CHICAGO - The Fox River Valley city of Menasha, Wis., and its advisers are continuing "good-faith" negotiations with investors who hold $24 million of city appropriation-backed steam plant revenue bond anticipation notes following the city's default on the notes that were due Tuesday.
The $24 million of debt comprises $12.6 million of Bans sold in 2005 to convert 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 revenue but are backed up with a city appropriation pledge.
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. Given the plant's losses and dim prospects, the city could not refinance the Bans into long-term debt as originally intended.
Without the financial resources to honor the debt payment, the city had hoped to reach a forbearance agreement with a committee representing 77% of the bondholders ahead of the Tuesday payment date that would have averted a default. Negotiations on terms continue.
"The city continues in its efforts to resolve this matter, including seeking refinancing-workout options and seeking purchase offers for the steam facility or other Menasha utilities to generate funds to pay noteholders," said Mayor Donald Merkes. It remains unclear how much bondholders will recoup.
The city drained a bond reserve fund of $1.9 million to make a $600,000 interest payment and a partial $1.38 million principal payment, according to Merkes. Market participants said the default on an appropriation pledge may have marked a first for a municipality in Wisconsin.
Unless a resolution is reached, the city faces a costly and difficult time accessing the tax-exempt market on its own. It could still seek low-cost loans from the state's trust fund loan program. Officials had hoped for help from various state agencies, but it appears that special state legislation might be needed to aid in any workout plan.
Stern Brothers and the law firm Hunton & Williams LLP are advising Menasha on its negotiations. RBC Capital Markets was underwriter on the notes. A report from its advisers this past spring warned the city that absent an agreement with bondholders, the city faced negative credit action and potential litigation from bondholders.
The steam plant's fiscal struggles have taken a steep toll on the city's credit ratings. Moody's Investors Service last month downgraded its $29 million of general obligation debt to B1 with a negative outlook, four notches below an investment-grade credit.
The downward slide began this spring when Moody's lowered the city's GO rating to Baa2 from A3 and then dropped the rating to junk-bond status at Ba2 following the Menasha Utilities Commission's vote to close the plant.
Moody's also downgraded $5.8 million of water and electric revenue debt one notch to Baa3 with a negative outlook. Moody's speculative short-term rating of SG remains on the $24 million of defaulted debt and on $14 million of taxable GO promissory notes. Those latter notes comes due on Sept. 1, 2010.
"The negative outlook reflects Moody's expectation that the city will continue to be challenged by the steam utility's cost over-runs and failure, as well as by the large amount of debt associated with the project," analysts wrote. "Results of arbitration and the feasibility of a coherent work-out plan are extremely uncertain. Additionally, large scale intervention by the state of Wisconsin seems unlikely at this point. The future direction of the ratings of the city and utility is directly dependant on the manner, timing, and recovery value for note holders."
Although the Utilities Commission voted to close the plant last spring, it has remained open as its shuttering would have immediately triggered a default event in bond covenants. Menasha does have approval for a $7 million state Bureau of Public Lands loan and the city is expected to seek approval for additional loans that could help in a workout plan or help cover the Bans coming due next year that carry the city's GO pledge. The cost to shut down the plant is estimated at $5 million.
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.
The utility struggled with mechanical difficulties and other technical problems through 2007. Financial operations improved in 2008 but those gains were offset by battles with two of its steam customers and regulatory challenges.
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 now faces litigation over the matter filed by the Sierra Club. Compliance costs are estimated at more than $1 million.
