Staff Report Item 14
Staff Report Item 14
TO: East Bay Community Energy Board of Directors
FROM: Howard Chang, Chief Operating Officer
SUBJECT: Prepay Overview and Approval of Counsel, Financial Advisor, and Rating Agency (Action Item)
DATE: April 20, 2022
________________________________________________________________________ Recommendation
Adopt a Resolution authorizing the CEO to negotiate and execute Agreements with the following firms for legal representation, financial advisory services, and rating agency services on EBCE’s second energy prepayment transaction. The expected total costs are $975,000 and we are requesting authorization for up to $1,125,000 for the four Agreements, which includes an additional $150,000 for contingency that could be used to increase the cost(s) for one or more of the Agreements above the amounts listed below.
A. Orrick, Herrington & Sutcliffe – Bond Counsel and Tax Counsel for a total amount of $300,000
B. Chapman & Cutler LLP – Disclosure Counsel, Issuer’s Counsel, and to prepare the Official Statement for a total amount of $200,000
C. PFM Financial Advisors LLC & PFM Swap Advisors LLC – Financial Advisor for a total amount of $200,000
D. Moody’s Investor Service Inc – Credit rating of the prepay bond transaction for a total amount of $275,000
Background and Discussion
EBCE is preparing to execute a second energy prepay transaction in light of favorable market conditions. EBCE has a sizeable energy procurement portfolio needed to serve our load and expects to execute multiple prepay transactions over the next several years to realize procurement savings by utilizing its tax-exempt status. Staff is seeking to get enabled with the set of legal counsel, advisors, and other counterparties to replicate the initial transaction as efficiently as possible. EBCE plans to have documentation prepared in the May timeframe and seek board approval to move forward and go to market soon after. Depending on market conditions, EBCE could close on a transaction in the June to July timeframe.
Previous Energy Prepay Transaction:
Staff Report Item 14
EBCE and Silicon Valley Clean Energy (SVCE) jointly executed the first energy prepay transaction by a CCA on September 23, 2021, with a notional size of $1.48BN. EBCE has 59MW around the clock that is assigned into the Prepay transaction and currently generates approximately $2MM in annual savings to EBCE.
For this transaction, EBCE and SVCE jointly performed due diligence and negotiated the initial transaction over a 1.5yr period and issued a number of solicitations to select a number of counterparties and advisors. Included was a solicitation in November 2019 to identify potential Prepay Suppliers, through which Morgan Stanley (MS) was shortlisted and selected.
MS is one of a small number of large financial institutions that is experienced in executing on the bond underwriting and prepay structuring aspects of this transaction.
The CCAs jointly issued a solicitation in June 2020, for the counsel roles, through which Orrick, Herrington & Sutcliffe and Chapman & Cutler LLP were selected. Both firms have significant experience representing parties on prepay transactions since the market inception in the 1990s, and both firms are industry leaders in serving the roles for which they’ve been selected.
The CCAs also jointly issued a solicitation in September 2020, to identify municipal financial advisors. Given the niche market for prepayments, there are very few firms who provide this type of advisory service and experience. While the advisor solicitation received only three responses, the respondents’ combined experience covers more than 80% of the deals executed to date across the country, and ten of the eleven deals executed to date in California. EBCE and SVCE reviewed and scored the respondents, ultimately selecting PFM Financial Advisors, LLC & PFM Swap Advisors LLC (PFM).
Moody’s Investor Service Inc. was selected due to their unique experience in rating prepayment type transactions and alternative rating agencies are not suitable to complete such work.
Prepay Parties:
The prepay transaction requires the selection and involvement of multiple parties. Names and functions are as follows:
Prepay Buyer: East Bay Community Energy
• Role: Provide energy contracts to flow through prepay Prepay Seller: Morgan Stanley
• Role: Structure transaction and pay contract price to PPA provider • Note: No legal obligation or liabilities are being entered into currently; approval of counsel allows EBCE to negotiate documents with Morgan Stanley for which staff will later return to the Board for approval of the official prepay transaction and associated bond issuance.
