DALLAS — With high ratings and low water supplies, drought-stricken Austin expects a strong response from the muni market Tuesday when it prices $235.4 million of bonds to finance a new water treatment plant.

The negotiated deal, led by First Southwest Co., will refund $175 million of commercial paper and up to $72.6 million of callable bonds, according to the preliminary official statement.

The bonds targeted for refunding are 1998 Series B and 2001 Series A and B. The city is expecting interest rate savings on the refundings as well as strong demand for the new-money issue.

“The city of Austin is always well received in the market, and the coverages on these bonds are very strong,” said Chris Allen, senior vice president at First Southwest.

The underwriting team includes Bank of America Merrill Lynch, Estrada Hinojosa & Co., Goldman, Sachs & Co., JPMorgan, Ramirez & Co., and RBC Capital Markets.

The deal is one of the largest for First Southwest as lead underwriter. The Dallas-based company is perennially the top financial advisor in Texas but usually handles smaller clients as underwriter.

“We’re excited about the opportunity,” Allen said.

Public Financial Management Inc. is handling financial advisory services. Fulbright & Jaworski is bond counsel.

The Series 2011 bonds are backed by Austin Water Utility revenues, after coverage of first-lien debt. The Series 2011 bonds are on a par with the previous subordinate-lien obligations and outstanding water and wastewater revenue bonds.

Austin, which owns both the water and electric utilities for the city, issues bonds as “combined utility revenue bonds.”

With final maturities in 2041, the tax-exempt water bonds carry ratings of AA from Standard & Poor’s, Aa2 from Moody’s Investors Service, and AA-minus from Fitch Ratings. All the ratings have stable outlooks.

“The stable outlook reflects our expectation that management will continue to adjust rates proactively, and implement or continue other as-necessary policies in line with its to-be-adopted business model,” said Standard & Poor’s analyst Theodore Chapman.

Though Fitch maintained its stable outlook, the rating agency last month warned that the worsening drought in Central Texas could affect ratings for all area water utilities by reducing usage, and thereby revenues.

“As the volumes drop, the utilities have to ratchet up their rates, which causes sales to drop even further,” said Fitch analyst Doug Scott. “Municipal utilities will have to issue debt to meet the demand for water by a growing population, and lower revenues will eat into their ability to do that.”

Fitch will be watching to see if conditions change next winter and spring before making any decisions on rating impacts, Scott said.

“Negative rating pressures could emerge if the drought continues into 2012, forcing water utilities to escalate conservation measures and negatively affecting financial performance,” Scott said in the October report.

John Nielsen-Gammon, the official state climatologist and professor of atmospheric sciences at Texas A&M University, said that 95% of Texas is in either a “severe” or “exceptional” drought status.

Nielsen-Gammon said the state has a 50% chance of lower-than-normal precipitation this winter. He said if equatorial Pacific Ocean waters cool off in late fall, a situation known as the La Niña effect, odds of a dry winter in Texas go up to an 80% probability.

Municipal water utilities had strong finances in fiscal 2011 because consumption restrictions were not put into place in most areas until late in the year, Scott said.

Utilities serving almost 50% of Texas’ 25 million residents have imposed some sort of mandatory restriction, he said. Most of the others have now imposed voluntary curbs in anticipation of shrinking supplies.

Municipal utilities that began voluntary drought restrictions in the spring may show some early weakness, Scott said, but so far none of the utilities rated by Fitch have elevated mandatory restrictions in place.

The Texas Water Development Board said more than 900 of the state’s 4,700 water systems have restrictions, double the number in a normal dry year.

The Austin City Council last week directed city staff to work with a joint subcommittee to develop recommendations for short- and long-term Austin Water Utility financial plans.

The joint subcommittee includes the Resource Management Commission, the Water and Wastewater Commission, and the Impact Fee Advisory Committee. It also receives input from the public.

The joint subcommittee met for the first time Nov. 7 with a mandate to strengthen the financial stability of the Austin Water Utility. It was told to focus on developing a separate revenue stability reserve fund with target funding levels, with a view toward stable debt ratios.

Austin Water Utility’s long-term water supply agreement with the Lower Colorado River Authority runs through 2050, with the option to extend through 2100.

The utility’s conservation efforts are expected to blunt a potential LCRA mandate to reduce usage if drought conditions persist, according to Fitch’s report on the upcoming bond deal.

The bonds will provide long-term financing for a water treatment plant that is expected to open in 2014. Water Treatment Plant No. 4, as the new facility is called, will draw water from Lake Travis in the hills west of Austin. The authority reports indicated that drought conditions on Lake Travis could reach record levels next spring.

Austin’s two primary water treatment plants, Davis and Ullrich, provide a combined capacity of 285 million gallons per day. In September 2008, the city decommissioned a third water treatment plant, the 80-year-old Green Water Treatment Plant, to make way for a downtown development project.

The new plant will supply between 50 million and 75 million gallons per day, according to city estimates. Austin Water Utility serves about 214,000 water customers and about 201,000 wastewater customers.

Austin and other water utilities throughout the state received strong financial support last week when Texas voters approved $6 billion of general obligation bonds for the Texas Water Development Board.

The board lowers borrowing costs for utilities for water and wastewater by pooling loans and then issuing triple-A rated bonds to finance the loans.

The additional bonding authority, which will not require further voter approval as long as the total outstanding debt remains at or below $6 billion, is expected to help Texas keep up with its rapidly growing population.

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