Lottery Securities Beating AAA Provide Winning Bet: Muni Credit
Oregon’s AAA rated bonds, whose historic default risk is near zero, are backed by lottery revenue and compare with odds of one in 176 million to win the multistate Mega Millions jackpot. Since November, yields on the debt have dropped almost seven times as much as those on top-rated municipal securities as interest rates in the $3.7 trillion market have fallen to lows not seen since the 1960s.
Florida (STFLA1) and Oregon are among four U.S. states that have sold $5.5 billion in bonds backed by cash from games of chance, mostly to fund school construction, said Natalie Cohen, a senior analyst at Wells Fargo & Co. who wrote a report on lottery revenue this month. Mega Millions, played in 42 states and the District of Columbia, awarded a record $640 million jackpot after a March 30 drawing.
“In economic good times and bad times, people want to play the lottery,” said Terry O’Grady, senior vice president of muni trading at FMS Bonds Inc. in North Miami Beach, Florida. “Lottery revenues, while they are discretionary, are not going to be that volatile.”
Of the 43 states with lotteries, 26 saw revenue grow in the past fiscal year, with total sales up 3 percent to $56 billion, according to Rockville, Maryland-based research firm La Fleur’s. Florida, Texas and California each pulled in more than $1 billion in 2010 from lotteries and other forms of gambling, while New York generated $2.2 billion, according to Cohen.
Lottery bonds maturing in 2025 issued by the Oregon Department of Administrative Services traded last week at a yield of 2.21 percent, down 120 basis points from 3.41 percent five months earlier, according to data compiled by Bloomberg. That beat the 18-basis-point drop in yields on top-rated 13-year debt over the same period, Bloomberg Valuation index data show. A basis point is 0.01 percentage point.
The Oregon agency sold about $75 million in lottery-backed debt April 11, about two weeks after the Mega Millions drawing. A $54 million portion included 10-year securities priced to yield 2.27 percent, Bloomberg data show. That’s 38 basis points below similarly rated revenue debt. The agency issued lottery debt three years ago with yields 19 basis points above the index.
Standard & Poor’s gives the Oregon lottery debt its top AAA grade, one level higher than the state’s Aa1 ranking.
“It really is an asset-backed security -- it’s not a state credit,” said Joe Deane, who helps oversee $16 billion as head of munis in New York for Pacific Investment Management Co., which manages the world’s biggest bond fund. “The amount of money you can raise is just astronomical.”
Still, revenue may drop as more states legalize other forms of gambling, such as casinos, Deane said. New York and Massachusetts are among states seeking to open Las Vegas-style gambling houses.
Oregon’s lottery players are among those doing the least damage to their personal finances by participating. They get back 67 percent of what they pay for tickets in winnings, second-best among states, according to data compiled by Bloomberg Rankings.
More than $50 billion was spent on lottery tickets in the U.S. in 2010, while prizes totaled $32.8 billion, the data show. Alabama, Alaska, Hawaii, Mississippi, Nevada, Utah and Wyoming don’t have lotteries.
S&P also gives lottery-backed debt from Florida and West Virginia its top grade. Moody’s Investors Service assigned its Aa2 rating, third-best, to the Oregon sale and gives an A1 grade, fifth-best, to the Florida State Board of Education and West Virginia Economic Development Authority (26924MF).
A Florida lottery bond maturing in July 2024 traded April 11 at an average yield of 2.06 percent, down from 3.09 percent a week earlier, according to data compiled by Bloomberg. That’s the lowest since it was issued in 2007. The 103-basis-point drop compares with a seven-point decline in a 12-year AAA index over the one-week span, BVAL data show.
Governments reduced borrowing last year for the first time since 1996 as the longest downturn since the 1930s created more than $500 billion of budget deficits for states. They have increased efforts to boost lottery sales after income from the games fell for the first time in more than a decade in 2009, according to census data.
“Most people understand the whole probability of buying a Mega Millions ticket,” said Wells Fargo’s Cohen. “It doesn’t stop us. It’s the human condition.”
Following are descriptions of coming sales:
PENNSYLVANIA (STOPA1) plans to sell $950 million of tax-exempt general-obligation bonds via competitive bid as soon as April 17. The proceeds will be used for construction and environmental projects. It’s the state’s biggest sale of long-term, tax-exempt debt since 2006, data compiled by Bloomberg show. Moody’s Investors Service rates the state’s full faith and credit pledge Aa1, second-highest, Bloomberg data show. (Updated April 16)
METROPOLITAN TRANSPORTATION AUTHORITY, the biggest U.S. transit agency, plans to sell $600 million in tax-exempt revenue bonds as soon as this week, according to an offering document. The proceeds will be used to finance transit and commuter projects. Moody’s Investors Service rates the bonds A2, its sixth-highest investment grade. Wells Fargo Securities is the underwriter. (Added April 16)
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