Municipal Advisor: PFM
• Role: Advise Prepay Buyer in negotiations; required by Municipal Securities Rulemaking Board (MSRB)
Bond Counsel: Orrick, Herrington & Sutcliffe
• Role: Represent bondholders
Tax Counsel: Orrick, Herrington & Sutcliffe
• Role: Provide tax opinion on transaction
Issuer’s Counsel (also known as Prepay Counsel or Prepaid Counsel): Chapman & Cutler LLP Staff Report Item 14
• Role: Represent issuer’s interests, supporting drafting and negotiating terms of prepay agreement and associated energy supply agreements
Disclosure Counsel: Chapman & Cutler LLP
• Role: Prepare Official Statement / Prospectus
Bond Issuer: CCCFA
• Role: Issue municipal bonds for prepay
Timeline:
With this approval, staff will begin prepay structuring and document negotiations with Morgan Stanley. Draft documents should be prepared for a deal execution in the May timeframe.
Prepay Structure Overview:
An energy prepayment – or ‘prepay’ – is a long-term financial transaction available to municipal utilities and tax-exempt entities such as CCAs that enables a meaningful power procurement cost savings opportunity. Utilizing the municipal bond market, a tax-exempt Load Serving Entity (LSE, also called “Prepay Buyer”) and a taxable financial counterparty (bank, called “Prepay Supplier") enter into a 30-year agreement through which the LSE assigns existing power supply contracts to the Prepay Supplier. The Prepay Supplier pays the contract price to the PPA provider, while the LSE pays the Prepay Supplier at a discounted rate. The discounted rate is agreed upon in the prepay documents for the initial term of the bond and is based in part on the spread between the taxable and tax-exempt bond interest rates. The market availability of this interest rate spread is critical to the savings opportunity available to an LSE through a prepay. At future bond repricing periods, this discount rate will be reset.
Tax-exempt bonds are issued by a third-party conduit to raise funds for the prepay transaction, which flow to the Prepay Supplier. The LSE does a limited assignment of the PPA to the Prepay Supplier. The LSE is required to continue to perform under the contract, while maintaining rights to the electricity and attributes under the PPA. The Prepay Supplier utilizes the bond funds and provides a discount on the PPA to the LSE based on the spread between the taxable and tax-exempt rates. The discount is estimated at 8-12% but is subject to change based on market conditions.
The total combined present notional value of the assigned contracts flowing through the prepay over the 30 years is anticipated to be in the range of $500MM-1BN; these contracts can be long-term renewables PPAs or short-term commodity supply contracts. While the contracts are assigned to the Prepay Supplier, the LSE continues to ultimately take and pay for all the energy and attributes delivered through the contract; all other terms of the PPA remain unchanged. If the prepay program terminates early for any reason – either the Prepay Supplier or the LSE fail to perform – the LSE forgoes future savings and the assigned PPA is put back completely to the LSE.
Two key features of the municipal bonds utilized in a prepay greatly reduce risk to the LSE.
First, the bonds are non-recourse to the LSE, meaning they are neither secured nor guaranteed by the LSE and EBCE will at no point be responsible for repaying the bonds.
Secondly, prepays are off balance sheet for the LSE as the bonds are issued by a third-party conduit.
Ultimately, prepays are employed to save ratepayers money while maintaining both (a) the economics for the PPA provider and (b) the terms of the energy supply contract. They have Staff Report Item 14
been used for natural gas transactions in the US since the early 1990s, with over 90 transactions completed nationwide ($50+ Billion) and 11 transactions completed in California ($5.7 Billion). The same tax law1 and similar transaction structure that enables the natural gas prepays enables the program for electricity, and specifically renewables contracts, creating an opportunity for CCAs to provide renewable energy at a lower cost than the IOU competition.
Financial Impacts
The financial impacts of this item pertain only to the counsel, financial advisor, and Moody’s fees outlined below. These fees may be structured as contingent fees paid out of the proceeds of the prepay transaction upon the successful execution of the program.
Alternatively, EBCE may pursue non-contingent fees based on an hourly fee structure, which is subject to further negotiation. In all cases, the total counsel, financial advisor, and rating agency fees total an amount not to exceed $1,125,000, which reflects the estimated total of $975,000 and $150,000 of contingency.
• Bond and Tax Counsel: $300,000
o Contingent on a successful prepay execution
• Issuer’s Counsel and Disclosure Counsel: $200,000
o Contingent on a successful prepay execution. If the deal does not materialize fees will be assessed on an hourly rate of $750/hr up to a max out of pocket of $30,000
• Financial Advisor: $200,000
o Contingent on a successful prepay execution
• Transaction Credit Rating Services: $275,000
o Contingent on a successful prepay execution
It is important to also note the financial benefit available through the prepay. It is estimated to achieve an 8-12% discount per year on power quantities delivered under the prepay, compared to the assigned contracts. However, the exact discount will be dependent on the spread between taxable and tax-exempt debt rates. While savings are not guaranteed in the structure, there is no negative financial impact associated if the deal does not produce targeted savings levels.
