CHICAGO - The Indianapolis Public Improvement Bond Bank plans to enter the market by the end of the month to begin refunding a trio of troubled variable-rate water revenue bond issues that have become such a drain on Indianapolis' water department that officials are seeking an emergency rate increase.

(Click here to see larger version of chart).

The problems with the issues reflect those that have afflicted borrowers with insured floating-rate debt over the last year as insurance downgrades prompted failed remarketings. Skyrocketing liquidity costs complicated restructurings that leave the debt in a floating-rate mode while negative swap valuations that would lead to costly termination payments dampened the appeal of converting to a fixed rate.

As the cost of the variable-rate debt rose, the water district was unable to maintain required debt service coverage levels, and earlier this year began petitioning Indiana for an emergency rate increase to boost those coverage levels, said officials.

In addition to spending roughly $15 million more than budgeted last year on interest costs, the bond bank was forced to take out a $14 million loan to serve as collateral on a chunk of the debt that failed during a previous remarketing cycle and is now held by the bank liquidity provider. A $22 million payment under an accelerated repayment schedule required under the liquidity contract will be due in July if the debt is not refinanced by then, bond bank officials said.

The bond bank will also have to make a roughly $85 million swap termination payment as it refunds one of the debt series into a fixed-rate mode.

"We're at the point where we can't wait this out," said Deron Kintner, the bond bank's general counsel and deputy director. "We need to act. The water works bonds are priority number one."

Fitch Ratings recently downgraded the water utility's outstanding debt to A-plus from AA-minus. Moody's Investors Service on Monday put the A1-rated debt on negative watch. Analysts cited the deteriorated debt service coverage as well as a number of other problems associated with the variable-rate debt, as well as the uncertainty of the pending rate increase. Standard & Poor's rates the debt AA-minus.

The three debt series, which total roughly $488 million, were originally sold in 2002 as part of a larger borrowing that allowed the city to purchase the water utility, which had been run by a private owner for a number of years. At the time, the $600 million deal was the largest borrowing in the city's history.

The bond bank refinanced a swath of the debt in 2005 to achieve savings to use for capital improvement projects.

The Indianapolis Department of Waterworks covers both Indianapolis and nearly all of Marion County, as well as portions of seven surrounding counties. The utility serves about one million customers. Of the district's $843 million of debt, nearly 60% is in the variable-rate mode. If the planned restructurings are successful, the utility's floating-rate exposure will drop to 5%.

The plan calls for refunding a $388 million series and a $48 million series, both VRDOs. Both are currently held by liquidity provider Depfa plc. A third series totals $50 million and is currently in auction-rate mode.

The bond bank plans to enter the market within the next few weeks to refinance the two smaller bond series and return in June to refund the $388 million issue, officials said.

Morgan Stanley is the underwriter and Crowe Horwath LLP is the bond bank's financial adviser. Ice Miller LLP is bond counsel.

The refundings will allow the bank to shed the insurance coverage provided by now-downgraded MBIA Insurance Corp. on all three series.

In refunding the $48 million 2005 VRDOs, the finance team plans to maintain the debt in the variable-rate mode but substitute a letter of credit from Harris NA in place of a standby bond purchase agreement with Depfa. Keeping the debt in the variable-rate mode allows the bond bank to maintain the existing swap with JPMorgan and avoid a termination payment, Kintner said.

The bond bank plans to refund the $50 million of auction-rate debt into fixed-rate mode and drop MBIA. He said no swaps are associated with the debt, and the finance team is still considering whether to purchase new insurance for those bonds.

In June, the bond bank expects to refund the $388 million series into fixed-rate debt, shedding the insurance as well as Depfa as the liquidity provider. The utility will be forced to pay roughly $85 million to terminate a swap on the debt, Kintner said. The swap counterparties are JPMorgan and Loop Financial Products LLC.

"The big piece has caused the most headaches," he said. "The termination value is extremely high, and the market isn't producing the liquidity needed to keep those in variable-rate mode. Our only option appears to be refunding those bonds with fixed-rate bonds and terminating the swap. We would like to avoid the fee but don't see any way around it."

The bond bank hopes to increase the size of the final refunding transaction to include the swap termination payment, but is still talking with its bond counsel to determine whether it would qualify as tax-exempt under the tax code, Kintner said.

The bank estimates it paid around $15 million more than budgeted last year - $57.3 million - on debt service, largely due to downgrades of MBIA and Depfa. The escalating costs led to a decline in debt service coverage to 0.99 times, below the bond-covenant requirement of 1.1 times. Under the original bond agreement, the city is required to immediately petition the state commission for a rate increase once coverage drops below 1.1 times.

In January, Indianapolis began the process of requesting an emergency rate increase of 17.6%. If the rate increase is approved, debt coverage would rise up to 1.4 times, according to Kintner. The proposed rate increase would tack an additional $4.50 onto the customer's average monthly bill of $25. The request comes only a year before the utility planned to ask for another rate increase to finance a series of capital improvement projects.

"We don't know if we'll get the full 17.5%, but we are confident [the commission] understands the situation and sees that we don't have an option but to increase the rates," he said. If approved, the rate increase would take effect in June.

So far the utility has escaped additional penalties associated with the roughly $438 million held as bank bonds. The debt became Depfa-held bank bonds after failed remarketings last year, and the bond bank was to begin an accelerated amortization payment schedule beginning Jan. 1, Kintner said.

But after a series of negotiations, Depfa agreed to delay the deadline and instead allow the bond bank to post $14 million in collateral. The collateral - which the bond bank got through a loan from a commercial bank - should be released back if the restructurings are successful, Kintner said.

If the bank doesn't refund those bonds by July 1, it will be forced to make a $22 million payment on July 1 as the 10-year accelerated schedule kicks in.

"We thought we were really close to getting the refunding done" in January, he said. "But it's taken a little longer to find a letter of credit in the market. [Depfa has] been very cooperative and very willing to work with us on the first payment, but we don't necessarily want to go back to the well and ask them to defer a second time. The likelihood of getting a second extension is probably unlikely."

As Moody's monitors the situation, it noted that the two key measures that would allow the utility's A1 rating to be confirmed or to go up are whether the utility receives a sufficient rate increase and whether it's able to restructure its debt as planned.

"Both criteria are measurable milestones whose outcomes are expected within the next 60 days," Moody's wrote.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.