Market Selloff Doesn't Hamper Desalination Plant Pricing

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LOS ANGELES -- The builders of a Carlsbad, Calif. seawater desalination plant pulled off a $734 million bond sale at a lower-than-anticipated interest rate in the midst of a massive sell-off in the bond market.

Officials said the historic deal was the first public-private bond financing of a desalination project in the U.S. and only the second large desalination project constructed in the country.

The first, constructed in Tampa, Fla., was financed with private activity bonds, but at full credit recourse to the Tampa Water Authority, said Andrew Kingman, chief financial officer of Poseidon Resources, builder of the Carlsbad plant.

Stamford, Conn.-based Poseidon's deal moved forward even as large issues like the $638 million Subordinated Triborough Bridge and Tunnels, $162 million Hillsborough County Florida Industrial Development Authority, and $117 million Oklahoma Municipal Power Authority were yanked from the market as rates turned against their issuers.

"I think people had been watching this deal for a long time and were comfortable with it," said Fred Lowther, a partner in Washington, D.C.-based Dickstein Shapiro and Poseidon's legal advisor. "It was one of a few major deals in the market at the time, so it was not as likely to be impacted by short-term movement in the market."

Poseidon priced the debt on Dec. 14 through the California Pollution Control Authority.

The deal closed Monday.

The proceeds combined with a $172.6 million equity contribution from Stonepeak Infrastructure Partners LLC will pay for the $922 million desalination plant and pipeline project.

San Diego County Water Authority officials said they were expecting interest rates from 5.1% to 6.1%, but were able to achieve 4.78% on the bonds rated BBB-minus by Fitch Ratings and Baa3 by Moody's Investors Service.

And they did so even as "the seemingly bottomless muni liquidity came to a screeching halt," according to a report from Richmond, Va.-based Caprin Asset Management.

"We were fortunate to see the amount of investor interest we did," said Sandy Kerl, deputy managing director of the San Diego County Water Authority. "The rates were at an all-time low, so we were right in that sweet spot."

The market was so bleak at the time the bonds were priced that Caprin traders joked in a Dec. 21 report that muni participants may have worried "that the Mayans were correct in their apocalyptic predictions."

"Despite all of this, there are still buyers out there willing to capture the higher yields that are only offered by lower rated deals like Poseidon," said Peyton Studebaker, Caprin's head of trading. "We are still near historically low yields in the municipal market, and 4.78% on the Poseidon deal was evidently attractive enough for those accounts willing and able to take on the credit and duration exposure."

The lowered rates will save an estimated $200 million over 30 years lowering the cost of water from the project by $125 per acre-feet to $1,917 per acre-feet, SDCWA officials said.

"Several issuers cut back the amount of bonds they sold last week because they couldn't sell them - we weren't in that situation," Kerl said.

A receptive environment for high-yield bonds likely helped to counter the market jitters caused by a looming fiscal cliff and proposed 28% cap on municipal tax exemptions.

The market cap in the High Yield Muni exchanged-traded fund HYD had grown from $340 million at the beginning of 2012 to over $1 billion - an increase of 201% by mid-December, Studebaker said.

The bonds were only being offered to qualified institutional buyers in denominations of $250,000; and can only be re-sold to the same kind of buyer in similar denominations, limiting their liquidity. The bonds were sold in maturities from 2027 to 2045.

Lowther described investors in the bonds as those who have a long-term perspective similar to power company bond investors.

"I think a lot of bond buyers see this as the beginning of something significant," Lowther said. "There will be a lot of opportunities to invest in this industry. We have built the highway through the jungle, so now a lot of people will be using the highway."

Poseidon plans to be among them with plans to issue bonds in late 2013 for an undisclosed amount for a similar project planned in Huntington Beach, Calif.

Complications inherent in having 60-plus signatories sign the financing agreements pushed the close from last Thursday to Monday, but did not result in any changes to pricing, Lowther said.

"Closing the financing on an approximately $1 billion project is no small feat, and to do so just three-and-half weeks after the water purchase agreement was approved required a monumental effort by all involved," said Thomas Wornham, chairman of the water authority's board of directors, a retired banker.

The project, a reverse osmosis seawater desalination plant on a six-acre plot leased from the Encina Power Plant in Carlsbad, is designed to produce 54 million gallons a day of water. Poseidon will also construct a 10-mile pipeline.

Poseidon received approval on Nov. 29 from the San Diego County Water Authority's board for a $3 billion purchase agreement in which the water authority will purchase 56,000 acre-feet of water annually.

The following day, the California Pollution Control Authority agreed to act as conduit issuer on the bonds, which were sold in two series.

There are $203 million in tax-exempt governmental bonds issued on behalf of the water authority to finance construction of the 10-mile pipeline, and $530 million in private-activity bonds for Poseidon to finance construction of the plant, which were subject to the alternative minimum tax.

If Poseidon fails to provide the amount and quality of water agreed to or doesn't open on time, it will be responsible for debt service on the bonds being issued for the water authority.

The water authority will be the primary obligor of the pipeline bonds payable under an installment agreement starting after the plant and pipeline are up and running.

Poseidon gave the joint venture responsible for design, construction and start-up operations notice to begin construction on Wednesday, said Andrew Kingman, Poseidon's chief investment officer.

The project is expected to be completed in 2016.

A joint venture of Kiewit Infrastructure West Co. and J.F. Shea Construction will design and build the Carlsbad plant and the Water Authority's pipeline. Israel-based IDE Technologies will design desalination plant and run the facility.

JPMorgan, the lead underwriter, pushed ahead with pricing the bonds despite the short time frame, because Poseidon and the water authority were committed to finishing the financing by the end of the year, Kerl said.

The 2012 private activity bond volume allocation through the conduit issuer would have expired at year-end and Poseidon's lease agreement with the power plant would have expired if construction had not begun by year-end.

"It would have been nice had it been stretched out for a longer time," Lowther said.

But making adjustments like rejiggering the lease agreement would have resulted in a situation where "when you move one peg, three others jump off," he said.

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