In the News: Recent Developments

March 27, 2009

Corporate-Style Muni Liquidity?

By Andrew Ward

Calif. Issuers Seek Lower Costs, Risk

SAN FRANCISCO — A group of California muni bond issuers is looking to the corporate bond market for a liquidity structure that members hope will dramatically lower costs and reduce the bank risk that plagues the municipal variable-rate demand obligation market.

“We are trying to get banks to provide us liquidity at rates that are more comparable to the corporate market,” said Gary Breaux, director of finance at the East Bay Municipal Utility District in Oakland. “We think we ought to get at least as good a price as the corporate market because we’re usually more highly rated.”

Breaux manages a portfolio of over $1 billion in variable-rate debt and commercial paper for one of the San Francisco Bay Area’s largest municipal water and sewer utilities. EBMUD has about $400 million a year in revenue, and its most recent bond issue was rated AAA by Standard & Poor’s, Aa2 by Moody’s Investors Service and AA by Fitch Ratings.

Despite the low credit risk, Breaux says the municipal utility faces huge price increases for the liquidity that supports its variable-rate debt, much higher prices than a lower-rated investor owned utility would pay to get liquidity.

He’s joined with the Metropolitan Water District of Southern California and Irvine Ranch Water District to seek access to the corporate liquidity market. They’ve hired Saber Partners LLC to help them understand the market and to devise a strategy to garner access.

They’ve met with banks such as Wells Fargo & Co., JPMorgan Chase & Co., Citibank and Bank of America to discuss terms of a corporate-style liquidity agreement.

None of the banks responded to requests for comment by press time yesterday.

Municipal and corporate borrowers both commonly issue variable-rate debt. In the municipal market, the most common structure is the variable-rate demand obligation with liquidity in the form of a standby bond purchase agreement or a letter of credit from a bank.

This liquidity is key because investors can put VRDOs back to the issuer at short notice, and investors carefully manage the liquidity providers in their portfolios so that they don’t build up too much exposure to any one bank.

Municipalities like EBMUD have historically paid 30 to 50 basis points for standby bond purchase agreements. That obligates the bank to pay investors in case of a put or a failed remarketing. The municipality then repays the bank.

But demand for muni SBPAs surged after the auction-rate market’s collapse, pushing prices for SBPAs up to 85 to 200 basis points. The market was buffeted further as some banks began to falter in the fall of last year.

But Saber Partners CEO Joseph S. Fichera said corporate liquidity prices haven’t spiked in the same way. That’s left solvent, highly rated muni issuers like EBMUD paying much more for liquidity than private companies that do the same business and have lower ratings.

Members of the group in California are looking to see if there is an opportunity for municipal issuers to garner lower costs by negotiating access to the same type of liquidity offered to the corporate market.

For example, in December, when many municipalities were reporting that they couldn’t get liquidity at any price, Portland General Electric, which is rated BBB-plus by Standard & Poor’s, secured a 12-month line of credit for 25 basis points, according to Reuters Loan Corp.’s “Gold Sheets.” Piedmont Natural Gas Co. of Charlotte, N.C., which is rated A by Standard & Poor’s, paid 25 basis points.

Breaux and Fichera said the Reuter’s Gold Sheets also make the corporate market much more transparent, putting corporate treasurers in a much better position to negotiate with banks.

Breaux said there are some key differences between the structure of the corporate and muni liquidity agreements that may explain some of the pricing differential.

The corporate deals aren’t directly tied to bond issues that they support. In a muni SBPA, a bank is first in line to pay any puts. In the corporate sector, issuers only tap their revolving credit agreement if they don’t have sufficient liquidity to pay a put out of their own cash.

Both the ordering of the payments and the fact that the corporate revolving credit agreements are generally underwritten by a syndicate of banks appeals to Breaux.

“That’s preferable to us because as an investor you’d be looking to us, East Bay MUD, to use our own cash or to draw on lines of credit if it’s needed,” he said.

That means a problems at a single bank in the syndicate would be less likely to undermine an outstanding bond issue’s performance in the market. Investors would also have less worry about overexposure to the few muni SBPA providers.

Breaux hopes to convince banks to offer EBMUD a revolving credit agreement on terms similar to corporate borrows. He plans to try to bring a deal to market with the new liquidity structure when he does.

With the corporate liquidity plan still in the formative stages, he’s also trying other strategies to deal with the liquidity drought. He brought $331 million of subordinated water revenue bonds with a mandatory tender at one year to market earlier this month. EBMUD is using self-liquidity for that deal.

He’s also bringing $330 million of extendable municipal commercial paper to market soon without an external liquidity provider. The CP is “extendable” because investors agree to hold it for an extra 150 days at a higher interest rate if the utility can’t roll it over.

The overall aim is to try to think of new ways to sell variable-rate debt now that the existing market structures are no longer working well for the utility.

“We shouldn’t just be price-takers,” Breaux said. “We need to push a little for better prices.”

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