Fitch : Rates Public Energy Authority of Kentucky's 2019A Gas Supply Revs 'A'; Outlook Stable
11 Feb 2019 05:05 PM ET
Fitch Ratings-Austin-11 February 2019: Fitch Ratings has assigned an 'A' rating to the following bonds issued by Public Energy Authority of Kentucky (PEAK):
--Approximately $371.96 million gas supply revenue bonds, series 2019A-1, 2019A-2, 2019A-3 and 2019A-4.
The Rating Outlook is Stable.
The series 2019A-1 bonds will be issued with a long-term interest rate, and the 2019A-2, 2019A-3 and 2019A-4 bonds will be issued with a variable rate. The allocation of bonds remains to be determined. While the bonds will be issued with a final maturity date of Dec. 1, 2049, all bonds will be subject to a mandatory tender on June 1, 2025 (the mandatory tender date). Fitch's rating on the bonds only addresses the credit risk of the bonds up to and including the mandatory tender date.
The bonds are expected to price in February 2019.
All of the gas supply revenue bonds (collectively, the 2019A bonds) are secured by the trust estate pledged under the indenture, including revenues derived from the sale of natural gas, payments received from the commodity swap provider and interest rate swap provider, and any payments due pursuant to the receivables purchase provisions in the prepaid natural gas sales agreement (PGSA).
KEY RATING DRIVERS
COUNTERPARTY PAYMENT OBLIGATIONS: The rating on the PEAK gas supply revenue bonds reflects the structured nature of the prepaid energy transaction and Fitch's analysis of the principal transactional counterparties, including Morgan Stanley Capital Group Inc. (MSCG; the gas supplier and interest rate swap provider) and an investment agreement provider for the debt service account, which will be determined at bond closing. MSCG's obligations will be guaranteed by Morgan Stanley (Issuer Default Rating [IDR] A/Stable).
WEAK LINK COUNTERPARTY: The rating on the bonds is driven by the credit quality of the weakest counterparty whose default risk is not otherwise mitigated. Although the investment agreement provider related to the debt service fund (DSF) is undetermined, the provider is required to have a rating at least at the same level as the gas supplier (or, if the gas supplier is not rated, the guarantor of the gas supplier) by Fitch. The rating of the series 2019A bonds therefore reflects the credit quality of Morgan Stanley, which is also the current constraint in the transaction's rating.
ADDITIONAL SUPPORT FROM MORGAN STANLEY: Credit risk to the gas purchasers is mitigated through receivables purchase provisions in the PGSA between PEAK and MSCG, requiring MSCG (supported by the Morgan Stanley guaranty) to cover certain non-payments by the participants.
COMMODITY SWAP PROVIDER: The commodity swap provider will be BP Energy Company (BPEC; not rated), guaranteed by BP Corporation North America Inc. (not rated). A custodial agreement between MSCG, BPEC and The Bank of New York Mellon Trust Company, N.A. (BNY; custodian; AA/Stable Outlook) will, in Fitch's view, insulate bondholders from the credit risk of the commodity swap provider.
CHANGE IN COUNTERPARTY CREDIT QUALITY: The long-term rating of the Public Energy Authority of Kentucky's gas supply revenue series 2019A bonds will continue to be determined by Fitch's assessment of the structure, including the role and credit quality of each counterparty in the structure. Therefore, unless otherwise mitigated, shifts in the rating or credit quality of Morgan Stanley or the rating or credit quality of the debt service account investment agreement provider below the current rating on the bonds would result in a downgrade. Conversely, shifts in the rating or credit quality of all of the counterparties above the current rating on the bonds would result in an upgrade.
PEAK is a natural gas acquisition authority organized by the cities of Carrollton and Henderson, Kentucky created for the purpose of acquiring, transporting, managing and financing supplies of natural gas on behalf of certain public agencies.
PEAK will enter into Gas Supply Contracts (GSCs) with 12 public utility systems (the Project Participants) to provide natural gas supply for delivery to retail customers, or fuel for the generation of electricity that will be provided to retail customers.
STRUCTURE DESIGNED FOR TIMELY PAYMENT
PEAK will use the bond proceeds to prepay MSCG for a specified approximately 30-year supply of natural gas. By virtue of the sales, hedging and investment agreements outlined below, the project is structured to ensure that monthly net payments to PEAK are sufficient to pay scheduled debt service, regardless of changes in natural gas prices, the physical delivery of gas, or the acceptance of delivered gas.
