CHICAGO — Facing insolvency as it struggles with $140 million of debt, the Xenia Rural Water District in Iowa is pinning its hopes on a workout plan that relies on a rate increase and sale of district assets to raise revenue plus $45.4 million in debt relief.
The district approved a 22% rate increase in March and has a tentative offer of $110.5 million from the Des Moines Water Works to buy its assets.
The plan, however, also hinges on the more uncertain gamble that its two largest lenders — the U.S. Department of Agriculture’s Rural Development Agency and the insurer of its 2006 municipal bond issue — will together forgive $45 million of debt.
The prospects for any debt forgiveness remain unclear as negotiations with both are still ongoing, according to officials.
“Xenia Rural Water District has a debt load that its members cannot sustain. It is clear that an increase alone can’t address the district’s insolvency as the rate structure necessary to service all debt will likely cause significant membership attrition that could result in the collapse of the district,” the XRWD wrote in its proposed workout published in March. “Such an outcome is in the interest of neither the district’s members nor its lenders.”
The district’s challenges — stemming primarily from its rapid expansion — have accelerated over the last year. Standard & Poor’s stripped it of its investment-grade rating last summer.
The agency remains behind on payments owed to the USDA and has tapped debt-service reserves to cover its most recent debt-service payments. A June debt-service payment on the 2006 bonds also looms. The district’s budget for 2010 anticipates a net loss of $5.4 million.
It also faces repayment of a $5.2 million Bank of America loan next month. It has proposed either repaying the loan with long-term financing from the USDA or using proceeds from the asset sale. The department said yesterday the proposal is among several it is still evaluating.
The district also owes $1.5 million to the Iowa Finance Authority this year and is asking it to forgive the loans as part of its debt relief request.
The district, which is working with Public Financial Management Inc. as its adviser, fell into arrears on $45.6 million in loans owed to the USDA last September. It owes $83 million in principal on bonds issued in 2006 were insured by CIFG Assurance NA.
Assured Guaranty Corp. is acting as CIFG’s agent under a reinsurance agreement executed early last year.
“We are conducting a financial review to make sure we have accurate information to evaluate the request,” said Darin Leach, spokesman for the USDA Rural Development Agency’s Iowa office.
Leach said Rural Utilities Service field accountants are on site at the water system’s offices conducting a review of financial records.
Assured, acting as CIFG’s agent, has so far refused to forgive any debt but said it is evaluating the district’s operations, according to published reports that cited discussions among board members at a meeting last month.
Assured had countered Xenia’s preferred workout plan with one of its own crafted with the help of consultant R.W. Beck that called for a much steeper rate increase and the adoption of a standardized rate structure.
The plan, however, does acknowledge that rate increases alone won’t resolve the district’s crisis.
The district has pledged not to raise rates but has acknowledged that it could be forced by the courts to further raise rates to enforce bondholder rights under the transaction’s indenture.
Assured spokeswoman Betsy Castenir declined to comment on the company’s position on debt relief.
“We continue to work with the parties to the transaction to resolve the situation in our role as administrator of the Xenia policy,” she said.
In the most recent development with negative implications, Assured, which carries top marks from Standard & Poor’s, is challenging its reinsurance of the Xenia policy, leaving CIFG — a distressed company — on the hook for repayment in the event of any defaults.
Under the agreement executed in January 2009, Assured and CIFG are working to transfer covered policies, a process known as novation, to Assured so that they become a direct obligation of that firm. But the insurer has now said the Xenia policy is not covered by the reinsurance agreement and is not eligible for novation. CIFG is challenging the decision.
Standard & Poor’s last August lowered the rating on the 2006 bonds to a junk-level BB from BBB and assigned a developing outlook to reflect the district’s efforts to shore up its finances.
“The downgrade reflects the district’s deteriorating financial position, which necessitates the use of the district’s debt-service reserve to sufficiently cover the system’s outstanding water debt,” wrote analyst Corey Friedman. “We could raise the rating if the district’s actions are able to adequately address its structural imbalance.”
Its strengths include serving an area that is close to Des Moines, a growing service base, and a bountiful water supply. The district has shed equipment to raise money and cut staff to 39 from 129 two years ago.
The district in December used $2.2 million from the debt-service reserve to cover interest and principal due on its 2006 bonds. It also made draws on the reserve to cover its December 2008 and June 2009 payments.
The bond resolution allows the issuer to replenish draws on the account in 18 equal monthly installments. Xenia made the required 1/18 payment in January 2009 but failed to make the payments due in February 2009 and thereafter, according to the December notice.
The reserve holds a balance of $579,165.
In addition to its favored workout plan, in which the district would sell its assets to a new entity operated by Des Moines Water Works, it also laid out a second scenario in March that called for a complete reorganization and new management.
The second option called for a steeper rate increase of at least 60% and relies on the USDA forgiving $19 million and bondholders another $14.7 million.
A third option relied solely on a dramatic rate increase and one-time assessment.
The district has said it would consider the second option but added that the third would drive away too many customers to allow it to continue operating. Membership in the district is voluntary.
Officials wrote that while the first two options call for substantial debt forgiveness, and without it the district will have difficulty remaining solvent.
“The board understands its lenders may find either alternative difficult to accept. Even so, it cannot be denied that timely action must be taken to remedy the district’s financial condition,” the workout proposals read.
Xenia, which has a 9,000 members, took on its debts to fund a rapid expansion of its water delivery capacity north to the Minnesota border and waste treatment facilities beginning in 2002 to serve customers that have been slow in joining the district, contributing to operating deficits.
The district also experienced cost overruns on a connection line to an ethanol plant, according to published reports.
It serves customers in 11 counties to the north and west of Des Moines.
Iowa auditor David Vaught’s office is also currently conducting an audit of the district’s 2009 financial statements. Officials had expected to complete it this month, but due to delays in obtaining some information, the office doesn’t expect to release the results until next month, an official there said this week.
The district asked for the audit based on the requests of its members.
Under Iowa law, the district cannot file for bankruptcy. Xenia officials did not return calls to comment.