CHICAGO — Citizens Energy Group, a nonprofit utility, will enter the market next week with up to $1 billion of new-money and refunding tax-exempt bonds to finance the purchase of Indianapolis’ water and sewer systems.
The triple-A rated city is the largest municipality to sell its water and sewer systems, and the $1.9 billion deal marks one of the largest such purchases in the United States, officials said.
The complicated, high-profile transaction has been in the works for years and stands to define Mayor Greg Ballard’s first term as he faces off with his Democratic challenger on Nov. 8. His opponent is Melina Kennedy, a public finance attorney formerly with Baker & Daniels LLP who was deputy mayor for economic development under former Mayor Bart Peterson.
Ballard proposed the sale and other privatizations, including the city’s parking meters, to finance infrastructure improvements without raising taxes. Kennedy has suggested the city set aside a third of the proceeds for early-childhood, crime-prevention, and job-training programs.
To finance the $1.9 billion purchase, Citizens will issue up to $550 million of new-money debt and $500 million of refunding sewer bonds, and substitute its own credit for another $958 million of water bonds issued by the city.
Citizens already runs Indianapolis’ gas utility, and at the heart of the purchase agreement is the company’s expectation that it will generate up to $60 million in annual savings by consolidating the three utilities.
Supporters say the savings will help offset — by up to 25% — planned rate increases needed to finance the estimated $5 billion in sewer system upgrades required under a 2005 consent decree with the Environmental Protection Agency.
“We started talking about this with the city extremely early on, and started performing due diligence back in the summer of 2009,” said Aaron Johnson, Citizens’ vice president of integration. “It’s been an extremely complicated transaction, given all the various parties, the political process and the regulatory process.”
Indianapolis will receive up to $425 million, $260 million of it in cash.
The purchase agreement includes a steep, 30-year increase in the amount of payments in lieu of property taxes, or PILOTs, to be made to the city.
The deal won its final nod of approval — following a 29% rate increase — from a state regulatory agency on July 13. The utility is heading to market as soon as a mandatory 30-day public appeal process ends on Aug. 12.
The finance team expects to sell the bonds next week despite market uncertainty in order to close the sale by Aug. 25, a day before the closing of the deal itself, set for Aug. 26.
The Indiana Finance Authority is the conduit issuer.
Fitch Ratings assigned an A-minus to a $39.2 million tranche of new-money water bonds and affirmed the A on the $958 million of outstanding water bonds, noting that the sale of the water system has no impact on the credit. Fitch does not rate the sewer bonds.
Standard & Poor’s and Moody’s Investors Service have yet to release their ratings.
Morgan Stanley, which was Citizens’ financial advisor during sale negotiations, is senior underwriter on the borrowing. City Securities Corp. and JPMorgan are also on the underwriting team. Ice Miller LLP is bond counsel.
The size of the transaction is still uncertain. All of the debt is tax-exempt and backed by the utility’s revenues.
The tranches include $39 million of new-money water bonds and $40 million of new-money sewer bonds. Those series will feature five-year bullet maturities and proceeds will be used to generate working capital for the systems, Johnson said.
Another $262 million of new-money bonds will be used to finance a cash payment to the city as well as payments to the various advisors involved in the deal, Johnson said.
A $106 million series will be used to finance half of Citizens’ capital projects scheduled for 2012. Another $104 million, new-money tranche will be used to pay off a bank line of credit with Wells Fargo that Indianapolis had opened to finance construction projects associated with the EPA consent decree.
Citizens will also issue up to $500 million of refunding sewer bonds to pay off 20-year sewer debt owned by the Indiana state revolving fund.
Some of that $500 million debt might simply be assumed by Citizens, which the state considers a governmental entity, instead of refunded, Johnson added.
“It’s clear that some $300-odd million it makes sense to defease, but another couple hundred million it’s not real clear, given flux in the market,” he said.
The two $40 million series and the $262 million series are subordinate-lien bonds. All the debt, with the exception of the $80 million of working-capital bonds, will have 30-year maturities and all will be in a fixed-rate mode.
As part of the deal, Citizens will also take over $958 million of water bonds. In that case, Citizens will simply substitute its own credit for the city’s credit, a move that is allowed in part because the pledge, rating, and bond covenants will be equal to or stronger than existing covenants, said Fitch analyst Doug Scott.
“They could not impair bondholders by changing covenants,” Scott said. “The pledge is the same and the rate covenant and the additional bonds test will strengthen over time.”
The existing water bonds are also all in a fixed-rate mode, after a massive refinancing the city undertook in 2008 and 2009 to shed troubled variable-rate debt.
Indianapolis was selling bonds backed by sewer and water payments as recently as April to continue to finance various projects. In April, the city priced $58 million of water bonds even as it neared a sale of the system, and last year, it sold $170 million of sewer bonds in a deal that securitized 75% of future PILOT payments.
