LOS ANGELES -- An independent power project in Sacramento, Calif., apparently attracted solid investor interest yesterday for the first tax-exempt issue of its kind with investment-grade ratings.
Market participants and utility officials have followed the deal with interest, largely because similar projects may follow in the Sacramento issue's footsteps if adequate investor interest exists.
The deal is different from other investment-grade power financings in that bond security is derived only from the project revenues, rather than from a general utility pledge.
Underwriters led by Goldman, Sachs & Co. priced and repriced yesterday's $144 million offering of cogeneration project revenue bonds on behalf of the Central Valley Financing Authority.
The final offering included $66 million of term bonds, due in 2020, that were priced with 6.20% coupons to yield 6.32%. The repricing lowered yields by three basis points on those bonds.
The pricing levels surprised some institutional investors, based on a small survey of some portfolio managers and analysts.
"We felt comfortable with the credit," one analyst said, but he added that his firm decided against a purchase on grounds that the yields were "not commensurate with the level of risk" associated with the project.
But enough other investors apparently found the bonds to their liking, and the issue was oversubscribed, according to Steve Nielsen,
assistant treasurer of the Sacramento Municipal Utility District.
"We're very, very happy at the levels we saw," Nielsen said yesterday. "A lot of the big orders that came in" were from funds who participated in investor meetings last week, he said, adding that it was "gratifying to see positive evidence" that there were benefits from face-to-face meetings to explain the project and let people meet the participants.
The Sacramento district helped form the Central Valley authority -- a joint powers agency -- and controls the authority through board representation. The district's involvement in the project played a key role in convincing Standard & Poor's Corp. and Fitch Investors Service to assign BBB-minus ratings to the bonds.
Bond proceeds will fund a 99-megawatt cogeneration facility, known formally as the Carson Ice-Gen Project, that is designed to benefit the district by drawing on diverse power resources that will help meet future growth requirements.
Unlike traditional utility financings, security for the bonds hinges on project revenues alone, which makes the transaction riskier from the standpoint of investors. Such bond issues are commonly known as nonrecourse financings.
A few taxable offerings by independent power producers have achieved investment-grade ratings, but the Central Valley deal marked the first nonrecourse municipal deal to obtain investment-grade ratings.
New Jersey-based Vineland Electric Utility also helped break ground for such tax-exempt financings last fall by arranging a $77 million nonrecourse bond sale for a cogeneration project at a local food processing plant. The nonrated issue, underwritten by First Boston Corp., apparently was the first public offering of a tax-exempt issue on behalf of an independent power project, and showed there was a market for the deals.
Sacramento district officials said the Central Valley financing structure makes sense for them, partly because the deal's nonrecourse nature allows an issuer to push risk off its balance sheet.
In investor meetings across the country last week, district officials also attempted to convey "this idea of SMUD's overall need for the power." Nielsen said Monday.
At the meetings, Nielsen said he also emphasized that the district is not the typical "disinterested utility" that purchases power from independent power projects. Rather, the district stressed that the Carson Ice-Gen Project is replacing current outside power purchases, "not serving speculative [power] load," Nielsen said.
Potential investors last week did inquire about various aspects of the project, Nielsen noted, including the district's decision to assume the price risk of natural gas used as fuel.
That decision came down to "the old price-reward structure," Nielsen said. SMUD could have passed the price risk to the project, but utility officials believed the lack of flexibility "would translate to more expensive power" overall, he added.
One portfolio manager who said he viewed the transaction as a "strong credit for a cogeneration project" said he still decided against buying the bonds, but not because of any shortcoming in the deal itself.
The portfolio manager cited the "very, very narrow" credit spreads in today's tax-exempt market between higher- and lower-rated,
At current levels, investors are generally "paid a paltry amount for accepting credit risk," the manager said.
The manager said "garden-variety" insured bonds are trading around 5.80% to 5.85%, adding that the question arising with deals such as the Central Valley project is whether 50 basis points is enough of a spread to justify buying a BBB-minus bond.
Given today's compressed market spreads, however, the manager said he might not be as surprised as some over the Central Valley pricing levels. Few other low-rated investment-grade bonds offer higher yields, except for certain triple-B-rated hospital debt, he said.
Certain other investors who shied away from the bonds cited construction-related risk, along with the pricing level.
"You're buying SMUD when the thing is up and running." said another portfolio manager who was uncomfortable with construction risk in the event of delays.
Project officials believe sufficient funds are available to pay debt service in the event of construction delays. But the portfolio manager said he would have preferred a debt service reserve with one year's coverage of payments, rather than the half-year include in the financing.