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Massachusetts Trust Sells Its First Inflation-Linked Bonds
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By Jeremy R. Cooke
Nov. 24 (Bloomberg) -- The Massachusetts Water Pollution Abatement Trust sold $828 million of triple-A-rated bonds, including the issuer's first-ever inflation-linked securities, in this week's largest borrowing among U.S. states and localities.
The trust, which helps local governments finance clean-water and drinking-water projects, sold $77.3 million of bonds maturing in 2022 and 2023 that will pay investors interest at a variable rate based on changes in the U.S. consumer price index, or CPI.
The sale brings the total amount of inflation-linked municipal bonds sold in 2006 to more than $750 million, according to data compiled by Bloomberg. That's almost as much as the total amount of such bonds sold from 1997, when this kind of variable- rate debt debuted in the tax-exempt market, through 2005.
``We ended up pulling from the fixed-rate deal two maturities and selling those as CPI bonds instead,'' said Scott Jordan, executive director of the Massachusetts trust.
In connection with its inflation-linked bonds, the trust entered into an interest-rate swap agreement with Bear Stearns Cos., the managing underwriter on the overall sale, in which 22 other investment banks also participated.
A division of New York-based Bear Stearns, acting as the counterparty, will pay the water trust a variable rate matching what the bond investors will get. The trust will in turn pay the bank a fixed rate that's 12 basis points, or 0.12 percentage point, lower than comparable bonds, Jordan said.
``To us, they look and feel and act just like the bonds they replaced, except they're 12 basis points lower than the fixed- rate bonds we would've sold in those maturities,'' he added. ``We saved approximately $1 million, present value, over the life of the deal by using this structure rather than the fixed rate.''
Rate swaps are a kind of derivative, or a contract whose value is derived from tradable securities or linked to events such as interest-rate changes or the weather.
Dallas-based First Southwest Co. acted as the trust's adviser on the swap.
``First Southwest made the pricing fully transparent,'' Jordan said. ``It was done with tax counsel and bond counsel involved every step of the way. I'm comfortable and confident that we got a good deal.''
The trust's variable-rate bonds offer investors a rate equal to the consumer price index, a common measure of inflation, plus 99 basis points. The coupon will change each February and August, based on the year-over-year change in the index.
Officials at the Massachusetts water trust, which is run out of the state treasurer's office in Boston, decided to sell CPI bonds after the commonwealth itself sold $100 million of such securities during its general obligation sale earlier this month.
``We used their general structure,'' Jordan said.
Massachusetts' rates ranged from the consumer price index plus 86 basis points on bonds maturing in 2017 to the index plus 89 basis points on those due in 2020.
Eight other municipal borrowers this year, including the University of Dayton in Ohio and the New York Yankees baseball team, have linked part of their bond sales to inflation.
The Massachusetts Water Pollution Abatement Trust's CPI bonds were part of a $408 million portion of non-callable bonds that will be used to refinance existing higher-interest debt.
Demand for those so-called refunding bonds outstripped the total amount available, allowing the underwriters to raise prices and lower yields by as much as 3 basis points on some maturities.
The rest of the deal featured bonds to raise new money for 70 cities, towns and local authorities in the state that are building or improving water-quality projects.
The new-money piece offered a top yield of 4.45 percent on bonds due in 2036, which can be called, or bought back, by the trust beginning in 2016. That's 10 basis points more than where the Municipal Market Advisors' Consensus index of what top-rated issuers pay to borrow for 30 years stood earlier this week.
Orders from individual investors were equal to about 15 percent of the water trust's overall offering.
``We had great market focus. We were the only deal on the Street this week'' of any substantial size, Jordan said.
U.S. municipal issuers plan to sell $12 billion of fixed- rate bonds next week, after a holiday-shortened week of issuance that saw less than $3 billion of new sales, according to data compiled by Bloomberg.
The U.S. bond markets were closed yesterday and are to close early today in observance of the Thanksgiving holiday weekend