SAN FRANCISCO - While opponents of a $3.9 billion bond plan to merge two Orange Countytoll roads scored a decisive victory earlier this month, it remains to be seen if theiralternative plan will save one of the roads from defaulting on its debt.
Opponents, led by Orange County supervisor Bill Campbell, said the plan to merge the SanJoaquin Hills Transportation Corridor Agency with the Foothill/Eastern TransportationCorridor Agency was too risky and expensive.
The eight-year-old San Joaquin Hills highway, beset with weaker than projected traffic,is on a trend that will lead to default. The agency lost its last investment-graderating this week when Moody's Investors Service dropped it to Ba2 from Baa3.
Campbell, who sits on the boards of the toll roads by virtue of his seat on the countyBoard of Supervisors, says his plan provides an alternative framework that can keep theSan Joaquin tollway's non-recourse revenue bonds from defaulting without a massive newbond refinancing.
But supporters of the original bond plan, which called for a new agency to issue thebonds to acquire the assets of the original two, still believe in that proposal.
Mark Young of Gardner, Underwood & Bacon LLC, financial advisers on the proposed bond-merger transaction, said of Campbell's proposal: "It's not a compelling or competitiveplan relative to the merger," going on to call the underlying assumptions of the plan"just fundamentally flawed."
The San Joaquin and Foothill/Eastern roads are not connected, but they were builtsimultaneously and are managed by one staff. Both opened in the mid-1990s.
While Foothill/Eastern has met revenue projections, the San Joaquin Hills highwayhasn't.
The toll roads' staff and governing board set the goal of keeping the San Joaquin Hillshighway from default while preserving the ability of Foothill/Eastern to finance asouthern extension.
Campbell says he can do it by using the revenues of the Foothill/Eastern to help the SanJoaquin Hills meet its debt service requirements. His proposal has two parts.
The first part is a $120 million settlement payment from the Foothill/Eastern to the SanJoaquin Hills agency to compensate it for the future impact of the southern extension toFoothill/Eastern.
The second part calls for using excess cash flow from the Foothill/Eastern as a sourcefor loans to the San Joaquin Hills agency, to be repaid after its bonds are retired inabout 30 years.
Young said the merger agency, the Transportation Corridor System, had secured a $240million line of credit from the federal government for the life of the bonds.
Each of the two existing roads had a $120 million line from the government, Young said,but the commitment ends in 2007 for the San Joaquin Hills and in 2009 for theFoothill/Eastern.
"For tax reasons, they cannot extend those," he said. "They just threw away a $240million line of credit."
Campbell believes that the situation isn't as dire as Young paints it, saying he'stalked to federal officials who have indicated that they'd be able to work somethingout.
"At first blush it appears to be workable," he said.
The San Joaquin toll agency first issued $1.2 billion in bonds in 1993, following thatwith a $1.5 billion deal in 1997 that took out all but $220 million of the 1993 bonds.The 15-mile corridor linking the Orange County cities of Costa Mesa and San JuanCapistrano opened in November 1996.
The Foothill/Eastern agency issued $1.26 billion in bonds in 1995, followed by a $1.6billion refunding in 1999 that left $180 million outstanding from the 1995 deal.
All the debt would have been refinanced in the $3.9 billion merger proposal, which gavetoll directors the option of $1 billion in interest rate swaps.
The merger deal was to have been led by Citigroup Global Markets Inc., with MBIAInsurance Corp. insuring part of the new deal. MBIA insures about $1 billion of thecombined outstanding toll-road debt, including about $400 million of the speculative-grade San Joaquin highway bonds.
Citigroup, then Salomon Smith Barney, led the 1999 Foothill Eastern and 1997 San JoaquinHills refunding deals. J.P. Morgan Securities Inc. led the 1995 Foothill Eastern deal.First Boston led the 1993 San Joaquin Hills deal.
Few of the uninsured San Joaquin Hills agency bonds trade very often, according to dataavailable on The Bond Market Association's investinginbonds.com Web site. One exception,the 5.5% bonds due 2028, were trading in the low 90s in late 2003. They rose close topar in early 2004, but fell back into the low 90s as the merger deal began slippingaway.
Major institutional holders of the agency's uninsured debt include the FranklinCalifornia High-Yield Municipal Fund and the Franklin California Tax-Free Income Fund.Franklin did not respond to two requests for comment.
Merger proponents had been trying to get the deal approved since February. But getting16 votes out of 21 from the board of the Transportation Corridor System proved to be amajor obstacle. This supermajority structure for major transactions was created to getthe IRS private-letter ruling allowing the new agency to issue bonds on a new-moneybasis, since both of the component toll roads had already issued refunding bonds.
Campbell, who used the supermajority requirement to hold up the bond-merger deal, saidthe unwieldiness of such a requirement for major decisions by the merged authoritiesmight have been the final straw turning other toll-road directors against the merger andthe deal.
"I think more and more as they thought about it, I think the deal-killer was not thefinancing so much as the super-super majority of 77%," he said.
Orange County Treasurer John J.W. Moorlach opposed the bond-merger plan and came up withhis own alternative before throwing his weight behind Campbell's plan. They wereparticularly critical of MBIA, which stood to make more than $100 million in premiumsfor bonds that would take out its exposure to the outstanding speculative-grade debt.He said heavy lobbying from the deal team may have backfired in the end.
"There was a lot of pressure put on these board members," Moorlach said. "MBIA has a lotof head scratching to do."
A spokesman for MBIA declined to comment.
Tony Hughes, a Citigroup managing director, said the deal was structured to meetdeadlines based on the earlier projection that San Joaquin would enter technical defaultJuly 1.
As it happens, Orange County motorists appear to have bought the county's leaders sometime by increasing their usage of the San Joaquin highway.
Last year, when the agency filed its 2003 financial statement, it predicted that the SanJoaquin tollway would fail to meet its debt coverage requirements beginning in fiscal2005. Increased traffic and revenue have pushed that date back to fiscal 2006 at theearliest.
"We're OK for at least this next budget year," said Clare Climaco, spokeswoman for thetoll road agencies.
Campbell says his plan is far from a finished product. This month's 10-to-5 vote by theFoothill/Eastern board to was just to develop the plan further.
He also needs approval from the San Joaquin Hills board. Each board is made up ofelected officials from communities serviced by the roads.
"I gave them a reason to say no to the other option," Campbell said. "For a long timethe only option this board had was to have to basically do a merger," he said.
While the Foothill/Eastern board has voted for further studies of Campbell's plan, theSan Joaquin Hills board has yet to weigh in.
"That discussion will happen next week," Climaco said. The agency's finance committee isscheduled to meet Tuesday, with the next full board meeting June 8.
Both boards need to study the plan more thoroughly. "That's something were going to lookat over the next few months," Climaco said.
Moorlach said the first recourse should be to let rising traffic take care of itself.
"We're watching toll revenues go up year over year by 10 %," he said. "That's plan A."
But the agency's rising debt service requirements mean the road is unlikely to workitself out of trouble, as Moody's warned in its downgrade report this week.
The debt service schedule was based on traffic growth that has already failed tomaterialize. The highway's revenues are running at about 76% of the projections used tostructure the 1997 bond issue - and those original projections called for revenues to goup every year.
"It's tough to recover lost ground in those earlier years as the growth expectationswere so relatively high," said Moody's analyst Maria Matasanz.
Moody's also warned that it would closely scrutinize the effect any final plan has onthe Foothill/Eastern agency, which carries ratings of BBB from Fitch Ratings, BBB-minusfrom Standard & Poor's, and Baa3 from Moody's.
