A treatment facility of Michigan’s Great Lakes Water Authority, which plans to refund more than $1.5 billion of Detroit water and sewer debt.

CHICAGO – The Great Lakes Water Authority is preparing its first bond issues since launching on Jan. 1, when it assumed Detroit's $5.5 billion water and sewer debt portfolio and took charge of regional water management.

The authority expects to refund up to $600 million of sewage disposal system revenue bonds and will sell up to $1.13 billion of new money and refunding water supply system revenue bonds.

The water revenue authorization includes up to $284 million of new money for capital projects planned over the next two years and provides room to refund up to $850 million.

Ahead of those issues, the authority will borrow through the state revolving fund up to $75 million of sewage revenue bonds and $17 million of water revenue bonds with a closing date expected at the end of September, said its public finance manager, John Wheatley.

"The refundings are for savings and we are targeting late September or early October," Wheatley said. The authority expects significant savings that could exceed a threshold of 7% in present value savings, but it's not yet been decided how to structure the savings.

Citi is running the books and Goldman Sachs is the co-senior manager with another six firms as co-managers.

Public Financial Management Inc. is advising the authority and Dickinson Wright Pllc is bond counsel.

The projected savings could help ease pressure to raise rates when the authority loses as customers Flint and Genesee County and their $25 million of revenue at the end of fiscal 2017, when the Karegnondi Water Authority pipeline is expected to come on line, said GLWA chairman Robert Daddow.

The authority recently extended its emergency service agreement with Flint. The city's water contamination crisis was triggered after its contract with the Detroit department for treated Lake Huron water ended in 2014.

Flint began drawing water from the Flint River while waiting for construction of the Karegnondi pipeline, but failed to treat the water properly. It later switched back but that did not end the crisis because the river water had corroded pipes. Genesee County and Flint backed $220 million of bonds issued to establish the Karegnondi authority.

GLWA, formed out of the ashes of Detroit's bankruptcy, is the regional manager of water and wastewater services with responsibility for the system's assets and rate-setting, all of which had been previously handled by Detroit. The city retains control of water and sewer services within city limits.

The authority intends to incorporate a "springing amendment" in its water and sewer bond indentures that lays the ground work for the future reduction in debt service reserve fund requirements under certain conditions.

The criteria would require that at least two of the three major rating agencies assign a double-A level rating to its senior lien debt and that any reduction in debt service reserves not result in a downgrade. A majority of existing bondholders would need to consent and new bondholders would consent to the provision as part of their purchase.

The agency's ratings are far short of the threshold now.

"It's definitely going to be a gradual process," Wheatley said.

Detroit historically funded its reserves with bond proceeds or with a surety bond. The reserves currently hold about $89 million in cash. Existing sureties begin expiring in 2022 which could force GLWA to put in more cash to the DSRF or fund new surety policies both at potentially higher costs.

"The springing amendments could significantly reduce the cost to GLWA if it obtains AA category ratings," its documents say.

"We believe we have an argument for an upgrade" in our continued positive operating momentum, Wheatley said.

Detroit's old water and sewer debt earlier this year won back across-the-board investment-grade ratings for the first time since the city left bankruptcy in late 2014.

After the authority became the obligor, Moody's Investors Service lifted $617 million of junior-lien water bonds and $17.3 million of junior-lien state revolving fund water bonds two notches to Baa2, from junk-level Ba1, and raised $908 million of second-lien sewer debt and $465 million of junior-lien SRF sewer bonds to Baa2 from Ba1.

Senior-lien debt, already at investment grade, was also upgraded two notches, to Baa1 from Baa3.

The upgrade recognized GLWA's assumption of all the debt secured by the net revenues of the Detroit Water and Sewerage Department. A 40-year lease with Detroit gave GLWA sole ownership interest in revenue generated by the combined regional and local system.

"This significantly limits the risk that a future bankruptcy filing by the city of Detroit or intensified fiscal pressure on the city in general would contribute to bondholder impairment with respect to the water revenue debt," Moody's wrote in its report.

Despite the Detroit water department's independence from the city government, its debt was dragged into the Chapter 9 bankruptcy.

Moody's said its ratings also reflect the massive scale of water operations and a customer base that extends beyond Detroit's borders, very strong operational and fiscal management, healthy liquidity, and the expectation of stable or improved debt service coverage. The low investment grade ratings also recognize as the authority's high leverage of pledged revenue, extensive capital needs, and labor market and demographic weaknesses.

Standard & Poor's late last year 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.

Fitch Ratings, which gave the debt a one-notch upgrade last summer, rates the second-lien water and sewer bonds BBB-minus and the senior lien BBB.

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.

The water system serves nearly 40% of Michigan'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 treats water from Lake Huron, Lake St. Clair and the Detroit River and distributes treated water to a service area population of about 3.8 million. The sewer system treats and disposes of wastewater produced by a service area population of approximately 2.8 million.

The city's restructuring plan laid the groundwork for the new authority, which had long been discussed by regional officials.

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 last year clearing the path.

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.

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