Regional News

N.C. Agency Targets Unused Deal

WASHINGTON - The North Carolina Eastern Municipal Power Agency on Wednesday plans to sell $80 million of fixed-rate bonds and use about one-third of the proceeds to get out of an interest rate swap for a variable-rate deal it never got the chance to sell.

The NCEMPA will pay $25.2 million to terminate a forward-starting swap it has had with Citigroup Global Markets Inc. since 2006. The swap became effective in October 2008 when the utility planned to issue a variable-rate deal to refund some fixed-rate debt. The credit crisis upset those plans, and now the cost of a variable-rate sale exceeds the termination expense.

"If you're not going to issue variable-rate debt behind [the swap], it is no longer a hedge," said Timothy Tunis, chief financial officer for the agency. The high costs for a liquidity provider and bond insurance became too much in this environment, "if it is available at all," he said.

As issuers increasingly have shunned selling variable-rate bonds in favor of fixed-rate deals, terminating swaps has become "more common," said Baye Larsen, a credit analyst with Moody's Investors Service.

Issuers are choosing to avoid the market volatility and cost uncertainties associated with variable-rate deals, said Chris Jumper, a credit analyst with Fitch Ratings. "Pretty much everyone is going back to the basics. Investors are requiring that, too. Investors are being very reluctant about anything fancy."

The power agency is a member-owned electricity provider comprised of 32 cities and towns with a combined population of 402,000. It was organized in 1976, but local ownership of the power plants dates back more than 80 years. It was the fourth-largest North Carolina issuer in 2008, according to Thomson Reuters.

The NCEMPA gets a Baa1 rating from Moody's and a BBB-plus rating with a positive outlook from Fitch. The outlook reflects the ability of the agency's members to weather the financial crisis, Fitch analysts said. Moody's has a stable outlook. Standard & Poor's rates the new bonds BBB-plus and affirmed the same rating on the outstanding debt with a stable outlook.

Last year, the utility decided to get out of its variable-rate debt after the auction-rate securities market collapsed in February. Last April, it used a portion of a $429.1 million deal - the largest deal in North Carolina last year - to refund all of its auction- and variable-rate debt.

The NCEMPA has used debt twice before to finance swap terminations. In December, it used part of a $40.3 million deal to finance a swap termination. Including the current deal, the utility will have issued about $88 million of debt for swap terminations, according to Moody's. It has total outstanding debt of $2.5 billion.

The power agency has made $1.7 million in payments toward the swap being terminated with next week's bonds since the agreement became effective. After the swap is terminated, it will still have one swap outstanding. That swap, also with Citi, has a notional value of $120 million and currently has a negative mark-to-market of $20.8 million. The agency is not required to post collateral on the swap and is expected to sell debt later this year to terminate it, analysts said.

Citi will be lead underwriter with Banc of America Securities LLC, Morgan Stanley, and Wachovia Bank NA as co-underwriters. Hawkins Delafield & Wood LLP in New York will be bond counsel for the agency and Poyner Spruill LLP of Rocky Mount, N.C., will be counsel on some legal matters for the state of North Carolina. Sidley Austin LLP in New York will be the underwriters' council.

The bonds are not expected to be insured.

In addition to raising funds to terminate the swap, proceeds from the deal also will be used to pay for construction and improvements at the agency's five power plants. The bonds will pay for deferred costs associated with scrubber installation to reduce sulfur dioxide emissions at two coal-fired plants. The utility also owns shares in three nuclear power plants.

The NCEMPA has a strong financial position, analysts said. It had a debt ratio of 293% at the end of 2008, well above the joint-power authorities median ratio of 120%, Moody's said. The agency built up "sizeable" cash reserves earlier this decade in anticipation of electricity deregulation, according to Fitch's Jumper.

"They're in a pretty good position from a liquidity standpoint," he said.

The agency had a debt-service coverage ratio of 1.10 at the end of 2008, according to Fitch. Debt service coverage declined to 1.09 in fiscal 2008 from 1.16 in fiscal 2007, according to Moody's.

High energy prices in 2008 forced the utility collective to raise rates and may compel some of its owners to look for cheaper electricity providers. It raised electricity prices 14% last August and 4% in February. Its rates are now well above the prices other North Carolina customers pay, "suggesting that the agency is somewhat less economical for its participants," Moody's said.

But the ownership structure prevents members from leaving until the agency's debt has been paid off, which is expected to be in 2026. The 32 local governments that own the NCEMPA "do not have another option to go out on the open market" for electricity, according to Richard Olson, city manager for Elizabeth City, a member of the agency. The members do not have flexibility to negotiate rates with the utility, he said.

Moody's factors the ownership structure into its ratings methodology, Larsen said. There is a risk to the NCEMPA's rating that members may look to break contracts if prices rise too much, she said.

Jumper said higher energy prices also affected most of the agency's regional competitors. The Fitch analyst added that the current bond issue to terminate the swap will not prompt another rate increase.



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