Overview -- We are revising the outlook on U.S. natural gas prepay transaction entity Texas Municipal Gas Acquisition And Supply Corp II’s (TexGas II) series 2007A and 2007B bonds to negative from stable -- We are also affirming the ‘A’ rating on the bonds. -- The outlook revision follows a similar action on JPMorgan Chase & Co. (JPM;A/Negative/A-1) -- The rating on TexGas II’s gas supply revenue bonds are linked to the rating on JPM, which guarantees the obligations of TexGas II’s gas supplier.
On May 15, 2012, Standard & Poor’s Ratings Services revised its outlook on Texas Municipal Gas Acquisition and Supply Corp. II’s (TexGas II) series 2007A and 2007B bonds to negative from stable. At the same time, we affirmed the ‘A’ rating on the bonds.
The rating action follows the May 11 revision of our outlook on JPMorgan Chase & Co. (JPM; A/Negative/A-1) to negative from stable. (See “JPMorgan Chase & Co. and Banking Subsidiaries Outlook Revised On Unexpected Loss; Rating Affirmed,” published May 11, 2012 on RatingsDirect the Global Credit Portal.)
The rating and outlook on the TexGas II bonds are linked to those on JPM, which guarantees the obligations of TexGas II’s gas supplier and interest rate swap counterparty. We could revise the ratings or outlook on the prepaid transaction to the extent that we revise the rating on JPM, or if we lower the ratings on another counterparty and it becomes the primary rating constraint on the transaction.
The A+/Stable rating on TexGas II’s $516.2 million series 2007A and $1.418 billion series 2007B gas revenue bonds are tied to the various transaction participants, which include:
-- JPM, which guarantees the obligations of JP Morgan Venture Energy Corp. (JPMVEC; not rated), TexGas II’s gas supplier;
-- JPMorgan Chase Bank N.A. (JPMCB; A+/Negative/A-1), the interest rate swap counterparty;
-- BNP Paribas (AA-/Negative/A-1+), the fixed-price commodity swap counterparty; and
-- Transamerica Life Insurance Co. (TLIC; AA-/Stable/A-1+), the guaranteed investment contract provider for the debt service reserve fund, debt service fund, and price swap reserve fund.
The ratings on the bonds reflect our views of the following strengths:
-- JPMVEC’s highly rated parent, JPM, guarantees JPMVEC’s gas supply obligations.
-- Bondholders are not exposed to the operating risks associated with the gas deliveries because if JPMVEC fails to deliver gas for any reason, including force majeure, JPMVEC must either obtain alternative supplies or reimburse TexGas II for the cost of replacement gas.
-- The credit risk of Municipal Gas Acquisition and Supply Corp. (MuniGas; not rated), an affiliate of TexGas II, is mitigated by provisions that require the remarketing of gas volumes to other qualified municipalities in a participant payment default scenario. The intention behind these provisions is to provide adequate funds for payments to the swap counterparty and for debt service.
-- We believe that JPM’s option to fund reserve loans may avert an event of termination and that it also supports participant credit risk.
-- We calculate that a termination payment from JPMVEC, along with other required funds, would be sufficient to redeem bonds in the event of an early termination of the prepaid contract.
-- In addition to the standard swap terminations, the various agreements state that a downgrade of BNP Paribas to less than ‘A-', in certain circumstances, could cause a termination under the commodity swap agreement.
-- The contract terms also state that if the commodity swap is terminable by TexGas II, it must replace the swap counterparty with an entity that is rated at least ‘AA-'. In addition, the agreement requires the replacement swap counterparty to be rated at least the higher of ‘A-’ or the rating on the bonds.
Partly offsetting the above strengths, in our view, are the following weaknesses:
-- Bondholders are exposed to JPM’s payment and performance risk. Therefore, if we lower the gas supplier rating, we would most likely lower the rating on the bonds.
-- Payment on the bonds depends on the ability of several different counterparties to perform under the terms of the transaction documents.
TexGas II used the bond proceeds to fund the prepayment of about 400 billion cubic feet of natural gas to be supplied by JPMVEC to TexGas II over 20 years. TexGas II has entered into an agreement with its affiliate MuniGas to purchase and remarket all gas to qualified municipal buyers.
JPMVEC will deliver a scheduled amount of gas to TexGas II at the Henry Hub delivery point every month. Delivered gas will be simultaneously resold and delivered to MuniGas, which markets the gas to municipal buyers. Currently, about 100% of the gas supplied is sold under long-term supply contracts, and the rest is sold on a spot basis to qualified municipal buyers. Gas sold to MuniGas will be priced at the first-of-the-month market index price, less a discount.
The discount results from the lower cost of tax-exempt financing compared with taxable debt, and the discount will be periodically adjusted by TexGas II to ensure receipt of sufficient revenue from sales to MuniGas, together with investment income and swap receipts, to pay its expenses and debt service requirements. Revenue from the sale of gas will be used to make semiannual or quarterly interest payments and annual principal payments (based on an amortization schedule that reflects quantity of gas delivered) for the life of the bonds.
TexGas II matches revenue generated from gas sales to MuniGas with principal and interest obligations on the issued bonds by using a long-term commodity swap with BNP Paribas and a fixed-pay, receive floating interest rate swap with JPMCB. The interest rate swap synthetically fixes TexGas II’s net interest expense related to the variable-rate bonds. The commodity swap and interest rate swap ensure that as long as gas is supplied as scheduled, and the municipal buyers and investment contract providers make payments on schedule, TexGas II should generate sufficient cash to pay its operating expenses and scheduled debt service as well as offer a discount to the municipal buyers on purchased gas.
Termination of either the commodity swap or the rate swap without a replacement will cause the transaction to unwind, and will obligate JPMCB to make a termination payment that is calculated to be sufficient, together with funds in the debt service reserve account and debt service reserve fund, to redeem the senior-lien bonds.
The debt service reserve fund and price swap reserve fund were initially funded with $45 million and $12 million, respectively. The debt service reserve account compensates for any periodic shortfall in revenue, and equals the maximum two months of fixed payments under the BNP Paribas commodity swap. TexGas II can draw on the account to make up for a shortfall in interest or principal or interest rate swap payments on any payment date. The swap reserve fund serves a similar purpose for commodity swap payments. Reserve loans that are subordinate to the bonds can replenish the reserves, and if a default occurs the receivables purchase agreement would cover any amount required to restore the reserve balances as a result of a MuniGas payment default.
The negative outlook on TexGas II’s senior secured gas supply revenue bonds reflects that on JPM as the guarantor of JPMVEC’s obligations under the gas purchase agreement. We could revise the ratings and outlook to the extent that we revise the rating on JPM, or if we lower the ratings on another counterparty and that rating becomes the primary ratings constraint on the transaction.
The negative outlook on JPM reflects our view of the miscalculations associated with JPM’s hedging strategy, specifically those applicable to the Chief Investment Office portfolio. Among the risks, in our view, are other possible risk management weaknesses.