Since the 2019A-2, 2019A-3 and 2019A-4 bonds will be issued with variable interest rates, PEAK will enter into an interest rate swap with MSCG (guaranteed by Morgan Stanley) in order to hedge its exposure to interest rate fluctuations. The interest rate swap terminates on the mandatory tender date.
STRUCTURE PROVIDES FOR MANDATORY TENDER
The bonds are being issued as approximately 30-year amortizing debt with a mandatory tender on June 1, 2025. Proceeds to fund the mandatory tender are expected to come from remarketing proceeds. If PEAK does not enter into a bond purchase agreement, firm remarketing agreement, or similar agreement of the bonds before the last day of the reset period prior to the mandatory tender date, or if PEAK enters such an agreement, but the funding for the remarketing of the bonds is not delivered to the trust estate five business days before the mandatory tender date, a failed remarketing of the bonds will occur.
A failed remarketing will cause an early termination of the PGSA and the extraordinary redemption of the bonds. In this case, MSCG (supported by the Morgan Stanley guaranty) will be required to make a termination payment to PEAK. The termination payment, together with other available funds (including the DSF), are designed to be sufficient to pay off the bonds plus accrued interest, ultimately covering all principal, unamortized premiums and accrued interest through the redemption date (redemption price).
Fitch's rating on the bonds only addresses the credit risk to bondholders up to and including the mandatory tender date.
PEAK SELLS GAS TO PROJECT PARTICIPANTS AT MONTHLY OR DAILY INDEX RATE
PEAK will sell all of the natural gas delivered by MSCG to the Project Participants pursuant to the GSCs. Gas volumes will be purchased at a price equal to either a monthly or daily index, less a discount, and used to meet gas system requirements or as fuel for electric generation. Payments to PEAK pursuant to the GSCs will represent an operating expense of the utility system of each Project Participant.
COMMODITY SWAP HEDGES COUNTERPARTY RISK
To hedge the risk of changes in gas prices, PEAK will enter into a commodity swap agreement (front-end swap) with BPEC, exchanging a monthly or daily index price for a fixed price that is sufficient, together with the payments for gas, to cover PEAK's debt service requirements. BPEC will also enter into a matching swap agreement with MSCG (back-end swap), exchanging a fixed price for a monthly or daily index price to further hedge its position.
A custodial agreement amongst BPEC, MSCG and BNY insulates bondholders from the credit risk of BPEC, which is unrated, but guaranteed by BP Corporation North America, Inc. BNY will hold the payment from MSCG and will pay the swap provider only after BPEC has paid PEAK under the front-end swap. In the event of nonpayment by the swap provider to PEAK under the front-end swap, the custodian shall be authorized to remit payment received from MSCG directly to PEAK.
FAILURE TO ACCEPT OR DELIVER GAS
The failure by MSCG to deliver gas, or PEAK to accept gas deliveries, is not expected to jeopardize the transaction's performance. If MSCG fails to deliver gas for any reason, it is required to pay PEAK for the undelivered volumes at prices sufficient to allow PEAK to meet its obligations, including debt service payments. Alternatively, under the GSCs, if PEAK provides notice to MSCG to remarket gas to other purchasers that it does not need, or does not accept delivered gas, MSCG is required to remarket such gas. If the gas cannot be remarketed, MSCG is required to purchase the gas for its own account. In either case, MSCG's payments from the remarketing or purchasing of the gas will be based on index prices sufficient to preserve transactional cash flows.
BONDS SUBJECT TO EXTRAORDINARY REDEMPTION
The bonds are subject to extraordinary redemption prior to maturity. Under certain circumstances (a designated seller default and buyer default) or events such as changes in laws resulting in nonperformance of the seller or buyer (designated non-default termination events), the bonds may be called prior to the stated maturity through the extraordinary redemption mechanism. In the case of an extraordinary redemption, MSCG will be required to make an early termination payment, which together with available funds in the DSF, is designed to be sufficient to pay the redemption price of the bonds.
Morgan Stanley, the parent company of MSCG, will provide a financial guaranty to secure the supplier's performance under the purchase agreement, including its obligation to make a termination payment.
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U.S. Public Finance Prepaid Energy Transaction Rating Criteria (pub. 10 Jan 2019)
U.S. Public Finance Structured Finance Rating Criteria (pub. 22 Feb 2018)
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