CHICAGO — The Indianapolis-Marion County City County Council Monday night approved a high-profile plan to sell the city’s water and sewer systems to a local nonprofit utility.
Indianapolis would become the largest city to sell its water and sewer systems if the proposal is realized.
The council’s yes vote on the proposed transaction — which still needs approval from Indiana — comes as the city prepares to enter the market with $170 million of debt backed by annual payments in lieu of taxes.
The council’s approval marks a significant political victory for Mayor Greg Ballard, whose first term will be defined in part by the success of the plan.
The state regulatory commission could take months to review the deal, which is also contingent on state approval of rate increases.
Citizens Energy Group, a nonprofit trust that currently runs the city’s gas utility, would pay at least $425 million and assume nearly $1.5 billion of outstanding debt to acquire the assets.
“Keeping in mind that this was a transaction done in the political arena and done very publicly — the city wanted to set up a minimum number so we talked about $425 million,” said Aaron Johnson, associate counsel for Citizens. “I think it’s going to add up to somewhere around $500 million.”
Part of the purchase agreement includes a steep increase over 30 years in the size of sewer district payments in lieu of taxes, or PILOTs, made to the city. Next week’s borrowing will securitize 75% of the PILOTs.
Ballard plans to use the cash from the sale and next week’s borrowing to finance infrastructure improvements across the city and to purchase abandoned houses.
The sale of the utility systems would allow Indianapolis to avoid paying for an estimated $5 billion in sewer system upgrades required under a 2005 consent decree with the U.S. Environmental Protection Agency.
Citi is the senior underwriter on the borrowing and also served as the city’s financial adviser on the water and sewer system sale. Morgan Stanley served as the financial adviser for Citizens Energy.
Citizens plans to issue its own debt, either Build America Bonds or tax-exempt debt, to finance the acquisition. That sale would likely take place early next year.
The city’s borrowing arm, the Indianapolis Local Public Improvement Bond Bank, expects to take retail orders on the $170 million of PILOT-backed revenue bonds next Wednesday, and will open it up for institutional buyers Thursday.
The bond bank opted to enter the market next week instead of waiting for the deal to close because it needs to ramp up its infrastructure work. The debt payments also are not reliant on the completion of the sale, according to bond bank executive director Deron Kintner.
“It doesn’t matter who owns the utility, whether it’s the sanitary district of Indianapolis or Citizens — the owner of the assets of the wastewater utility will be making PILOT payments,” Kintner said.
The debt will likely be a mix of serial and term bonds with a final maturity of 2039. The bonds will carry the moral obligation pledge of the triple-A rated city. Credit rating agencies have not yet released ratings on the bonds.
In what Kintner said is “basically a left pocket is paying the right pocket” deal, the sanitary district currently pays $9 million in PILOTs to the city annually. Over the last year Indianapolis officials locked in a new payment schedule that pushes annual payments to an average of $25 million or more through 2039, the life of the bonds.
The city will continue to set aside the $9 million in payments for police and fire operating budgets. Debt service is expected to total roughly $12 million annually, Kintner said. Money left over from the PILOTs will informally be set aside to build a debt service cushion.
Altogether the borrowing will securitize roughly 75% of the PILOTs through 2039.
“At the end of the day we’re going to have more than $100 million of excess PILOT payments, and it could be over $120 million,” Kintner said.
The bonds will carry insurance and a surety bond from Assured Guaranty. The surety bond will allow the city to avoid setting up a reserve fund.
“Otherwise we’d be borrowing $12 million to deposit annually over the next 30 years, and not getting that much on the investment side, so we’re going to save a significant amount of money,” Kintner said. The city will pay about $750,000 for the insurance and $360,000 for the surety bond.
The finance team projects an interest rate of 4.6% based on the current market.
Along with Citi as the lead, co-managers include Andes Capital Group, Cabrera Capital Markets LLC, RBC Capital Markets, Seibert Brandford Shank & Co., and Wells Fargo Securities. The bond bank’s financial adviser is Crowe Horwath. Sycamore Advisors LLC is the sanitary district’s financial adviser. Bond counsel is Baker & Daniels LLP.
Meanwhile, Citizens Energy Group expects to issue its own debt — at least $260 million but likely more depending on capital needs — to finance the purchase if approved, Johnson said.
The nonprofit expects to enter the market early in 2011 and hopes to issue Build America Bonds if the program is extended beyond the end of the year.
The company would issue the bonds through a yet-to-be formed authority dubbed CWA Authority Inc. that will operate the city’s sewer system and issue all debt associated with the massive EPA mandates.
At the heart of purchase agreement is Citizens’ expectation that it would generate more than $40 million in annual savings by consolidating the water, sewer, and gas utilities.
The savings would help offset rate increases that will be needed to finance the $5 billion environmental upgrade to the sewer system.
The city had estimated it would need to raise rates 400% to finance the upgrades, while Citizens expects to raise rates 300%.
“Rates are still going up a significant amount like communities across the country,” Johnson said. “But under our ownership the rates are going to increase 25% less than they otherwise would have.”
Citizens’ ability to set future rate increases — and approval of pending rate increases made by the city — is another key to the deal, he added.
The Indiana Regulatory Commission is currently considering a 34% water rate increase and would also need to approve a sewer rate increase of 10.75% yearly through 2013 for Citizens to follow through with the purchase.
If the increases are approved, Citizens has agreed to not seek water rate hikes for at least two years unless “there’s an emergency or the debt covenants appeared to be in potential impairment,” according to Johnson.
“The practical reality is that if an order comes out of the commission that isn’t something we can live with, the deal wouldn’t be closed,” he said.
Citizens’ status as a nonprofit allows it to issue tax-exempt debt and means it won’t have to refund into taxable debt the $1.5 billion of outstanding tax-exempt water and sewer bonds it will take over as part of the deal.
Most of the debt, $1.34 billion, is held by the Indiana State Revolving Fund. Citizens plans to substitute its own bond agreement with the SRF for the city’s existing agreement. It would also make all debt service payments on $54 million of outstanding general obligation debt, set up an escrow account to defease $39 million of non-state revolving fund debt, and take over responsibility for liquidity costs associated with $40 million of downgraded water debt.
“The transfer of the Indianapolis water and sewer assets to Citizens addresses the city’s key objectives of creating economic value through operating and capital synergies and economies of scale as well as finding a trusted partner with a track record of more than 120 years of operations,” Ray Kljajic, a managing director at Citi, said in an e-mail. “Indianapolis’ plan avoided the destructive elements of privatization which include a higher cost of capital, federal and state taxation, and significant refinancing costs.”
Officials expect to present the proposal to the state regulatory commission by mid-August.
Critics who lost the local battle said they plan to lobby Indiana to deny the transaction.
“We’re going to intervene with the commission,” said Grant Smith, executive director of Citizens Action Coalition, a lobbying group for environmental and consumer rights. “This has to do with the city wanting to do some infrastructure improvements instead of raising taxes. This has been touted and spun to the public as saying there’s going to be savings but even Citizens has said that these savings aren’t guaranteed. It’s the ratepayers who carry the risk of that uncertainty.”
