ALAMEDA, Calif. — The tight supply situation in the primary tax-exempt bond market will get a $2 billion boost from one issuer next week when the California Department of Water Resources prices power supply revenue bonds.
The deal will refund and restructure part of the debt portfolio created by the DWR’s landmark $11.3 billion issuance of 2002 in the aftermath of the state’s energy crisis.
Proceeds from the transaction, which prices Wednesday after a two-day retail order period, will be used to redeem outstanding variable-rate bonds, advance refund outstanding fixed-rate bonds, and pay associated swap termination payments, according to the preliminary official statement.
Morgan Stanley, De La Rosa & Co., and JPMorgan are running the books for a syndicate of 25 broker-dealers
“It is an economic refunding,” said Tom Dresslar, spokesman for the state treasurer’s office. The deal will reduce interest rate risks, liquidity costs for variable-rate debt, and risks associated with interest rate swaps, he said.
The office is running its retail-targeted Buy California Bonds marketing campaign to promote the deal, with newspaper and radio ads.
“We do expect strong retail,” Dresslar said, noting that the maturities, from 2011 to 2022, are well-suited to retail buyers.
As a refunding of outstanding debt, the deal has to come in tax-exempt form, something that has been harder to find as issuers take advantage of federal subsidies by selling taxable Build America Bonds in new-money deals.
That trend has reduced the tax-exempt supply, according to Alex Anderson, portfolio manager at Envision Capital Management in Los Angeles.
“That is why even though municipal finances have really struggled though the credit crisis and are struggling right now, yields are still low,” he said.
It will be the third-largest tax-exempt deal of 2010, according to Thomson Reuters.
“The economic tone from California has been better of late, so there should be an increase in demand for California bonds,” said Michael Pietronico, chief executive officer of Miller Tabak Asset Management.
“We suspect the deal will go very well, provided it’s priced on a national basis,” he said. “Our anticipation is that it should be one of the cheapest bonds on the market because of its size and should perform very well in the aftermarket.”
The DWR deal comes with underlying double-A-minus ratings from all three ratings agencies, after Fitch Ratings upgraded the credit from A-plus Tuesday.
The credit exists as an outcome of California’s failed attempt to deregulate electricity in the late 1990s. That effort led to rolling blackouts in 2000 and 2001 as the state’s major investor-owned utilities, faced with caps on the prices they could charge their customers, could not pay skyrocketing wholesale electricity costs.
The state was forced to step in as the buyer of last resort, leading to the $11.3 billion power revenue bond deal to repay loans from private banks and the state general fund that were used to buy electricity.
The bonds are secured with surcharges on customers of the state’s three major investor-owned utilities.
The DWR was forced to reevaluate its portfolio after the 2008 financial crisis, because of the collapse of the auction-rate market and the ensuing dislocations in the variable-rate note market as most bond insurers lost investment-grade ratings and the cost of liquidity soared.
In late 2008, a $350 million chunk of the DWR power revenue bonds became bank bonds for a period after the utility could not find buyers for a fixed-rate conversion deal. The deal eventually went ahead in early 2009.
Last year, the DWR sought and received state legislation that clarified its ability to continue to restructure its portfolio of variable-rate power revenue bonds.
In its rating report this week, Fitch noted that DWR’s “proportionately large variable-rate debt exposure is a credit concern,” but added that several factors mitigate the risk.
Among those factors was that the refunding deal will reduce gross variable-rate debt to about 38% of the DWR power bond portfolio from 52.9%.
However, “a credit concern for the near term is the significant, approximately $3.6 billion (declining to $2.2 billion after this refunding) in bank-provided letters of credit/liquidity facilities which will expire on Dec. 1, 2010,” the rating agency said. “Fitch will be monitoring DWR’s ability to renew and/or replace the remaining bank-provided support or conversely refinance the variable-rate debt with fixed-rate securities in the fall of this year.”