In the News: Recent Developments

April 21, 2009

University of Virginia Suffers Too Little Credit With New Bonds

Darrell Preston, Michael Quint and Jeremy R. Cooke

April 21 (Bloomberg) — — The University of Virginia, rated AAA by Standard & Poor’s, is paying more in the bond market than a company ranked five levels lower, even with President Barack Obama’s new federal program that subsidizes municipal borrowers.

The school, founded by Thomas Jefferson in 1819, raised $250 million for 30 years at a taxable interest rate of 6.22 percent in the first sale under the government’s Build America Bonds program, which pays 35 percent of borrowing costs. Emerson Electric Co., the St. Louis-based maker of InSinkErator garbage disposals, sold the same amount of A rated bonds due 2039 at a rate of 6.125 percent. Both securities were priced to yield 2.5 percentage points more than Treasuries on April 15.

While the Charlottesville, Virginia-based university will save about $2 million a year compared with municipal bond rates, the difference shows how state and local government officials leave taxpayers’ money on the table when they borrow. The bonds, originally sold at 99.711 cents on the dollar, provided instant profits to investors, trading as high as 105.28 the next day, to yield 5.83 percent, according to data compiled by the Municipal Securities Rulemaking Board.

“There is a lot of savings available under this program,” said Austin Tobin, the founder of Delphis Hanover Corp., a Southbury, Connecticut-based state and local government debt research firm. “The potential for this market is huge.”

Government Subsidies

Build America Bonds are part of the American Recovery and Reinvestment Act passed earlier this year to create jobs rebuilding roads, schools and infrastructure. The bonds are exempt from local taxes in the state of issue, though not from federal taxes. The market for the securities may grow to as much as $150 billion over the next two years, according to strategists at Barclays Capital in New York.

University of Virginia’s borrowing costs were the equivalent of 4.04 percent on a tax-exempt basis once the subsidy was included. The yield would have been about 4.88 percent in the tax-free market, according to data compiled by Bloomberg.

The New Jersey Turnpike Authority issued $1.38 billion on yesterday. New York’s Metropolitan Transportation Authority is offering $250 million. California plans a part of a $3 billion to $4 billion taxable debt sale as Build America Bonds.

“There’s a big pool of investors that typically don’t have an interest in tax-exempt bonds,” said Patrick McCoy, finance director of the New York MTA. “There’s a broader group of taxable institutional investors we’re looking to attract.”

Virginia sold the debt to asset managers, insurance companies, pension funds and banks, Yoke San Reynolds, the university’s chief financial officer, said in an e-mail.

Prices Jump

Investors snapped up five times as many of the 6.2 percent bonds as were available, according to JPMorgan Chase & Co., which sold the debt with Morgan Stanley.

After 5 p.m. April 15, the same day terms of the sale were announced, more than $2 million were issued to customers at 101.88 cents on the dollar to yield 6.06 percent, according to trade reports compiled by the MSRB. The gains continued the next day, when there were 31 trades of $1 million or more, including sales to customers at prices as high as 105.28 cents.

Emerson Electric sold $250 million of 6 1/8 percent bonds a day earlier through underwriters led by Charlotte, North Carolina-based Bank of America Corp. at 99.59 cents on the dollar to yield 6.16 percent.

Sacrificing Calls

New Jersey’s bonds rose within hours of the initial sale yesterday. The securities, priced at 100 cents on the dollar with coupons of 7.414 percent, increased to as much as 106 cents to yield 6.94 percent, according to MSRB data.

The university and the New Jersey Turnpike Authority sacrificed flexibility to refinance, or call, their debt. Instead of the typical call feature that permits municipalities to refinance in 10 years if interest rates fall, both bonds include a “make whole” provision, which would require them to pay a premium to redeem their securities.

“The issuer is locking in a rate for 30 years at a time when municipal credit spreads are near historic highs and is sacrificing financial flexibility and be unable to benefit from any future improvement of their credit or of the markets,” said said Joseph Fichera, the chief executive officer of New York- based Saber Partners LLC, who provides independent analysis for Bloomberg News. “Whether it is worth it is a judgment that needs to be based on analysis of a broader set of alternatives than what has been discussed.”

Fannie Mae, the Washington-based, government-controlled mortgage company, would have paid a yield of 3.66 percent to sell non-callable bonds on April 15, according to data compiled by Bloomberg.

California Deal

California is preparing to sell Build America Bonds, meeting with investors and posting notices on Internet sites.

“We’re aggressively pitching them to various groups of investors,” said Tom Dresslar, spokesman for California Treasurer Bill Lockyer. Target groups include insurance companies, taxable bond funds and pension funds.

Traders were showing that the portion of the bonds maturing in five years may be priced to yield 3.35 percentage points above Treasuries.

To contact the reporters on this story: Darrell Preston in Dallas at; Michael Quint in Albany, New York, at; Jeremy R. Cooke in New York at

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