DALLAS — San Antonio’s CPS Energy is planning its fourth and largest issue of Build America Bonds on Thursday as it faces an Internal Revenue Service audit of a previous BAB deal.
The city-owned utility plans to price two series of the junior-lien taxable debt worth $500 million in a negotiated deal. JPMorgan will be senior manager on the $300 million Series A, with Bank of America Merrill Lynch leading the $200 million Series B.
Public Financial Management Inc. serves as financial adviser on the upcoming deal.
The city disclosed last week that the IRS was including a $375 million CPS issue in its surveillance of how the federally subsidized bonds are being priced. The bonds, issued in June 2009, were the first BABs issued in Texas. Since then, the utility has issued two more deals. CPS’s total BAB issuance before this new deal comes to about $875 million.
An IRS official said in an interview Friday that the agency is in the process of conducting “for the most part” random audits involving 15 to 20 BAB deals. San Antonio officials, stressing that the audit appears to be routine, filed a disclosure notice with the Municipal Securities Rulemaking Board’s online EMMA system. Late Friday, the Metropolitan Water Reclamation District of Greater Chicago disclosed it is being audited by the IRS. The identities of other issues under review were not revealed.
Despite the audit, the Texas public utility is comfortable proceeding with its fourth issue of the federally subsidized debt, according to chief financial officer Paula Gold-Williams.
“We understood that that was a possibility, and we expect them to follow through,” she said. “We feel comfortable that BABs are the right instrument to use.”
The 30-year BABs priced in June 2009 with a yield 145 basis points over comparable Treasuries, five basis points narrower than earlier price guidance, according to IFR, a Thomson Reuters service. Recently, the bonds have yielded 4.946% with a spread of 119.6 basis points over Treasuries, according to Thomson Municipal Market Monitor.
In its audits the IRS is asking for pricing information and data as to who is purchasing the BABs and how the proceeds are being allocated to expenditures.
Clifford Gannett, director of the IRS’ tax-exempt bond office, said there is no reason at this point to believe the BABs have violated tax-law requirements.
For issuers such as San Antonio’s CPS, the advent of taxable BABs has allowed traditional issuers of tax-exempt debt to reach a new market that trades in corporate and taxable debt.
BABs were created as part of the federal economic stimulus effort. The Build America Bond program is set to expire at the end of the year unless it is extended by Congress, setting the stage for a year-end rush to market by issuers.
San Antonio has added flexibility to its issue with 10-year call provisions on the Series B bonds. The Series A will carry make-whole call provisions, Gold-Williams said.
As the nation’s largest public utility, CPS Energy rates among the best in terms of credit quality.
Standard & Poor’s, which rates no public utility higher than AA-plus, pegs CPS at AA-minus with a stable outlook. Fitch Ratings confers its AA-plus, while Moody’s Investors Service rates the deal Aa2, both with stable outlooks.
“The San Antonio City Council demonstrated its support of CPS Energy’s strong financial-risk profile when it approved a 7.5% rate increase for electric rates and an 8.5% rate increase for gas rates on Feb. 18, 2010, which increased the average residential bill 4.2% and annual revenue $109.2 million,” Standard & Poor’s analyst Judith Waite wrote. “Management expects rate increases every other year starting in fiscal 2013 to maintain debt-service coverage and liquidity ratios at levels that are adequate for the rating.”
Proceeds of the upcoming bond sale will be used for transmission facilities and for the $1 billion J.K. Spruce Unit 2 coal-fired power plant completed in May. The 750-megawatt plant at Calaveras Lake in Southeast Bexar County is expected to provide about 25% of the utility’s electricity demand.
The plant was recently taken offline so that technicians could repair or replace a Hyundai-manufactured transformer that remains under warranty.
“The outage comes during CPS Energy’s shoulder months and is not expected to result in any material cost to the utility,” according to Fitch analyst Christopher Jumper.
About 33% of CPS electric power comes from low-sulfur, low-cost coal from the Powder River Basin. Another 35% comes from units 1 and 2 of the South Texas Project nuclear plant that are among the top-performing nuclear generating units in the world.
Earlier this year, CPS signed a settlement that allowed the company to reduce its ownership of the planned STP units 3 and 4, to 7.6% from the original 50%.
“We view this as positive since CPS Energy’s investment is limited to about $400 million, with no additional funding obligation after Jan. 31, 2010,” Standard & Poor’s Waite noted. “The utility’s 200-megawatt share of the plant, which the developers expect to begin operating in 2016 and 2017, will provide about one-third of the additional electricity management expects to need by 2020. Management is reviewing options for the remaining supply.”
CPS enjoys a near-monopoly of electric service in an area that includes all of Bexar County and parts of seven adjacent counties. There is no service area boundary for the utility’s gas system. The system is governed by a five-member board of trustees that includes the mayor of San Antonio. CPS is separately managed from the city but the City Council has final rate-making authority.
“CPS has retail electricity rates that are consistently well below U.S. and regional averages,” Moody’s analyst Dan Aschenbach pointed out in his rating report. “Rates are competitive despite the burden on CPS of the substantial revenue transfers to the city’s general fund. In FY 2010, transfers amounted to $260.6 million and represented almost 14% of utility gross revenues, which is well above the U.S. public power utility general fund transfer median of 7%.”
Aschenbach also noted that CPS made it through the market turmoil of 2007-2009 without any significant damage. “The CPS debt structure was absent of auction-rate securities, interest rate swaps and any problematic insured bonds,” he wrote.
San Antonio has also been spared some of the worst effects of the recession, analysts said. Unemployment was 7.6% in August 2010, compared with the state average of 8.3% and the U.S. average of 9.7%. New and expanded businesses in the San Antonio area include data storage, Toyota Motor Corp.’s truck assembly plant, and Medtronic Inc.’s diabetes business unit. In addition, 16,000 military service personnel and federal employees will transfer to Fort Sam Houston as part of military base realignment.
CPS expects annual demand growth to be less than 2% for electricity and gas.
