The Pennsylvania Turnpike Commission this week sold $115 million of oil franchise tax revenue bonds, marking the first time in the state that such revenues have been pledged to back a tax-exempt issue.
The Turnpike Commission received authorization to use the franchise tax to support bond issuance in 1991. At that time, the state legislature increased its oil franchise tax to 115 mills from 60 mills and authorized the commission to issue up to $400 million of bonds backed by the tax. The law allows 14% of the receipts from the additional 55 mills to be pledged for bonds sold to extend and improve the turnpike system.
Standard & Poor's Corp. gave the underlying credit quality of the bonds an A rating, citing the "stable and undynamic nature of the pledged revenue stream, strong state support for the capital program to be financed, and the protection afforded bondholders by the legal provisions."
Moody's Investors Service also rates the underlying credit quality A.
AMBAC Indemnity Corp.'s insurance secured triple-A ratings from Standard & Poor's Corp. and Moody's Investors Service for the offering.
In a turbulent market on Tuesday, however, the deal struggled.
RRZ Public Markets Inc. was the lead underwriter for an 18-member syndicate that ran the offering, which had a total interest cost of $6.26%.
The final pricing on Tuesday included serial bonds maturing from 1995 to 2009 with yields ranging from 3.50% to 6.15%. At the repricing, yields were raised five basis points in 2005 to 10 basis points on serials maturing from 2006 to 2009 from the levels at the preliminary pricing on Monday.
Originally slated at $27.4 million, a term bond maturing in 2014 was scaled down to $12.2 million at the repricing, and a $15.9 million term in 2012 was added.
The 2012 term was priced as 5 1/2s to yield 6.38% and the 2014 term was priced as 6s to yield 6.45%, or 15 basis points more than the yield on the original 2014 term.
The amount of the term bond maturing in 2019 was increased slightly to $37.85 million. The term was priced as 6s to yield 6.15%, or 12 basis points higher than at the first pricing.
Charles A. Gomulka, president at chief executive officer at RRZ, attributed the resistance that the long end of the deal encountered to the "market's overall skittishness.
"The deal did not go as fast as we'd like on the first day," Gomulka said, but we "did a slight restructuring Monday evening and cleaned it up by Tuesday afternoon."
The Turnpike Commission did consider delaying the issue when it was revealed that the Federal Reserve had raised short-term interest rates on Monday, but "it was felt very strongly among the group that this may be the cheapest money as were going to get for a few years," said John D. Fogarty, deputy executive director of the commission.
"The deal did hit some resistance, but we repriced and restructured, and were able to come up with a pretty fair deal and a yield that was much less than we thought we were going to do," Fogarty said.
RRZ's Gomulka said the preliminary pricing was held on Monday because the Turnpike Commission meets every other Tuesday, and "we wanted to report to them and get their approval on the consummation of the deal."
When asked why the syndicate on a relatively small deal included so many firms, Gomulka said that it is the commission's "modus operandi to have a rather large management team." Many of the firms are based in Pennsylvania, he said.
To win the right to insure the deal, AMBAC outbid nearly all of the other major bond insurance firms AMBAC's bid was 27.5 basis points, followed by Municipal Bond Investors Assurance Corp. at 29 basis points, Capital Guaranty Insurance Co. at 30 basis points, and Financial Security Assurance Inc. at around 32 basis points, according to a source familiar with the transaction.
Robert P. Moore, vice president in AMBAC's public finance underwriting group, said the deal was attractive because of its "good structure, good coverage, and the commission's strong operating history."
If the bonds had been issued last year, there would have been 4.6 times debt service coverage based on the $40 million of pledged revenues collected, according to Standard & Poor's.
"The essentially of the commodity taxed, combined with strong state support for this program, should assure debt service coverage of at least 1.5 times," the rating agency said.
"The tax has a real broad base and the legal structure was there," Moore added. "A big selling point was that the money went directly from the state to the trustee. The commission didn't touch the funds."
Some bond insurance officials, speaking anonymously, said there was some concern about backing the turnpike bonds because of their reliance on oil revenues. In the long term, the officials said, alternative sources of energy could eliminate the need for oil, and thus the taxes that provide the revenue stream.
The possibility of oil being replaced was "one of the risks we considered," AMBAC's Moore said. "But the commission is convenanted to petition the General Assembly for additional revenues in the event that [oil tax] revenues are insufficient" to cover principal and interest payments.
Mary McKeon, an AMBAC vice president and assistant general counsel, said that while the "definition of revenues talks about the franchise tax, there is a provision that allows other revenues to be pledged for payments of the bonds. It's an additional belt and suspender."
Another quirk of the transaction, in addition to a unique revenue stream, was that the Turnpike Commission required that the bond insurers bid in two components: for the deal itself and for a surety bond that would act as a debt service reserve fund.
Although such a structure is not unusual on revenue bond deals, "It seemed like the Turnpike Commission was saying ~we want you to prove your love to us,'" a bond insurance executive said.
In the end though, AMBAC will not have to provide the surety bond.
"They determined that it didn't work," Moore said. "The prices quoted didn't make economic sense for them to go out and buy a surety as opposed to having cash in reserve."
