Long Island Power Crisis Spurs Bondholder Interest: Muni Credit

New York Governor Andrew Cuomo
The securities held their gains even after LIPA’s chief operating officer resigned this week and as Governor Andrew Cuomo ordered a probe into the performance of the state’s utilities. Photographer: Daniel Acker/Bloomberg

More than two weeks after Hurricane Sandy, Long Island Power Authority still hasn’t restored power to all its customers. Protesters holding “Lie-PA” signs decry the nation’s second-biggest municipal utility.

As 90 percent of LIPA’s 1.1 million customers shivered in the dark at one point, bondholders reaped gains. Amid the best rally in three months in benchmark local debt, borrowings of the utility are doing even better. The securities held their gains even after LIPA’s chief operating officer resigned this week and as Governor Andrew Cuomo ordered a probe into the performance of the state’s utilities.

On Nov. 13, 10-year debt issued by LIPA and backed by bill payments traded at a yield of 2.23 percent, or 0.68 percentage point more than AAA securities, data compiled by Bloomberg show. That yield penalty is down from June, when LIPA sold the A-rated bonds at a spread of 0.83 percentage point.

“The technicals of the muni market have trumped what’s going on” as far as the credit risk, said Brian Steeves, a portfolio manager in White Plains, New York, at Belle Haven Investments, which manages $1.2 billion of munis. Investors are ignoring the credit risk, he said.

Beating AAA’s

Local bonds with an A rating, five steps below AAA, have earned 8.6 percent this year, according to Barclays Plc data. Investors looking for extra yield amid the lowest muni interest rates in a generation have bid up lower-rated debt. Top-rated state and city bonds have returned 5 percent.

The extra yield on LIPA revenue debt has dropped as much as 24 percent in the last month, Municipal Securities Rulemaking Board trade data show. A LIPA bond callable at par in April 2019 traded Nov. 9 at a 1.85 percent yield, or 1.1 percentage points more than top-rated securities. Two weeks earlier, the bonds traded with a penalty of 1.44 percentage points.

Investors looking to capture higher yields are more willing to buy riskier debt than bonds with longer maturities, said Kathleen Bramlage, a director in New York at Hightower Advisors’ Treasury Partners unit, which manages about $10 billion. The more years a bond takes to mature, the more vulnerable it is when interest rates rise.

“The risk is if interest rates move higher, you really don’t want to have a long-duration portfolio,” she said. In addition, many investors are betting federal income tax rates will climb, increasing the value of tax-exempt munis.

‘Weak’ Protection

Protection for LIPA bondholders is weaker than most other municipal electric utilities because the terms governing its rates only require that it cover costs, Moody’s Investors Service said in a May 17 report. LIPA’s debt-service coverage ratio, or the amount of cash available to meet interest and principal payments, is 1.1. That’s “weak” for the A3 rating on LIPA’s senior revenue bonds, Moody’s said.

Among U.S. municipal utilities, LIPA, which serves Nassau and Suffolk counties on Long Island and the Rockaways in the New York City borough of Queens, trails only the Los Angeles Department of Water & Power in the size of its customer base.

Sandy hit Oct. 29, knocking out power to 1 million LIPA customers as falling trees downed transmission lines and substations flooded. A week later, 200,000 LIPA customers still didn’t have power. Customers protested at a LIPA office in Hicksville, New York.

About 7,900 customers still didn’t have power as of 4:23 p.m. local time yesterday, according to the utility’s website.

Flawed Model

The utility outsources its power transmission and delivery operations. A unit of London-based National Grid Plc holds the contract. Public Service Enterprise Group Inc., based in Newark, New Jersey, will take over in 2014. That model creates conflict because 90 percent of LIPA’s 2,000-member staff is controlled by National Grid, not LIPA, according to a 2011 strategic review by the Brattle Group.

LIPA hasn’t estimated the cost of restoring power. Hurricane Irene, which last year left as many as 500,000 customers without power, cost $170 million. The utility still hasn’t received the full $100 million reimbursement from the Federal Emergency Management Agency for Irene-related damage, according to a Nov. 5 report by Moody’s.

Moody’s had the debt on negative outlook even before the storm.

LIPA won’t have to disburse cash for a few months until after contractors complete their audit and billing process, Moody’s said.

Rate Resistance

Fitch Ratings on Nov. 12 lowered the outlook on LIPA’s $5.9 billion senior electric-system revenue bonds to negative, saying the cost of restorations and repairs will frustrate efforts to improve financial performance.

LIPA expects the federal government to reimburse at least 75 percent of storm costs. Yet political pressure may limit its ability to raise rates to help pay storm expenses.

“Given the intense political pressure surrounding LIPA’s storm response and the authority’s historic objective to moderate already high electric rates, Fitch believes that LIPA’s willingness to increase rates may be limited,” the rating company said.

LIPA’s total average electric rate of 18.2 cents per kilowatt hour is among the nation’s highest, according to the Brattle Group.

Debt Service

One of the primary drivers is the cost of servicing $6.7 billion of debt LIPA issued in 1998 to finance the acquisition of the Long Island Lighting Co., an investor-owned utility. Lilco spent $6 billion to build the Shoreham nuclear power plant in Suffolk County from 1973 to 1984. The site never opened because of community opposition.

LIPA has about $500 million of cash and $100 million of untapped commercial-paper capacity, said Laura Schumacher, a Moody’s analyst in New York. Its cash will shrink by $100 million in December when it has to make a debt-service payment, according to Moody’s. LIPA is also close to establishing new credit lines for as much as $500 million, Moody’s said.

“They will evaluate all of these things and make a decision as to whether they need to raise rates or not,” Schumacher said. “It’s an issue for any public utility. Rate increases are not popular.”

Following are pending sales:

NEW YORK CITY TRANSITIONAL FINANCE AUTHORITY is set to borrow $895 million as soon as today to fund capital projects and refinance debt, according to bond documents. (Added Nov. 15)

TEXAS MUNICIPAL GAS ACQUISITION & SUPPLY CORP. plans to sell $1 billion of gas supply revenue bonds as soon as next week, data compiled by Bloomberg show. Proceeds will finance the prepayment of a 20-year supply of natural gas, according to bond documents. (Added Nov. 15)

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