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Wisconsin Steam Note Default Looms

CHICAGO - The clock is ticking for the Fox River Valley city of Menasha, Wis., and its advisers as they negotiate with investors who hold $24 million of city appropriation-backed steam plant revenue bond anticipation notes in an attempt to avert defaulting on the debt that comes due Sept. 1.

"Our intent is to pay the notes, but how quickly we can do that is something we are still looking at," Thomas Stoffel, the city's comptroller and treasurer, said in an interview yesterday. "We are exploring all our options and trying to come up with a solution that will satisfy our bondholders."

Stern Brothers and the law firm Hunton & Williams LLP are advising the city on its negotiations. RBC Capital Markets was underwriter on the Bans.

The $24 million of debt that matures Sept. 1 includes $12.6 million of Bans sold in 2005 to covert Menasha Utilities' power plant to coal-fired steam operations and $11.5 million issued in 2006 to cover the project's growing costs. Both are secured by steam plant revenues but are backed up with a city appropriation pledge. Another $13.9 million of notes sold in 2007 come due Sept. 1, 2010. Those carry the city's general obligation pledge.

The city's original intention in issuing all of the notes was to eventually refund them into longer-term debt, but that option is no longer on the table given the plant's operational losses and dim prospects and the city's limited GO capacity.

The coal-fired steam plant - burdened with growing construction costs, unfavorable regulatory rulings, and pricing disputes - has failed to generate sufficient funds to cover both operations and debt.

A city-commissioned report authored by Stern Brothers this past spring recommended the plant's closure given its current financial prospects under its existing steam contracts. The report concluded that ongoing operating losses would pose a "large and ongoing financial burden on the city and its taxpayers."

The Menasha Utilities Commission voted in late May to shutter the plant by early July. That move prompted Moody's Investors Service in June to strip the city of its investment-grade GO rating. Moody's lowered the credit to Ba2 from Baa2 and placed it on review for further downgrade.

"The future direction of the city and utility's ratings is directly dependant on the manner, timing, and recovery value for note holders," analysts wrote. Moody's rates $5.8 million of water and electric revenue debt Baa2.

The Menasha Common Council has not voted on the plant's closure to allow for negotiations with bondholders to continue. Stoffel said the plant's closure would trigger a default event in the bond covenants, and could prompt a demand from bondholders for repayment.

The city's stake in reaching an agreement with bondholders is summed up in the report that warned the likely default would result in "extensive work-out and negotiations with bondholders, and may result in further rating actions, have a negative impact on the city's ability to access the credit markets, and expose the city and Menasha Utilities to potential litigation from bondholders."

In one favorable development, the city did receive approval from the state Bureau of Public Lands for a low-cost trust fund loan of $7 million that could be applied to repayment of the September Bans, Stoffel said.

With its eye on preserving its economic base, the city decided in 2004 to convert a portion of its electric generation plant to produce industrial steam to support the area's paper mills that were interested in purchasing steam from a central plant that used coal as its primary fuel in an effort to save money.

The costs skyrocketed from an initial $12.6 million to $40 million as equipment and other costs grew. Stoffel said the second note issue was needed as officials shifted to a plan to burn Powder River Basin coal over Appalachian coal as the costs of that type of coal grew.

The utility struggled with mechanical difficulties that drove a $1.33 million operating deficit in 2006. Other technical problems through 2007 hurt its ability to raise expected levels of revenue from its participation in electric sales through the Midwest Independent Transmission System Operator and prompted the draw on reserves to cover interest payments.

Financial operations improved in 2008 as the utility resolved some technical issues and benefitted from a new coal supply contract putting the utility on track to generate revenues sufficient to cover all debt service in 2016.

But those gains were offset by new developments. Earlier this year, the utility announced it was battling with two of its steam customers - Whiting and Sonoco - over pricing. Sonoco is the plant's largest customer. Whiting was awarded $100,000 by an arbitrator and the utility was ordered to comply with its contract. The Sonoco dispute is still pending.

Separately, the utility received a notice of violation from the Wisconsin Department of Natural Resources over its alleged failure to use the best available clean technology during its conversion process and the utility now faces litigation over the matter filed by the Sierra Club. Compliance costs are estimated at more than $1 million.

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