On Its Own, Puerto Rico Water Agency Plans Return to Market With $1.6B

After a nearly 20-year hiatus from the market, the Puerto Rico Aqueduct and Sewer Authority this week will sell $1.6 billion of tax-exempt and taxable debt to refinance previously issued bonds and to raise new money for long-awaited capital projects.

For years the authority existed as a government subsidy, running on yearly allocations of $400 million to offer clean water and wastewater treatment services to commonwealth residents. But beginning in 2005, the government chose to transform PRASA into a self-sustaining agency by increasing its rates by 128% and cutting it from the central government's financing stream.

Standing on its own has garnered the authority ratings independent of the commonwealth, although the two entities do carry the same ratings. Fitch Ratings and Standard & Poor's rate the authority BBB-minus with a stable outlook. Moody's Investors Service assigns a Baa3 to the credit.

The transaction is comprised of four separate tranches of debt with maturities going out through 40 years.

Jorge Irizarry, president of the Government Development Bank for Puerto Rico, said the bonds will price by Thursday at the latest.

"Thursday is the day. We're trying to do it as soon as possible in the week, but no later than Thursday," Irizarry said.

Citi and Morgan Stanley are co-lead managers on $1.3 billion of Series A senior-lien revenue bonds, with Citi as book-runner. Popular Securities Inc. and Citi are senior managers on the taxable Series B senior-lien revenue bonds amounting to $22 million.

The Series A bonds offer serials, terms, and convertible capital appreciation bonds, which in the past have been called "step-up" bonds. Those securities are initially CABs, but change to current interest bonds later in the maturity schedule. The Series B bonds consist of one term bond.

The Series A and Series B senior-lien bonds will have first access to the authority's revenue stream.

Bond proceeds will pay off roughly $830 million of bond anticipation notes. Remaining proceeds will finance infrastructure needs throughout PRASA's system. The system includes 129 water treatment plants with 7,500 miles of pipeline for water distribution and 62 wastewater treatment facilities.

Citi and Morgan Stanley are co-lead managers on $161.5 million of Series A refunding bonds, with Citi as book-runner. Popular Securities and Citi are senior managers on the $125.3 million of taxable Series B refunding bonds.

Nixon Peabody LLP serves as bond counsel on all four series of bonds.

Debt service costs on the refunding series will be paid with revenues, after the senior-lien bonds are paid. In order to garner an investment grade rating for the refunding bonds, PRASA will also provide those securities with the commonwealth's full faith and credit pledge.

The combined $286.8 million of refunding debt will refinance Series 1995 general obligation bonds.

Irizarry said the impetus for the transaction is to restructure debt service payments and spread out maturities on the debt rather than generate savings on the bonds.

"The refunding was more a restructuring than a refunding for savings to adjust PRASA's cash flows," Irizarry said.

The transaction may contain some floating-rate securities along with fixed-rate bonds, if market conditions look favorable for variable-rate debt.

"We have some capacity to do floating rate and we'll see how the demand goes," Irizarry said. "It depends on whether there's demand for it and we get the right credit enhancement and right swap execution. But we're not going to do straight variable rate without a hedge."

As of Feb. 28, yields on triple-B Puerto Rico revenue bonds ranged from 3.08% in 2009, 83 basis points above that day's Municipal Market Data's triple-A general obligation curve, to 6.13% in 2038, which is 108 basis points above the MMD, according to Thomson Financial data.

Also on Feb. 28, yields on triple-B Puerto Rico GOs ranged from 2.65% in 2009, 40 basis points above that day's MMD curve, to 6.10% in 2038, which is 105 basis point above the MMD.

PRASA is in the first year of its $1.98 billion, five-year capital plan to upgrade its facilities and infrastructure. Projects include mandatory improvements for the authority to meet federal environmental compliance standards, with those projects totaling $978.7 million. The authority will spend nearly $40 million on new water meters during the next five years to improve its revenue collection system, according to the preliminary official statement.

Appropriate payment for water usage is an issue for PRASA. Currently, the authority's unaccounted-for water ratio is 60% in comparison to industry benchmarks of less than 10%, according to a Moody's report on the credit.

"The bottom line, really, is that there is a significant water loss in the system and that is something that within their capital program is something that they're putting a lot of emphasis on in trying to address, because obviously that's an untapped source of revenue for them," said Standard & Poor's analyst Horacio Aldrete.

The authority will need to reassure bondholders that there will be less free water for residents and businesses on the island than in years past.

"They were having problems meeting debt service because there was an incredible amount of loss of water and a lot of the problem was that people were literally stealing water and not being charged for it," said Bob MacIntosh, vice president and co-director of Eaton Vance's municipal bond group. "I have to be convinced that they've tightened things up."

Authority revenues have grown and PRASA gained its first operating surplus of $166.5 million in 2007, thanks to increased rates and cost-cutting initiatives, according to a Standard & Poor's report. A combined 128% boost in rates in 2005 and 2006 helped the authority gain an additional $426.8 million of revenue throughout that time.

Ratings analysts stressed that PRASA's strong management is a strength for the credit.

"Their management is a very experienced team that has already implemented substantial changes," said Moody's analyst Tom Paolicelli. "I think that is key. We have met with management several times and they really seem to be moving in the right direction."

Another strength for PRASA is that it serves 97% of Puerto Rico's population, more than four million, and has a diverse customer base of residential clients, commercial and industrial business, and government facilities.

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