In August 2011, the University of Southern California joined Yale University and the Massachusetts Institute of Technology (‘MIT’) in selling $300 million of 100-year bonds, also known as ‘century bonds’. In October 2011, Ohio State University (‘Ohio State’), the most recent investment-grade borrower, issued $500 million of taxable AA-rated century bonds. These institutions of higher education are heating up the century bond market, once considered a rather rare bond.
The appeal of century bonds lies in the current lack of attractive returns on shorter-dated debt. The Federal Reserve announced last month that rates would remain “exceptionally low” at least through late 2014, presenting the perfect window of opportunity for century bond issuers. Further, the unusually low interest rates of 30-year Treasury bonds have forced buyers to look for higher yields elsewhere.
Century bond issuers can thus capitalize on investment from underfunded pension funds looking for alternative investments. Such pension funds faced record shortfalls due to low interest rates on bonds and flat performance on the stock market in 2011. Insurance companies are another major set of buyers, purchasing a whopping $352 million out of $750 million MIT century bonds in May 2011. Such century bonds help insurance companies match long-term liabilities with assets, according to Anthony Crescenzi, a strategist and portfolio manager at Pacific Investment Management Co. in Newport Beach, California.
There are clear risks associated with century bonds and a key assumption is that the issuing entity will still exist in 100 years. Hence, investors buying century bonds will need to have a lot of confidence in the longevity of the issuing entity. Nevertheless, this considerable risk is compensated for with higher yield. Additionally, from the issuer’s perspective, a century bond issuance can send a strong signal about its ability to remain a going concern.
The majority of these century bond issues have taken the form of taxable bonds, rather than tax-exempt municipal bonds. This is due to the restrictions sometimes placed on the private use of facilities built with tax-exempt financing, according to Allen Marcum, Director of Budget, Finance and Treasury at MIT. For a 100-year tax-exempt bond, the associated record keeping and auditing could be especially onerous. Indeed, the Internal Revenue Service can revoke the tax-exempt status of securities if borrowers run afoul of the rules.
MIT is using the proceeds of its century bond issuance to finance part of its recently unveiled collection of new construction, campus renovations and real estate development projects. Ohio State too is in the midst of a five-year, $2 billion capital extension, including the development of a medical center, research facilities and student housing. Consequently, the election for taxable-bonds by such educational institutions is understandable.
Moreover, Mr. James D. Agate, Senior Counsel to the University of California, commented that, “100-year bonds provide an attractive source of financing for major capital projects at a time of reduced public support for higher education”.
Update: The University of California has issued its own century bonds. You can learn more here.