SAN FRANCISCO — The Los Angeles Department of Water and Power will bring its first Build America Bonds to market as part of a $500 million deal next week.
The new-money water revenue bonds will help fund a $540 million fiscal 2009-2010 capital improvement plan that includes water main replacements and upgrades to improve water quality at the nation’s biggest municipal utility.
The deal will include tax-exempt bonds in early maturities and taxable BABs in later years. The exact amounts will be determined closer to pricing, but the utility’s likely to have about $150 million of tax-exempt bonds and $350 million of taxable bonds, said Mario Ignacio, LADWP’s treasurer and assistant chief financial officer.
“The inflection between the cost-effectiveness of tax-exempt and taxable bonds changes” depending on market conditions, Ignacio said. “Sometimes it’s 10 years, sometimes it’s 11 or 12.”
BABs were created by the American Recovery and Reinvestment Act in February. They carry a direct interest subsidy of 35% from the U.S. Treasury rather than the implicit subsidy of tax exemption.
The utility’s tax-exempt water bonds will be sold as 2009 Series B, and the BABs will be sold as Series C. LADWP is one of California’s most active municipal bond issuers, with about $2.1 billion of long-term water system debt and $4.8 billion of long-term power system debt outstanding at the end of fiscal 2008.
At its Oct. 6 meeting, the department’s board approved the issuance of $980 million of water revenue bonds and $1.57 billion of power revenue bonds to meet capital financing needs for fiscal 2009-10 and fiscal 2010-11.
The utility last brought new-money water bonds to market in January, when it sold $150 million of tax-exempt debt in 2009 Series A. It expects to be back in the market with power revenue bonds early next year.
Like other issuers, the utility has elected to collect the 35% interest rate subsidy on its BABs directly from the Treasury rather than passing them on to investors in the form of tax credits.
LADWP’s Build America Bonds will have make-whole calls after the 10th year, said Ignacio.
Municipal debt managers have been wrestling with the taxable market’s distaste for traditional 10-year muni call provisions and their own dislike of non-callable debt.
Some debt managers have chosen to pay interest rate premiums of 20 to 50 basis points to lure taxable buyers to BABs with muni-like call provisions, but many have resigned themselves to losing the ability to do economic refundings by giving investors make-whole calls.
With a make-whole call, the issuer has to make an investor whole, or pay a premium, to call bonds when interest rates are low, negating the traditional impetus to refund debt.
“It’s more economical to go for a make-whole call at this point; we have the flexibility to call them if we have to restructure our debt profile, but not for savings,” Ignacio said.
“We already took our savings up front” by avoiding the call premium, he added.
LADWP is coming to market after a wave of state issuance, but the utility should find strong demand for its higher-quality paper, said Kenneth Naehu, head of fixed-income trading at Bel Air Investment Advisors in Los Angeles.
“I don’t think that deal’s going to have a problem,” given the expected sizing of the tax-exempt and BAB series, Naehu said. “The bigger question is whether there’s a saturation point for California bonds.”
He doubts that the market is close to saturation at current price levels, which have California debt trading cheaper than other similar credits elsewhere.
The system’s water revenue bonds are rated AA by Standard & Poor’s and Fitch Ratings and Aa3 by Moody’s Investors Service. Fitch and Standard & Poor’s affirmed their ratings earlier this week.
“The AA rating reflects LADWP’s strong debt service coverage levels, sound management planning practices, diversity of water supplies, and the economic strength and depth of the service area,” Fitch analysts Kathy Masterson and Doug Scott said in a report.
The utility provides water to about four million Angelenos. It imports most of its water via the Metropolitan Water District of Southern California and has been hit by rising prices and limited supplies amid the state’s three-year drought.
LADWP has enacted mandatory 15% reductions in water usage and raised prices to keep its revenue from falling, according to Fitch. Its retail customers have exceeded its rationing goals, cutting consumption by 25%.
The water utility’s debt-service coverage ratios have been on the decline since 2003, falling from three-times debt service to a projected 1.7-times next year, but Fitch said it expects the coverage ratio to return to 2-times by 2012.
“LADWP continues to exhibit sound financial metrics despite debt service coverage declines from rising debt and costs,” Standard & Poor’s analyst David Bodek said in a report. “Furthermore, the board recently adopted a resolution establishing debt-service coverage ratio targets of at least 2.0-times.”
LADWP will begin pricing its bond deal on Tuesday.
De La Rosa & Co. is the senior book-running manager on the tax-exempt Series B. The co-managers are JPMorgan, Morgan Stanley, Backstrom McCarley Berry & Co. and Fidelity Capital Markets.
Citi and Siebert Brandford Shank & Co. are joint senior book-running managers of the Build America Bond Series C. The co-managers are RBC Capital Markets Inc., Wachovia Bank NA, Goldman, Sachs & Co., Loop Capital Markets LLC and Ramirez & Co.
Gardner, Underwood & Bacon LLC and Public Resources Advisory Group are the financial advisers to the department. Orrick Herrington & Sutcliffe LLP is serving as bond counsel and Kutak Rock LLP is disclosure counsel.