BRADENTON, Fla. — Charlotte, N.C., should benefit from global factors pushing interest rates down as the city prepares to price $463 million of water and sewer refunding bonds this week.
The revenue refunding bonds, rated triple-A by all three rating agencies, price Thursday with Wells Fargo Securities as book-runner. Charlotte believes the offering is the largest single deal the city has ever issued.
The timing of this week's pricing is favorable for the city after a rise in Treasuries eroded the savings potential for some muni refundings during May and June, according to Matt Buscone, a senior vice president and portfolio manager at Boston-based Breckinridge Capital Advisors.
Rates had been on the rise in recent months as the odds of a Fed rate hike in September increased and positive domestic economic data was released, including a strong jobs report the first week of June, Buscone said.
The trend reversed in the last few weeks amid concern that slower global growth and a steep drop in commodity prices could lead to lower inflation, he said. The drop in rates the last two days, he said, is almost entirely due to the devaluation of China's renmibi.
Charlotte "caught a good week," Buscone said about Thursday's pricing. "Rates have dropped for them."
Buscone estimated that the deal should price within 5 basis points to 8 basis points of the high-grade scale.
While investors are still searching for credits with a little more spread, he said there typically is a lot of demand for paper from North Carolina.
Charlotte's transaction will price a little more aggressively because the bonds have the highest ratings, Buscone said.
"It's a well-run, highly rated city in a highly rated and well-run state," he said. "It's hard to find any fault with it."
Chris Doucet, founder of Birmingham, Ala.-based Doucet Asset Management, said that "market angst" about a potential Federal Reserve rate hike next month could have a greater impact on the pricing of Charlotte's offering.
"My sense is the deal will probably price at about 10 basis points cheap to the AAA-MMD scale on the 10 year maturities and about 70 basis points cheap to the curve on the long end," he said, adding that could translate into around a 2.35% yield on the 10-year bonds and a 3.80% yield on the 30-year bonds.
"For certain investors, these yields will represent a compelling investment and they will be cheap to the Treasury yield curve on both a relative and absolute basis," Doucet said.
Bond proceeds will prepay a 2014 bond anticipation note, refund 2006A, 2005A, 2002B, and 2002C bonds for cost savings, and pay termination costs associated with the water and sewer system's 2002B and 2002C swaps.
The transaction is structured with one amortization schedule that is designed to generate level debt savings.
Final maturity is in 2045. There is a 10-year call provision.
Maturities in the first 10 years have large-block sizes that should appeal to some investors, especially those concerned about duration risk, Buscone said.
"This is a complex deal," Treasurer Scott Greer said about the underlying refunding bonds and swap termination plan. "All of the pieces together determine the cost-benefit."
To be successful, Thursday's pricing must net a positive result, including the termination value of the swaps and the refundings, he said.
The deal was estimated to achieve $7 million to $8 million in overall savings as of July 23.
The transaction is part of the city's comprehensive oversight of the water and sewer system, and its effort to reduce its exposure to swaps and variable-rate debt, while keeping customer rates as low as possible, Greer said.
The water and sewer bonds are rated triple-A by Fitch Ratings, Moody's Investors Service, and Standard & Poor's. All have stable outlooks.
Charlotte, the seat of Mecklenburg County, anchors a large regional economy supported by major financial, communications, distribution, and manufacturing outlets.
The city, the largest in North Carolina, saw its population grow about 9% between 2010 and 2015. Unemployment was 5.1% in May.
After the current refunding and prepayment of the BAN, the water and sewer system will have about $1.4 billion of outstanding debt, including $162 million of variable-rate bonds hedged by a fixed-rate swap.
The capital improvement plan has ramped up since the recession, and is estimated at $845 million between 2016 and 2020.
About 65% of the cost will be pay-as-you-go financing, while the remainder will be supported by short-term notes that will eventually be taken out with bonds.
"We have an extensive capital program under way and we have a sophisticated model to balance operating and debt service needs while maintaining reasonable rates," said Ann Wilson, who became the city's Debt Manager in November. "The model includes estimated rate increases, minimum fund balance levels, and debt service coverage ratios that support the AAA rating."
While many municipalities slowed their capital plans during the recession, Wilson said continued growth in the region has required Charlotte to resume infrastructure investment.
"Charlotte Water is well managed and maintained," she said.
The city anticipates issuing about $180 million in short-term notes over the next two years for water-related construction projects.
Charlotte's water and sewer enterprise system serves 266,756 water accounts and 242,254 sewer accounts in Mecklenburg County, and has wholesale agreements with several local governments. New accounts grew by 4.5% from 2014 to 2015.
S&P said the city will lose York County Water & Sewer as its leading water customer this year, but it does not believe the loss will hurt system finances due to steady customer growth and regular utility rate adjustments. York County Water & Sewer accounted for 1.4% of fiscal 2014 water sales.
According to analysts, raw water is available to serve customers for about 40 years, while the sewer treatment capacity is adequate for 10 to 15 years.
Analysts also credited the city for maintaining the water and sewer system's strong financial performance, high liquidity with cash-on-hand exceeding a year's operation, and officials' willingness to adjust rates as needed.
The system's forecast incorporates 4% annual rate increases and assumes 0.5% annual customer growth, though more recent growth has approximated 2% annually, according to Fitch.
"The consistently high debt levels have led to objectively low, but very stable, financial results relative to similarly-rated credits," said Fitch analyst Eva Rippeteau.
Senior and all-in debt service coverage averaged 2 times in fiscal 2010 and 1.4 times in 2014, compared to Fitch's AAA medians of 4.4 times and 2.8 times. Net revenues yielded 2.1 times for senior lien coverage in fiscal 2014.
Unaudited fiscal 2015 results show coverage improving to 2.2 times, Fitch said.
"Fitch maintains that the system's strong cash position and ample rate-setting flexibility mitigates and offsets its relatively low DSC levels and higher leverage," Rippeteau said. "Since 2010 unrestricted cash balances have averaged over two years' worth of cash on hand, and in fiscal 2014 the system's $193.7 million in cash equated to a robust 659 days."
Moody's analyst Edward Damutz said, "The system's financial operations are expected to remain sound, supported by proactive management, regular rate increases as well as debt service and liquidity levels that are guided by formal policies."
DEC Associates Inc. is the city's financial advisor.
Bank of America Merrill Lynch, JPMorgan, and PNC Capital Markets LLC are also underwriting the deal.
Parker Poe Adams & Bernstein LLP is bond counsel. McGuirewoods LLP is underwriters' counsel.
