Commercial paper program helps Kentucky sewer district adjust to tax law changes

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A Louisville, Kentucky, sewer district is launching a $500 million tax-exempt commercial paper program to save money and finance repairs as part of its adjustment to a world without advance refundings.

The Louisville and Jefferson County Metropolitan Sewer District planned to kick off the program issuing $20 million in CP Wednesday.

MSD officials said they expect tax-exempt money market funds to quickly snap up the paper.

The program will be used for short-term financing as an alternative to using fixed-rate bonds, which have a higher carrying cost, particularly in the construction phase, said MSD Chief Financial Officer Chad Collier.

“[Advance] refundings are much more limited in the future so this is another tool to help manage and lower our interest costs,” Collier said. “Anything we can do to lower our costs provides additional funds that can go to our capital program without the need to raise rates.”

Collier estimated that MSD will save more than $3 million a year over traditional financing that will go toward the district’s 20-year capital program.

The program includes a $4.3 billion “critical repair and reinvestment plan,” some of which will upgrade aging infrastructure that he said dates back to the Civil War era.

“I only borrow what I need and I’m paying short-term interest rates,” he said.

According to an MSD presentation, the first year of the CP program is expected to have an all-in interest cost of 2.24% versus the first-year carrying cost of issuing new revenue bonds at 3.8%.

Even though the Federal Reserve is expected to raise the Fed funds rate target again this year, Collier said he anticipates CP interest rates will remain favorable.

“The CP allows us to take advantage of the short-term yield curve, which right now is probably 150 basis points to 200 basis points,” he said.

MSD expects to issue $20 million of CP each month as the program ramps up.

Wednesday's first notes come in two sub-series of $10 million each with liquidity support in the form of revolving credit agreements for each series - one from Bank of America NA and the other from JPMorgan Chase Bank NA. They will each provide liquidity support for up to $250 million of notes.

One note will be issued for 30 days and the other will be for 45 days, and both will probably be rolled over on maturity.

“These first few placements are just to make sure our internal processes are working before we begin using the program in full in August,” Collier said.

Moody's Investors Service assigned a P-1 short-term enhanced rating to the notes, while S&P Global Ratings assigned an A-1-plus short-term rating.

Hilliard Lyons LLC is the district’s financial advisor.

The district had about $2 billion of outstanding bonds at the end of fiscal 2017, according to its latest comprehensive annual financial report.

The bonds are rated Aa3 by Moody’s and AA by S&P. Both have stable outlooks.

Analysts said the ratings reflected the district’s large service area, stable customer base and debt service coverage levels.

The district collects and treats wastewater from more than 250,000 customers in Jefferson County and a portion of nearby Oldham County. MSD is also responsible for stormwater collection, drainage and flood protection within Jefferson County.

In fiscal 2017, the customer base grew 0.8% to 256,573 accounts, of which 91.1% are residential customers.

Louisville merged with Jefferson County in January 2003. The estimated population was 771,000 last year, according to the U.S. Census Bureau.

The MSD was created in 1946 as a public body corporate and subdivision of the Commonwealth of Kentucky. It is also a component unit of the Louisville and Jefferson County Metro Government.

Louisville’s mayor, with the approval of the Metro Council, appoints the members of MSD’s governing board as well as its executive director, chief engineer and secretary/treasurer.

According to the CAFR, the MSD has “no special financial relationship” with the Louisville Metro but it does provide the government with free sewer and drainage services, which was valued at $5.7 million in fiscal 2017.

“Louisville-Jefferson County is the Commonwealth's largest and best-performing metro area,” Moody’s said. “The economy will continue to expand steadily in the near term, supported by ongoing economic development in the manufacturing and logistics/shipping sector.”

Median family income, as measured by the 2016 American Communities Survey, is on par with the national medians for Moody’s Aa3 rating category.

Moody’s said the unemployment rate continues to improve as the labor force expands. In December, the county's unemployment rate of 3.3% was the lowest it has been in the last 10 years. It was also below the state’s 3.7% rate and the national unemployment rate of 3.9% for the same period.

On Tuesday, the U.S. Water Alliance named Louisville Mayor Greg Fischer as the 2018 winner of the U.S. Water Prize for an Outstanding Public Official, citing his commitment to water workforce development, according to the mayor’s office.

Fischer received the prize in Minneapolis, Minn., during the One Water Summit, an annual event that brings together hundreds of water agency leaders across the country discuss how to solve problems facing the water infrastructure sector.

Louisville is also part of the Rockefeller Foundation’s 100 Resilient Cities initiative, which helps municipalities develop programs to become more “resilient to the physical, social and economic challenges that are a growing part of the 21st century,” according to its website.

The MSD’s $500 million tax-exempt commercial paper program is designed to provide a cost-saving financing mechanism to replace aging wastewater and stormwater infrastructure.

“We have a consent decree ongoing and we have emergencies happen fairly frequently because a lot of the infrastructure is so old,” MSD Comptroller Bradley Sheldon Good said during a conference call.

Completing work under the 2005 federal consent decree will cost about $500 million for projects that reduce sewer overflows, according to MSD’s website.

Under the revolving credit agreements with the two banks supporting the CP, each bank can automatically terminate or suspend its payments under a number of scenarios, including if the district fails to make scheduled principal and/or interest payments on a reimbursement obligation to the bank, according to Moody’s.

The RCA can be terminated if a final, non-appealable judgment or order in an aggregate amount of more than $15 million is issued or filed against the district and it remains unsatisfied for a period of 60 days, or if the long-term rating assigned to parity debt drops below investment grade by each rating agency.

The district’s three-year liquidity agreements also include a feature whereby the district can borrow directly up to $250 million from each bank, as opposed to issuing notes.

The notes can be issued in daily, weekly and monthly modes, up to 270 days. At maturity, the district is required to roll the notes over or pay them off.

“That’s the beauty of CP,” Collier said, “it’s extremely flexible for your cash management needs.”

Once the notes are outstanding in a suitable amount, he said they will be taken out with long-term bonds.

The two banks were selected in an RFP process after the district hired four engineering firms to review MSD’s infrastructure and develop the “critical repair and reinvestment plan,” according to Collier.

To fund the $4.3 billion program would require raising sewer rates between 9% and 10%, he said, but so far the Metro Council has not addressed the funding issue.

The MSD board can only increase rates up to 7% without council approval, which the board has done, although Collier said that provides funding for only a small portion of the capital program and projects required by the consent decree.

Development of the commercial paper program took about two years.

“As with most infrastructure in the country, what MSD is trying to do is find the best way to keep costs down and commercial paper is providing a vehicle for that,” said Alex Rorke, Hillard Lyons’ senior managing director and head of the municipal securities group.

Rorke said he believes that Louisville’s CP program is the first of its kind in Kentucky to “take advantage of the short end of the yield curve.

“It’s unique for Kentucky at the moment,” Rorke said. “It takes a very strong double-A underlying credit to get access to this part of the market.”

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Infrastructure Commercial paper Revenue bonds Utilities Municipal utility districts Louisville and Jefferson County Metropolitan Sewer District, KY Kentucky