Attachments
A. Resolution authorizing the CEO to negotiate and execute agreements for legal representation, financial advisory, and Moody’s credit rating services on EBCE’s energy prepayment transaction; and
B. Prepay Presentation
1 Codified in US Tax Law. Since first prepayments of natural gas were done in the early 1990s, the IRS issued rules allowing tax-exempt prepayments and Congress enacted legislation specifically allowing the transactions (National Energy Policy Act of 2005; Section 1327).
Attachment Staff Report Item 14A
RESOLUTION NO. R-2022-xx
A RESOLUTION OF THE BOARD OF DIRECTORS OF THE EAST BAY COMMUNITY
ENERGY AUTHORITY TO AUTHORIZE THE NEGOTIATION AND EXECUTION OF
AGREEMENTS WITH ORRICK, HERRINGTON & SUTCLIFFE, CHAPMAN & CUTLER LLP, PFM FINANCIAL ADVISORS LLC & PFM SWAP ADVISORS LLC, AND MOODY’S INVESTOR SERVICE INC. TO SERVE AS COUNSEL, FINANCIAL ADVISOR, AND CREDIT
RATING AGENCY ON THE ENERGY PREPAYMENT TRANSACTION
WHEREAS The East Bay Community Energy Authority (“EBCE”) was formed as a community choice aggregation agency (“CCA”) on December 1, 2016, Under the Joint Exercise of Power Act, California Government Code sections 6500 et seq., among the County of Alameda, and the Cities of Albany, Berkeley, Dublin, Emeryville, Fremont, Hayward, Livermore, Piedmont, Oakland, San Leandro, and Union City to study, promote, develop, conduct, operate, and manage energy-related climate change programs in all of the member jurisdictions. The cities of Newark and Pleasanton, located in Alameda County, along with the City of Tracy, located in San Joaquin County, were added as members of EBCE and parties to the JPA in March of 2020.
WHEREAS The pursuit of a second energy prepayment enables a meaningful power procurement cost savings opportunity in which EBCE utilizes its tax-exempt status to access the municipal bond market to prepay existing energy supply contracts at a discounted rate,
WHEREAS Orrick, Herrington & Sutcliffe and Chapman & Cutler LLP were respectively selected for the respective counsel roles through a solicitation issued in June 2020,
WHEREAS PFM Financial Advisors LLC & PFM Swap Advisors LLC were selected for the financial advisor roles through a solicitation issued in September 2020, WHEREAS Moody’s Investor Service Inc. was selected for the Bond credit rating service due to its unique experience evaluating similar prepayment transactions, and WHEREAS The combined fees for counsel services provided by the firms identified above shall not exceed $1,125,000.
NOW, THEREFORE, THE BOARD OF DIRECTORS OF THE EAST BAY COMMUNITY ENERGY AUTHORITY DOES HEREBY RESOLVE AS FOLLOWS:
Section 1. Authorize the CEO to negotiate and execute Agreements with the following firms for legal representation on EBCE’s energy prepayment transaction:
Orrick, Herrington & Sutcliffe – roles of Bond Counsel and Tax Counsel, and Chapman & Cutler LLP – roles of Disclosure Counsel, Issuer’s Counsel, and to prepare the Official Statement; PFM Financial Advisors LLC & PFM Swap Advisors LLC – role of Financial Advisor; Moody’s Investor Service Inc. - role of bond transaction credit rating agency. The total combined costs to EBCE for the four Attachment Staff Report Item 14A
Agreements will not exceed $1,125,000 and the Agreements shall be approved as to form by the General Counsel.
ADOPTED AND APPROVED this 20th day of April, 2022.
