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Fitch Rts Public Authority for Colorado Energy Natural Gas Purchase Revs 'A+'; Outlook Negative

Posted on: Thursday, 5 June 2008, 18:00 CDT

Fitch Ratings assigns an 'A+' rating to Public Authority for Colorado Energy's (PACE) $630 million of gas purchase revenue bonds. The final rating will be assigned prior to closing and will be based upon final documentation in a form satisfactory to Fitch and consistent with the structure described below. The bonds are expected to price June 11, 2008. The Rating Outlook is Negative.

PACE is a Colorado nonprofit corporation organized for the purpose of acquiring, financing and supplying gas for the City of Colorado Springs. Bond proceeds from this issuance will be used by PACE to prepay a specified supply of natural gas for 30 years to be delivered by Merrill Lynch Commodities, Inc. (MLCI). Merrill Lynch and Co. (Merrill, rated 'A+', with a Negative Outlook by Fitch) will guaranty the financial obligations of MLCI.

Given the structured nature of the transaction, the expected 'A+' rating reflects the lowest rating of the following transaction counterparties (or their performance guarantees):

--The guarantor (Merrill, rated 'A+' on a Negative Outlook by Fitch) of MLCI's obligations as the gas supplier and remarketer;

--The commodity swap provider's obligation to make timely payments of contract price in exchange for index price (Royal Bank of Canada, RBC, rated 'AA', Outlook stable);

--The participating utility's obligation to pay for any gas received (Colorado Spring Utilities (CSU), rated 'AA' Outlook Stable);

--The guaranteed investment provider (GIC) provider to be selected at pricing (required to be rated at least 'AA-' by all three rating agencies at closing).

The bonds are structured with provisions that provide for timely payment of debt service regardless of changes in natural gas prices or transportation costs, or even the physical delivery of gas by the supplier (since financial payments will be due by the supplier, in the event of non-delivery of gas for any reason, including during Force Majeure events). The credit quality of the customer purchasing the gas from PACE (Colorado Springs Utilities) and their agreement to purchase gas delivered is an important component of the rating on this transaction.

Bondholder security is provided in the transaction structure outlined in:

--The trust indenture between Wells Fargo Bank and PACE that outlines certain commitments to bondholders, including extraordinary redemption of the bonds in the event of an early termination of the gas purchase agreement for any reason and the payment of swap netting payments prior to debt service.

--The Agreement for Purchase and Sale of Natural Gas (GPA) between MLCI and PACE requires MLCI to supply a specified amount of natural gas for 30 years to PACE in return for a prepayment made from bond proceeds. The GPA includes a guaranty by Merrill Lynch and Co. and provisions for termination payments and mandatory advances to be made by the gas supplier under certain early termination scenarios. The termination payment under the GPA does not include any amounts owed by the customer, the commodity provider, or GIC provider.

--The gas supply agreement (GSA) between PACE and Colorado Spring Utilities requires the customers to pay for any gas delivered by MLCI to PACE at a price equal to market index price less a fixed discount.

--Under the commodity swap between PACE and RBC, PACE will pay an index price (less a discount) and RBC will pay a fixed price. This swap is designed to hedge the risk of natural gas price differences between the fixed costs established through the bond financing (and paid by PACE to the trustee for debt service), and the index price paid by the customer.

--The uncollateralized GIC provider (to be bid at the time of pricing) will receive debt service and operating reserve account deposits from the trustee, and in return provide PACE with guaranteed investment earnings. The earnings from this contract are not included in the contract price discount to customers; however, bondholders do take the limited risk (limited in that providers shall post collateral if they are rated below 'AA-' and must be replaced if it falls below investment grade) of payment default on the debt service principal and interest amounts invested with the provider.

-The trust indenture between Wells Fargo Bank and PACE outlines certain commitments to bondholders, including extraordinary redemption of the bonds in the event of an early termination of the gas purchase agreement and the concurrent payment of debt service and commodity swap payments in the flow of funds.

While prepay transactions are similar in many ways, there are several variations. Below are some unique characteristics of this PACE prepay structure.

There is only one project participant and their credit is an important factor in the rating of the transaction. Typically, the risk associated with a project participant's failure to pay for gas is mitigated by a surety bond, cash reserve or mandatory receivables purchase agreement. In the case of this transaction, upon the failure of CSU to pay for gas delivered, MLCI has the option to either purchase the utility's receivables or terminate the transaction. If MLCI executes its option to purchase the receivables, the transaction would continue; however, if MLCI decides to terminate the transaction, the amount due by CSU would be subtracted out of the termination amount to bondholders. Therefore, CSU ('AA') and their payment for the gas delivered is an integral part of this transactions credit rating.

While there are no cash reserves in this transaction, a Funding and Assignment Agreement (F&A agreement) between PACE and MLCI (guaranteed by ML) requires full payment by MLCI (in most circumstances) in a mandatory redemption of the bonds. The F&A agreement also provides mandatory advances to cover certain commodity swap payment deficiencies, and at the option of the gas supplier the ability to advance funds to cover a general debt service deficiency on the part of the authority.

In prepaid energy transactions, there are sometimes collateral provisions for each of the counterparties at specific rating triggers. Below are listed certain collateral and GPA termination triggers for the PACE transaction.

If the swap counterparty (RBC) is downgraded below 'A+' they must post collateral equal to the cumulative amounts expected to be owed by RBC to PACE on the next three settlement dates (this is a stronger, more defined collateral posting provision than in previous gas prepay structures). Upon a downgrade below 'A', PACE has the option to replace the swap regardless of collateral posted as long as the new swap results in a rating that is greater than or equal to the transactions' rating at the time. If the swap counterparty's rating falls below Investment Grade ('BBB-'), replacement is required. If PACE fails to replace within 30 days, the GPA will terminate and the bonds will be extraordinarily redeemed.

If the GIC provider is downgraded below 'AA-', it must post collateral that the authority determines to be appropriate for the interest of bondholders. If the GIC provider's rating falls below 'A-', Pace has the option to replace the GIC with another entity rated at least 'AA-' (Qualified Provider) and with rating confirmation (of at least the same or equivalent rating) by each of the rating agencies then rating the bonds. If the GIC provider's rating falls, below 'BBB-', PACE will replace the GIC provider with another Qualified Provider. Although it is imperative that the GIC provider make its scheduled payments to the debt service fund, the interest earnings from the GIC are not reflected in the fixed discount to CSU and are not necessary to pay debt service. Therefore, in the event the GIC provider is terminated and is not immediately replaced, the transaction will continue to function normally and sufficient deposits to debt service will continue to be made.

The supplier's guarantor (Merrill) must post collateral if it is downgraded below 'BBB+', but only an amount equal to the unearned amount, which would be due to PACE in the event of an early termination. The collateral posted by the supplier is solely for PACE's benefit and not available to bondholders.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Source: Business Wire

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