Upgrade for desalination project as it plans private note placement

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Poseidon Resources received a one-notch upgrade to BBB from Fitch Ratings ahead of plans to privately place a $45 million note to finance construction of a new intake system for its desalination plant in Carlsbad, California.

Bank of America Merrill Lynch won the right to purchase the three-year note, expected to close in November, according to sources close to the deal.

The Claude “Bud” Lewis Carlsbad Desalination Plant was built by Poseidon as a partnership between the San Diego County Water Authority, Poseidon and other private partners.

Bonds for the plant and a related pipeline were issued by the California Pollution Control Financing Authority, a conduit issuer under the auspices of the State Treasurer's Office, in December 2012. The CPCFA issued $530.3 million of private activity bonds on behalf of Poseidon to build the plant and $203 million in tax-exempt governmental bonds on behalf of the water authority for the 10-mile pipeline. CPCFA won the Bond Buyer's Far West Deal of the Year award in 2013.

Outstanding pipeline bonds, which were issued with a five-year call provision, were refunded in a $183.2 million deal in February.

The Oct. 22 Fitch upgrade affected both pipeline and plant bonds, and the BBB rating was assigned to the new senior secured $45 million bank loan, issued at parity with the outstanding bonds.

The first large-scale ocean water desalination project on the Pacific coast took a decade of development effort. The transaction featured a 30-year water purchase agreement between the Water Authority and Poseidon that allows the Water Authority to transfer certain key risks to Poseidon, while supporting project financing at the investment-grade level.

The Carlsbad plant, located next to the Encina Power Station, has the capacity to produce 54 million gallons of drinking water daily through a reverse osmosis process that strips the salt from seawater. The seawater is drawn from the cooling water discharge of the power station, and the brine by-product is returned into the ocean using the power station’s existing discharge canal.

The $45 million note will pay for new intakes to transition away from the power station’s cooling water discharge to stand-alone pump intakes and discharge facilities after the 64-year-old Encina power plant ceased operations on Dec. 12, 2018. For now, the desalination plant continues to rely upon the power station’s existing pumps for current operations. The power stations eventual closure and the development of stand-alone pumps had been anticipated during the development process for the desalination plant.

The underwriter was selected following a competitive request-for-proposal involving senior underwriters on the water authority’s approved list, said Lisa Marie Harris, finance director for the San Diego County Water Authority.

Poseidon weighed the costs of issuing a $45 million bond versus a private placement, but ultimately decided on the quickest and least expensive route, Harris said.

“It made the process competitive and resulted in lower fees, because the five banks had to compete,” Harris said.

The project owner could have issued a tax-exempt bond, Harris said, but chose not to with the taxable rate for California bonds pricing below the Municipal Market Data’s triple-A scale. It also saves the expense of hiring disclosure counsel, and the cost and time associated with going through a conduit issuer, she said.

The plan is to refund the existing bonds along with takeout financing for the note when it matures in 2023, according to an Oct. 22 report from Moody’s Investors Service report, which affirmed its Baa3 rating. The bank loan will rank on equal footing with the $530.3 million series 2012 plant bonds and the pipeline bonds, both set to mature in 2045, but will not benefit from a debt service reserve, according to the ratings agency, which assigns a stable outlook.

The Carlsbad desalination project, which began producing water in December 2015, is moving to a more mature phase of its life cycle and expects to close by year-end on its sale to a new equity investor.

The water authority’s board approved last week Aberdeen Standard Investment’s purchase of the project, which was owned by Orion Water Partners LLC, a joint venture between Stonepeak Infrastructure Partners and Poseidon. The Stonepeak fund was maturing and their equity sale is the normal course of business for a financial investor, according to Poseidon.

Under the water purchase agreement, the SDCWA had the right to approve any change of control transaction, though it could not unreasonably withhold approval, according to emailed responses from Poseidon.

The rating agencies viewed Poseidon's continuation as the facility manager favorably as did the water authority.

"We are honored that maintaining Poseidon Water as the facility manager was integral to the Water Authority's approval of the ownership transfer," Carlos Riva, Poseidon Water's chief executive officer, said in a statement.

The rating primarily reflects the revenue stability provided under the water purchase agreement with the SDCWA, said Chris Joassin, a Fitch director.

Fitch affirmed the rating just a few weeks ago during its annual surveillance, but made the upgrade decision after a review that gave the analysts a better understanding of what the risks are, Joassin said. Fitch also sought out a third-party opinion from an engineer “to get more comfortable with the projected operational profile,” Joassin said.

The third-party opinion provided added assurance that the project will meet performance guidelines, Joassin said.

The project also has been trending in a positive direction though it has experienced some difficulties since it opened in 2015, he said.

Those issues included algae blooms clogging the pre-treatment filters over the past two years; that has been worked through, said Jeremy Crutchfield, a manager in the water resources department at SDCWA. They had to take the plant offline to make changes to protect the filters, so there was some down time associated with that, Crutchfield said.

The plant also experienced a mechanical failure in August 2017 in the link to the piping associated with reverse osmosis, Crutchfield said, which caused the plant to go offline for 34 days.

It was an unforeseen event described as an “Act of God” by Poseidon, said Crutchfield, meaning nothing could have been done to prevent it.

The result of the hiccups is that Poseidon has struggled to meet the minimum requirements of providing 48,000 acre-feet of water annually.

But Crutchfield said without the problems mentioned above, it would have been close to hitting the minimum production numbers and few problems are anticipated when the new intake system is completed.

When Poseidon doesn’t meet the minimum requirement, the water authority receives a discount and the project manager has to pay a penalty, he said.

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