DALLAS - After waiting months for market conditions to improve, Colorado Springs is ready to price its first prepaid gas deal, with a bond issue worth more than $662 million.
"It's been a long process, but we're extremely excited to get this deal done," said Robyn Moore, vice president at George K. Baum & Co., the city's financial adviser. The fixed-rate, tax-exempt revenue bonds will be sold Wednesday, with Merrill Lynch & Co. as senior manager. On Friday, the utility signed agreements with RBC Capital Markets as commodity swap partner.
The bonds carry the same ratings as Merrill Lynch, as the firm also plays the role of gas supplier in the transaction. Merrill was downgraded by Standard & Poor's and Fitch Ratings to A-plus from AA-minus last October. Moody's Investors Service downgraded the underwriter to A from A1.
Much has changed since Colorado Springs Utilities began contemplating the issue last year. Before the deal could get done in 2007, the subprime mortgage crisis erupted in August, followed by dramatic downgrades in the bond insurance business and the collapse of the auction-rate securities market.
As 2008 nears the halfway point, the volume of pre-paid gas deals is down sharply, totaling only $348 million, according to Thomson Reuters. That compares to $7.2 billion for all of 2007. The peak volume came in 2006, with $10 billion of issuance. Colorado Springs' issue is only the third such deal this year.
With a prepaid gas deal, issuers enjoy legal arbitrage for a year at a time, taking advantage of the spreads between interest rates on tax-exempt bonds and the taxable securities the supplier uses to acquire capital. But last March, the spreads between the two actually inverted after narrowing sharply, preventing issuance of pre-paid gas bonds.
This week, the spreads are regaining a more natural relationship, Moore said.
"It was a wonderful convergence of events that allowed us to go forward," she said. "One event was that gas prices were going up. For every 10 cent movement in the gas curve, we get about one cent benefit. The spreads are widening, and we were able to get all the documentation completed."
The bonds will be issued under the name of the conduit Power Authority for Colorado's Energy, which insulates Colorado Springs utility from risk. The deal is structured for 30 years, rather than the 20-year term of some deals.
Under the commodity swap, PACE will pay an index price and RBC will pay a fixed price. The swap is designed to accommodate the natural gas price differences between the fixed costs established through the bond financing and the index price paid by the customer.
Under terms of the deal, Merrill must post collateral if it is downgraded below BBB-plus.
With market conditions improving, more prepaid gas deals are likely to surface.
Paul Vinson, manager of gas supply for San Antonio's CPS Energy, said recently he has been told that about $12 billion of prepaid deals are in development or waiting to go to market, including CPS'. The city-owned utility did its first deal through a conduit issuer last year and is taking responses to its request for proposals from bankers.
With the downgrades affecting suppliers, counterparty risk is one of the major concerns in prepaid energy transactions, officials and industry executives told The Bond Buyer's Prepaid Energy Finance conference last week in the Woodlands, Tex.
"As we come out of the credit crisis - or nearly do - there is a level of comfort with the gas suppliers you have represented here," said Randall Finken, vice president of Goldman, Sachs & Co., who shared a panel with Mark Widener, managing director of Merrill and Lance Etcheverry, managing director of JPMorgan. Another major player in the prepaid market is Citi.
