DALLAS - Credit issues continue to roil the prepaid gas debt market after Fitch Ratings last week placed more than $2 billion of deals led by Merrill Lynch & Co. on negative watch.
The prepaid deals under scrutiny came from three issuers in the market: Main Street Natural Gas, Roseville Natural Gas, and the Long Beach Finance Authority. All of the deals carry Fitch's A-plus rating assigned to commodity provider Merrill Lynch.
Fitch, Standard & Poor's, and Moody's Investors Service downgraded $4.6 billion of gas deals along with Merrill in October 2007. Standard & Poor's lowered Merrill to A-plus with negative outlook from AA-minus. Moody's downgraded the long-term debt to A1, negative, from Aa3, while Fitch dropped the rating to A-plus from AA-minus.
Fitch analyst Lina Santoro said the agency will decide whether another downgrade is in order, based in part on Merrill's earnings reports in the next two quarters.
Standard & Poor's changed its outlook on the deals to negative from stable on June 4, based on Merrill's financial condition that has been hammered by subprime lending woes and related economic developments.
While the downgrades do not affect the natural gas deals themselves, they do diminish the value of the bonds and could hurt Merrill's ability to attract new business in the growing prepaid gas market. Competitors such as Goldman, Sachs & Co. and Citi retain ratings in the AA-category.
The deals on the watch list are Main Street's $527 million 2006B and $497 million 2007A issues; Roseville's $209 million 2007A; and Long Beach Finance Authority's $252 million 2007A and $636 million Series B.
Gas deals involve a gas supplier like Merrill Lynch and guarantor that ensures the issuer is paid if gas is not supplied. That provision typically comes from a bond insurer, several of which have lost their triple-A ratings in the last year.
While the insurer's rating can be a drag on the overall rating of a deal, it is unusual when the insurer's standing brings a prepaid gas deal down, Santoro said. The rating of the commodity provider or the utility that is the buyer of the gas typically prevails, she said.
However, the rating of Clarksville Natural Gas Acquisition Corp.'s $240 million Series 2006 revenue bonds did fall in June based on the rating of reserve surety bond provider XL Capital Assurance. Standard & Poor's and Fitch dropped the rating to BBB-minus from A-minus.
Fitch last month also downgraded a 2008A Main Street Deal based on the ratings of counterparty Lehman Brothers Holdings Inc. The rating fell from AA-minus to A-plus.
"The Lehman Brothers' downgrade resulted from increased earnings volatility, changes in its business mix due to contraction in the securitization and structured credit markets, and the level of risky assets exposing earnings to challenges in hedge effectiveness," Fitch explained in the ratings action.
While ratings uncertainty continues to be a factor, analysts and utilities see growing demand for prepaid deals amid volatile energy prices. By locking in a rate for natural gas as far out as 30 years or more, utilities gain stability while enjoying the legal arbitrage that comes with the tax-exempt market.
Freed by an Internal Revenue Service ruling allowing the use of tax-exempt financing for public utilities on purchase of natural gas, the number of deals began growing dramatically in 2007 before market uncertainty intervened.
Since June, some stability has returned to the market, creating more natural spreads between tax-exempt and taxable bond yields, a key factor in making the deals attractive.