Dianne Martinez, Chair
ATTEST:
Adrian Bankhead, Clerk of the Board
Prepay Energy
Update
APRIL 2022
Attachment Staff Report Item 14B
Existing Prepay Overview
Recap:
● Closed: Sept. 23, 2021
● Total Bond Proceeds: $1.48 Billion
● Rating: A1, “Green Bond” Certified
● Volume to EBCE: 59 MW Around-the-Clock Carbon-Free Energy ● Power Supply Start: January 1, 2022
● Savings, Years 1-10: $2 Million / year
In progress / Ongoing:
● Settlements and invoicing were initiated on January 1, 2022 ● Assessing future PPAs to be put through prepay structure 2 Attachment Staff Report Item 14B
Current Market Conditions
● Conditions are suitable for prepays
when the taxable and tax-exempt
spreads are wide
● Spreads have been volatile in
recent years and conditions have
been suitable for the last 9-12
months
● With an expectation for increasing
interest rates, this may improve
spreads in the near term
● 8 prepay deals have priced since
EBCE's transaction in September -
primarily gas deals
3 Attachment Staff Report Item 14B
Proposed Prepay Transaction
● Standalone EBCE Prepay transaction issuing through CA Community Choice Financing Authority (CCCFA), the JPA in which EBCE is a member
● Anticipate utilizing the prior RFPs issued/awarded in 2020 and 2021 to renew various counsel and advisory roles to gain efficiencies
● Prior transactions required >1.5yrs to complete and targeting 3 to 6 months for the second transaction
● Anticipate $500M to $1bn total size
Next Steps:
● April: Seek board approval to be enabled with legal counsel and advisors ● May/June: Seek EBCE board and CCCFA board approval to transact ● June onwards: Go out to market and determine optimal timing to price 4 Attachment Staff Report Item 14B
Approval Details
Adopt a Resolution authorizing the CEO to negotiate and execute Agreements with the following firms for legal representation, financial advisory services, and rating agency services on EBCE’s second energy prepayment transaction. The expected total costs are $975,000 and we are requesting authorization for up to $1,125,000 for the four Agreements, which includes an additional $150,000 for contingency that could be used to increase the cost(s) for one or more of the Agreements above the amounts listed below.
• Orrick, Herrington & Sutcliffe – Bond Counsel and Tax Counsel for a total amount of $300,000 • Chapman & Cutler LLP – Disclosure Counsel, Issuer’s Counsel, and to prepare the Official Statement for a total amount of $200,000
• PFM Financial Advisors LLC & PFM Swap Advisors LLC – Financial Advisor for a total amount of $200,000
• Moody’s Investor Service Inc – Credit rating of the prepay bond transaction for a total amount of $275,000
5 Attachment Staff Report Item 14B
• An energy prepayment is a long-term non-recourse financial transaction between a tax-exempt Load Serving Entity (LSE) and a taxable financial counterparty (bank, called “Prepay Supplier") utilizing the municipal bond market.
o Typically 30-year term, LSE committing ~$350MM-$850MM of energy supply contracts (combined contract notional values)
o LSE utilizes in order to lower customer energy costs
• Prepay Supplier is assigned an existing energy supply contract, pays the contract price to PPA Seller and immediately transfers all electricity and attributes to LSE. LSE pays the Prepay Supplier. • Municipal utilities (and tax-exempt entities such as CCAs) in the US can prepay for a supply of electricity or natural gas from a taxable entity and fund that prepayment with tax-exempt municipal bonds. The LSE must sell the commodity to their retail end-users residing within their traditional service area. o This structure is well known and regularly used for gas and is now being applied towards renewables PPAs o Codified in US Tax Law. Since first prepayments of natural gas were done in the early 1990’s, the IRS issued rules allowing tax-exempt prepayments and Congress enacted legislation specifically allowing the transactions (National Energy Policy Act of 2005; Section 1327) 6 Appendix - Prepay Overview
Attachment Staff Report Item 14B
Power Contract Assignment:
• Existing renewable PPAs are assigned to the taxable Prepay Supplier. The LSE continues to take and pay for energy and attributes delivered through the contract.
• All other terms of the PPA are unchanged
• If the prepay program terminates early, prepaid supplier fails to perform, or LSE fails to perform, the LSE forgoes the future savings and the assigned PPA contract is put back to the original LSE • Active Suppliers: Goldman Sachs, Morgan Stanley, Royal Bank of Canada, Citi, Bank of America are all investment grade rated financial institutions
Debt:
• Non-Recourse: Prepays utilize non-recourse municipal bonds and are not secured or guaranteed by the referenced entity (i.e. the CCA). Rather the debt is recourse to the Prepay Supplier (i.e. the bank receiving the prepayment). This significantly protects the CCA and mitigates risk related to the payment of power contracts novated through the prepay.
• Off Balance sheet for LSE: Bonds are issued by a municipal bond conduit and arranged by the Prepay Supplier 7 Appendix - Key Elements of a Prepay Transaction
Attachment Staff Report Item 14B
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Attachment Staff Report Item 14B