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UPDATE: After Sandy, J.P. Morgan Offers Unusual Guarantee on $2.6 Billion N.J. Muni Deal

Date : 11/14/2012 @ 4:49AM
Source : Dow Jones News
Stock : JPMorgan Chase & (JPM)
Quote : 60.34  0.04 (0.07%) @ 6:29AM
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UPDATE: After Sandy, J.P. Morgan Offers Unusual Guarantee on $2.6 Billion N.J. Muni Deal

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--J.P. Morgan offers unusual backing of New Jersey note sale in wake of Hurricane Sandy

--State's short-term debt sale expected to price Thursday

--New Jersey's revenue projections prior to Sandy were aggressive

(Update adds comments and details starting in the fourth paragraph.)

 
   By Kelly Nolan and Mike Cherney 
 

New Jersey intends to sell $2.6 billion in short-term debt later this week with an unusual guarantee from the bank running the offer: J.P. Morgan is offering to buy any notes the firm is unable to sell at or below a certain interest rate, a move that should help the state as it continues to struggle with Hurricane Sandy's devastation.

Specifically, J.P. Morgan will buy any notes in New Jersey's deal if it isn't able to sell them at an interest rate of 0.35% or less, according to bond-offering documents, a move that puts an upward limit on borrowing costs for the state.

"It is by no means normal," said Craig Mauermann, who manages the roughly $825 million BMO Tax-Free Money Market Fund and the approximately $800 million BMO Ultra Short Tax-Free Fund. "J.P. Morgan is really stepping up to the plate...they are basically taking any sort of market risk off the table" for New Jersey.

A spokesman for New Jersey Treasurer Andrew Sidamon-Eristoff said "these were by far the best terms" the state received when it was looking for an underwriter for its debt.

New Jersey originally planned to sell its notes through a competitive process two weeks ago, but postponed the offering in anticipation of Hurricane Sandy. The state opted to do a negotiated sale instead because it offers more flexibility in terms of when the debt can be sold, the spokesman said.

In competitive offerings, banks bid on blocks of debt through an electronic auction at a certain time and date; banks then sometimes reoffer bonds to investors. In a negotiated offering, such as the one New Jersey is slated to do this week, banks act as underwriters, marketing the debt directly to investors, but they assume the risk of buying the bonds if enough investors are not interested. Timing of the deal is also more flexible.

Disaster-modeling company Eqecat estimated that Sandy caused between $3 billion and $6 billion in insured losses in New Jersey, and as much as $20 billion in insured losses overall. At the upper end of Eqecat's range, Sandy would be the second-worst storm in U.S. history for the insurance industry, behind only Hurricane Katrina and its $41 billion pricetag.

Proceeds from New Jersey's $2.6 billion note sale this week will repay a $2.1 billion line of credit from Bank of America as well as fund the state's cash-flow needs.

Moody's gave the New Jersey notes a rating of MIG 2, its second-highest short-term debt rating, while Fitch and Standard & Poor's gave the notes ratings of F1 and SP-1, their highest short-term debt ratings, respectively.

Paul Palmeri, J.P. Morgan's head of public finance, said that the bank has more than 30,000 employees in the region, so it "wanted to help New Jersey in any way we could in the aftermath of the hurricane. We expect strong demand from investors who we think will want to step up as well."

Spokespersons from Goldman Sachs, Citigroup, Bank of America and Morgan Stanley, all of whom underwrite muni-debt deals, could not provide immediate comment as to whether they have offered similar guarantees on other muni-bond offerings.

Andrea Bacon, a partner at Chapman & Cutler and chairman of the law firm's public finance disclosure committee, said she has never seen an underwriter make such a guarantee in bond-offering documents before.

"I don't think there is a securities-law requirement that they would disclose this deal up front," she said. "There is a requirement they disclose what their compensation is, but it doesn't sound like that's what this is."

Dan Solender, director of municipal-bond management at investment firm Lord Abbett in Jersey City, agreed that the J.P. Morgan backing is unusual.

"Technically, when you underwrite a deal [as a bank], you are taking on the risk of buying the bonds if the deal cannot get done," said Mr. Solender. "But guaranteeing the price is unusual."

Mr. Solender added he didn't expect the New Jersey notes to have any trouble selling, despite unknown Sandy damage costs to the state.

Given that the New Jersey notes will mature in June 2013, buyers of the debt will likely be short-term muni mutual funds as well as money-market funds, which are starved for short-term debt and are looking to pick up securities with any incremental yield, he said.

"With rates so low, 0.35% is still something," Mr. Solender said.

To be sure, even before Sandy hit, New Jersey faced some financial challenges. According to Fitch Ratings, fiscal 2013 revenues through September this year ran 4% below budget projections. Moody's Investors Service said the state's available resources outside its general fund are lower than they have been in advance of any New Jersey note sale in the past five years, and the state's projected year-end cash balance has also "declined substantially" from the level expected a year ago.

"This leaves the state a narrow margin for error in the event that projected revenues fall short, or if expenditures escalate," Moody's said.

Market participants expect that New Jersey will get most, if not all, of its costs related to the storm reimbursed by the federal government. But, there is a concern there may be a short-term impact while the state waits for reimbursements to come in.

With the state's revenue projections already too aggressive, "now you throw in Sandy's impact, we have a lot of concern," said Todd Sisson, senior analyst of tax-exempt fixed income at Wells Capital Management. "Clearly they are going to miss their budget projections," and there's worry the state may have to do another short-term borrowing in the wake of Sandy, he said.

That said, there has been little muni-market reaction in New Jersey's longer-term debt to Hurricane Sandy so far. The state's 10-year general-obligation bonds, which are backed by its taxing authority, were yielding 0.33 percentage point more than the Thomson Reuters Municipal Market Data triple-A benchmark, as of Friday. That is the same level as when the hurricane hit.

Meanwhile, the S&P Municipal Bond New Jersey Index has returned 0.74% so far this month, about the same as the broader S&P National AMT-Free Municipal Bond Index, which has returned 0.72% this month.

New Jersey, as well as other states, sell notes repaid with future tax revenues to bridge seasonal imbalances between when money comes into state coffers and when expenses must be paid. According to Moody's, New Jersey has sold these notes, called "tax-revenue anticipation notes" in each of the last 21 fiscal years. Last year, the state's TRAN was roughly $2.2 billion in size, according to Ipreo LLC.

--Christian Berthelsen and Erik Holm contributed to this article.

Write to Kelly Nolan at kelly.nolan@dowjones.com and Mike Cherney at mike.cherney@dowjones.com.

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