TVA Without U.S. Leaves Little More Than Junk: Corporate FinanceCharles Mead
President Barack Obama’s suggestion that the U.S. sell the Tennessee Valley Authority reveals a utility with a higher debt burden than any domestic peer except Calpine Corp. and the former TXU Corp.
While the largest government-owned power producer issues bonds with an Aaa credit rating from Moody’s Investors Service, debt accounts for 57 percent of Knoxville, Tennessee-based TVA’s assets. That’s more than any utility with at least $1 billion of bonds except Calpine, which left bankruptcy protection in 2008, and Energy Future Holdings Corp., known as TXU before its $48 billion buyout in 2007, which Moody’s says faces a “material restructuring” within 12 months.
Obama is considering cleaving the New Deal-era legacy of President Franklin Roosevelt from government financial backing, with TVA, which has $23 billion of bonds outstanding, poised to exceed a $30 billion debt cap to pay for infrastructure improvements and meet new environmental rules. While a potential deal is likely to include the government injecting capital into TVA, the utility probably wouldn’t retain its top credit rating, according to Pierpont Securities LLC.
“There’s a lot of debt there,” Mark Pibl, the head of credit strategy at Pierpont in New York, said in a telephone interview. “As a standalone with the same credit profile, it’d be very levered,” which would require it to raise equity and cut debt to operate as a public company.
TVA’s $1 billion of 3.5 percent bonds due December 2042 dropped to 95.7 cents on the dollar yesterday after trading at 102.6 cents on April 9, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. A yield of 3.74 percent, or 74.3 basis points more than Treasuries, compared with a 4 percent average for similar-maturity debt issued by U.S. utilities, none of which have a Moody’s rating higher than Aa3.
The securities traded at 97.1 cents to yield 3.66 percent at 10:47 a.m. in New York.
The company, in common with other utilities across the nation, is contending with rising costs to upgrade power lines, replace old generators and meet new air-quality standards. The agency plans to invest more than $25 billion in the next 10 years for environmental and infrastructure improvements, leading the Obama administration to consider reducing or eliminating the federal government’s ownership as a way to help shrink the budget deficit.
“TVA still has a lot of investment in front of them,” said Noel Hebert, the chief investment officer at Concannon Wealth Management, which oversees about $250 million of assets in Bethlehem, Pennsylvania. “Being spun out would likely mean a loss of access not only to lower borrowing costs, but also” political support, he said.
The government will work with TVA over the next few months to develop a plan for the review, which will address the company’s financing issues, according to an administration official who asked not to be identified, citing lack of authorization to speak publicly.
“TVA can’t issue stock, so our primary vehicle for raising capital for investments in the power system are bonds,” Duncan Mansfield, a spokesman for TVA, said in telephone interview. “We are fairly competitive if you take that into account, compared with investor-owned utilities.”
The company will work with the Office of Management and Budget to provide information for the administration’s strategic review, TVA said in an April 10 statement. The 80-year-old organization, created during the Great Depression to bring electricity to rural communities, said the suggestion of a potential sale was unexpected.
“It’s a concept that’s in play,” Robert Smith, the chief investment officer at Austin, Texas-based Sage Advisory Services Ltd., which holds TVA debt, said in a telephone interview. “It’ll put an uncertainty into this name, and until the book is either closed or they get on with it, you’re going to see a bit more volatility in these spreads.”
TVA has a higher ratio of debt to its $3.4 billion of earnings before interest, taxes, depreciation and amortization than 95 percent of U.S. peers, according to data compiled by Bloomberg. Its total debt to capital ratio of 84 percent leaves TVA without an investment-grade credit profile on a standalone basis, according to FTN Financial.
“It’s been essentially free-cash-flow neutral for years with debt levels rising incrementally; the problem is now they’re expecting to be free-cash-flow negative going forward as they have to invest to upgrade their plants,” said Austen Gray, an analyst at FTN Financial in New York. “They’re going to have to raise that capital from somewhere.”
To retain a credit rating above Ba1 from Moody’s and BB+ from Standard & Poor’s in the event of a sale, TVA may require $8 billion of additional capital, Gray wrote in a report yesterday that said it’s unlikely TVA will be privatized.
S&P now ranks TVA AA+, equivalent to its grade for U.S. government debt.
The administration will have to contend with political opponents such as Senator Lamar Alexander, a Tennessee Republican, who said a government divestiture of TVA was “one more bad idea in a budget full of bad ideas.” Higher-cost debt may also lead to increased prices for TVA’s 9 million customers across seven states that pay below the national average.
A “multiple notch downgrade is likely” if a for-profit company were to own TVA, Toby Shea, an analyst at Moody’s in New York, wrote yesterday in a report. Along with government backing, TVA’s Aaa rating reflects its requirement to set rates to cover operating expenses and debt-service obligations.
The company, which gets no taxpayer money and makes no profits, also provides flood control, navigation and land management for the Tennessee River system, according to TVA’s website.
“It’s unclear what, if any, support the government might give to bondholders should a deal materialize,” said Joel Levington, managing director of corporate credit research at Brookfield Investment Management Inc. “But just based on the current figures and zero government support, the credit would be much weaker compared with its current Aaa credit rating.”