and interest on bonds for capital construction at eligible UT System and Texas A&M University System institutions. Any money remaining after debt service goes toward academic excellence programs at UT Austin, Texas A&M University and Prairie View A&M University.
"As a very large portion of our endowment is restricted for specific purposes and cannot be used to mitigate increases in operational expenses typically funded from tuition and fee revenues, the board's decision to increase the payout in the short term will help our campuses meet strategic goals such as growing and retaining faculty and infrastructure needs," UT System chancellor Mark G. Yudof said.