BRADENTON, Fla. - The Florida Gas Utility on Monday unwound a prepaid gas deal by redeeming $691.7 million of variable-rate bonds underwritten by UBS Investment Bank. And it did so at the behest of the bank, which also was the gas supplier in the transaction.
The deal represented UBS' first foray into the prepay natural gas market when the bonds were sold in September 2006, and the unwinding resulted in what could be considered a highly favorable outcome for FGU when compared to what other issuers have experienced when restructuring variable-rate bonds and terminating swaps.
The nonprofit utility's expenses related to the unwind were paid - including the termination payment for an out-of-the money swap - and FGU received a portion of the business value on the remaining 17 years of the gas contract related to the discounted natural gas rate the agency would have received had the contract remained in force.
That outcome, said FGU chief financial officer Nancy Holloway, was due to a well-structured underlying transaction with numerous provisions benefitting FGU that kicked in when the credit markets crumbled and UBS' credit rating was downgraded.
"We're very proud that all of the bondholders were paid in full," Holloway said. She said that when the deal originally was negotiated it was structured to protect FGU. "With early termination and the unwind we achieved that."
Because it was UBS that sought to terminate the deal, Holloway said that FGU "received a significant portion of its original business value and that will ultimately be distributed back to the 16 project participants later this summer following a final special audit of the transaction before distribution of the funds as a precautionary, conservative approach on FGU's part."
Holloway declined to release any specific numbers related to the negotiated settlement of the transaction, including the amount FGU received for the remaining life of the original 20-year contract.
UBS had no comment about the FGU deal, spokesperson Kelly Smith said yesterday.
When asked if the firm was exiting the prepay gas business with other issuers, Smith said UBS announced last June that it would exit the municipal bond business and since then it has not commented on various transactions. It was lead manager on one other prepaid gas deal, sold in 2007, according to data from Thomson-Reuters, and has been involved in various capacities in other such transactions.
But just two months before UBS said it would no longer work in the bond business, rating downgrades for the bank forced it to post $933 million in collateral in connection with FGU's prepaid gas bond sale. The amount was 102% of bond- and swap-related exposures, Holloway said, noting the collateral amount fluctuated with natural gas prices.
The collateral amount "had grown to $1.3 billion at one point and at closing I think we were at approximately $800 million," Holloway said. "So basically all those [collateral] payments went for redeeming the bonds, for the swap providers, and paying FGU a significant portion of its business deal. All the costs for closing the transaction came out of that collateral account and any excess was returned to UBS."
The transaction included two commodity swaps, one between FGU and Calyon, and another swap between UBS and Calyon, both of which were terminated June 1 at no cost to FGU and an undisclosed payment to Calyon, according to Holloway.
From its inception, UBS hailed the transaction for its unique features, including the fact that it was a 20-year prepay gas deal compared to mostly 10-year transactions prior to that time.
The bonds were initially sold in four series with three liquidity providers. Calyon covered 47% of the standby bond purchase agreement, Dexia Credit Local had 33% of the agreement, and UBS had 20%.
Under a proprietary feature of the UBS-structured deal, FGU received a Securities Industry and Financial Markets Association-indexed payment from Calyon and FGU paid Calyon a discount to market index gas prices - a floating-received and floating-paid swap that allowed the transaction to be completed with a single swap, UBS told The Bond Buyer before the bonds were sold.
The gas purchase agreement also unconditionally obligated UBS to fully redeem the bonds in the event of a termination, a feature that led all three rating agencies to base their long-term ratings for the bonds on UBS' credit.
Fitch Ratings assigned a long-term rating of AA-plus and a short-term rating of F1-plus. Moody's Investors Service assigned ratings of Aa2 and VMIG-1. Standard & Poor's assigned AA-plus and A-1-plus ratings.
All three agencies said rating changes would be based on changes in UBS' long-term rating, which eventually dropped to the point that collateral posting was triggered.
What followed was no different than the experience many other issuers had when the variable-rate market melted down. Holloway said that last October the bonds began trading at a premium to SIFMA because of difficulties experienced by Dexia as reports about its exposure related to the subprime market took hold. In February, Holloway said UBS agreed to do a wrap around of Dexia's interest, which essentially served as a backstop and the bonds began trading at or very close to SIFMA.
"They were really trying to help us keep the deal alive and then [UBS] came to the conclusion that it might be better to unwind the transaction," Holloway said.
While UBS would not discuss why it wanted to terminate the deal, Holloway said she believed UBS determined as early as last October to exit the energy trading business. UBS has been involved in different aspects of a number of prepay energy deals and it is not clear if it has exited all of them.
Several factors led FGU to agree to unwind the deal.
It faced expiration of one standby bond purchase agreement in September 2011 and costs for liquidity facilities have soared, Holloway said, noting that they are also more difficult to obtain in today's market.
"If we couldn't get a standby bond purchase agreement replaced, which was not caused by UBS, then they would not have been responsible to pay for anything other than the bonds and swaps and the expenses," she said, adding that FGU would not have realized any of the business value associated with the remaining life of the contract.
It was a risk FGU decided not to take and entered into termination negotiations.
Holloway said negotiations were complicated but accomplished fairly quickly despite the fact that the 16 project participants were spread out across Florida, and each had to approve the unwind.
The unwind included termination of the swaps, a guaranteed investment contract, remarketing agreements, liquidity facilities, and other agreements that occurred in a matter of weeks, said Richard Stephens, a partner at Holland & Knight LLP, which is FGU's bond counsel and lead negotiator on the settlement.
"The original prepay gas transaction was structurally sound and was providing significant benefit to FGU's participants," Stephens said in an e-mail. "It became apparent that, given the state of the market, finding a substitute gas supplier would be difficult, if not impossible. Thus, the parties agreed to arrive at a settlement amount, fair to both parties, to terminate the fully collateralized transaction early."
If the market collapse had not occurred, Holloway believed the transaction would have survived for the 20-year term. She also said FGU most likely would consider entering a prepay gas deal again if the market improves.
"We obviously would be trying to achieve the same type of protections and provisions as we did in this transaction, although I think that will be difficult to achieve primarily because ours required having a fully funded collateral account with a fairly high trigger point to fund," she said.
Because the agency probably will sell bonds for future energy deals, Holloway said it was important for the UBS unwind to benefit all parties.
"We were very conscious that we did not want anything to happen that would reflect poorly on FGU as a utility and our reputation. So it was very important for us that bondholders be kept whole," she said. "Our highest priority, obviously, was to protect the member participants of the project and get the best deal for their ratepayers ... that wasn't at the sacrifice of the bondholders because then we would never be able to do another deal."