The new Great Lakes Water Authority now manages Detroit water and sewer bonds

CHICAGO -- The Great Lakes Water Authority officially opened its doors Jan. 1, ushering in a new era of regional water management under an entity that is now the caretaker of more than $5 billion in Detroit water and sewer bonds.

"We are up and running," said GLWA chairman Robert Daddow.

The new agency doesn't expect any new money borrowing until fiscal 2017 but is eyeing refunding opportunities.

A majority of Detroit water and sewer bondholders late last year gave their consent to the transfer of the Detroit Water and Sewerage Department's bonds to GLWA. "It was the last critical milestone," Daddow said.

GLWA will manage regional water and wastewater services, assets, and handle rate-setting responsibilities, while Detroit retains control of water and sewer services within city limits.

The GLWA board is comprised of six board members: two from the city and one each from Wayne, Oakland and Macomb counties, plus one representing the state. The board last fall named the director of the Detroit Water and Sewerage Department, Sue McCormick, as the authority's chief executive officer.

Rating agencies and market participants have taken a favorable view of the transition because of its benefits to investors, including legal insulation from Detroit, which exited its historic Chapter 9 bankruptcy in late 2014.

As part of GLWA's 40-year lease with Detroit, the city will receive $50 million a year to overhaul its aging infrastructure as well as $4.5 million in assistance for low-income customers.

"It truly is a win-win as the city gets the lease payments to improve infrastructure," city deputy finance director John Naglick said in a recent interview.

Daddow, deputy Oakland County executive since 2000 and formerly the county's budget director, said it was long road to getting the authority operational. Former Detroit emergency manager Kevyn Orr's desire to monetize the city's water and sewer assets drove negotiations and the city's plan of adjustment to exit Chapter 9 laid the groundwork, with bondholder consent clearing the path.

As Detroit moved to exit bankruptcy, the plan of adjustment envisioned GLWA's establishment in mid-2015 but various technical and legal issues remained unresolved, led by the need for bondholder consent. Bond insurers Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp. wrap much of the debt.

Officials finalized and signed lease agreements on the condition that certain legal provisions be met by the new targeted start date of Jan. 1.

"It gave us the time to complete the process more thoughtfully instead of in a hurry," Daddow said.

The city sought out bondholder consent as it also plotted a December refunding through the Michigan Finance Authority due to favorable market conditions. To shift the debt, consent was needed from at least 51% of water holders and 51% of sewer holders. The city reported receiving the consent from holders of more than 67% of the outstanding bonds.

The city and GLWA officials initially expected more modest savings from the refunding, but the combination of rating upgrades and strong demand for high-yielding paper drove demand. The bonds were oversubscribed by 12 times, bringing down interest rates and more than doubling previously projected present value savings to about $38 million. The refunding's final size landed at $324 million.

"This is not only the latest successful step leading up to the transition, but also an important endorsement of the benefits of a new regional authority," Nicolette Bateson, GLWA's chief financial officer and the former CFO of DWSD, said in a statement.

The bonds won a series of upgrades recognizing departmental improvements and the impending water authority's assumption of the debt with new structural benefits. The water and sewer debt now carries mostly investment-grade ratings although one rating agency still has second-lien paper at junk.

Under the new structure, GLWA would not be consolidated into a hypothetical future Detroit bankruptcy proceeding. While the DWSD has enjoyed mostly independent operations from the city, its debt was still dragged into the bankruptcy process.

Under the new terms, bondholders will hold a statutory lien on pledged assets and rates must be set at a level to meet various coverage ratios. GLWA will have "step-in" rights to enforce rate increases set by the department.

Lease payments are restricted to debt repayment and capital projects and a debt stabilization fund must be established over the next three years to offset bad debts.

Ahead of the Dec. 3 pricing, Standard & Poor's raised its rating one notch on senior bonds and affirmed its ratings on the second lien bonds. That puts the second lien water and sewer bonds at BBB-plus with a stable outlook and the senior lien bonds at A-minus and stable.

"We believe that a significant amount of uncertainty regarding management and governance of both the Detroit retail and regional systems has been resolved," S&P said.

The credit reflects adequate-to-good financial performance and projections that indicate improving conditions, affordable rates, and strong management policies and procedures.

The $3.3 billion of sewer debt includes 61% under the senior lien, 25% under the second lien, and 14% in an unrated junior lien.

The $2.3 billion of water debt includes 73% in the senior lien, and 27% in the second lien, with a small piece of unrated junior-lien debt.

Fitch Ratings, which gave the debt a one-notch upgrade over the summer, affirmed its BBB-minus rating for the second lien water and sewer bonds and the BBB rating for the senior lien ahead of the December refunding.

Outlooks are stable.

"The planned lease of the systems by GLWA provides further assurance that system operations will remain independent of the city," Fitch said.

The credit reflects a system that is highly leveraged and expected to remain so. The water system serves nearly 40% of the state's population with 75% of revenue coming from wealthier suburbs, and the sewer system serves 30% of Michigan's population with more than 50% of operating revenues coming from suburban customers.

The water system revenues provided total debt service coverage of just under 1.1 times in fiscal 2015 while sewer coverage was at 1.2 times.

The systems' 2016-2020 estimated capital improvement plan calls for $796 million in water spending and $594 million for sewers, with about $520 million in water borrowing planned and $161 million for sewers.

Moody's Investors Service affirmed its Baa3 rating for senior-lien bonds and the speculative grade Ba1 rating on second-lien debt.

Moody's upgraded the debt in August, bringing the senior-lien debt to investment grade for the first time since before Detroit's August 2013 bankruptcy filing. It assigns a positive outlook, citing continued improvements to operating performance and the transfer.

Fitch and Standard & Poor's lifted the senior-lien bonds out of junk territory in 2014 ahead of a tender financing. Detroit's water and sewer revenue bonds were for years among the city's highest-rated debt, but the ratings agencies began knocking the debt down in 2013 after Orr declared he would restructure the department's bonds amid the financial crisis that sent the city into bankruptcy.

Daddow said given the strong interest and improved rates of the recent refunding, he’s asked the agency’s advisor Public Financial Management to look for additional potential refunding candidates.

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