CHICAGO — The city of Flint and Genesee County in Michigan are bringing $220 million of bonds to market next week to finance their break away from the Detroit Water and Sewerage Department and build their own 63-mile pipeline to Lake Huron.
It's the first borrowing for the Karegnondi Water Authority, which was launched in 2010 by several local governments in southeast Michigan. Genesee County is about 60 miles outside Detroit.
The authority expects to come back to market in November with another $80 million. Genesee County has already floated $35 million for the first phase of the project, and expects to issue $60 million later this year for construction of its own water treatment plant.
In light of Flint's severe fiscal distress — the city has been under state controlled emergency management since late 2011 — the bonds feature a back-up pledge from Genesee County.
The governments expect to make their payments from the system's revenues, but the debt carries the limited-tax general obligation pledge of both credits. Genesee has promised to cover Flint's payments within 15 days if the struggling city is unable to make its payments.
Flint and Genesee County leaders say their new system will deliver more reliable water supply at lower rates than they would pay to the DWSD.
"The rates are expected to be more competitive compared to Detroit's current charges and should be more stable in the future as capital costs will remain constant," John O'Brien, deputy CEO of the new authority, said in a presentation to investors.
The cost of water from the DWSD increased an average of 11.4% annually between 2009 and 2013, and is expected to continue to rise, O'Brien said. The KWA projects increases of 4% to 5% annually for the operation and maintenance portion of its expenses, he said. "Flint's total cost is expected to be less than its current costs with lower increases in the future," said O'Brien.
The deal comes as bankrupt Detroit is trying in connection with the Chapter 9 process to create a regional water authority to lease the city's massive water and sewer system, which serves more than 40% of the state's population. The departure of Flint and Genesee County could mean an annual loss of up to $22 million for the DWSD, roughly 6% of its revenue.
DWSD officials have spent the last several weeks in negotiations with Flint and Genesee County to try to mitigate the impact of their exit, said Nicolette Bateson, the chief financial officer of the DWSD.
"We are currently in negotiations for short and potentially long-term use," said Bateson. "There's dialogue going on about their water needs."
Flint is set to no longer receive water from the DWSD as early as April 17, relying on its own water treatment plant and water drawn from the Flint River. The city expects to see significant savings from the move.
Genesee will pursue a separate contract with the Detroit system through at least 2016. The DWSD and Genesee are also negotiating a separate contract that would require Detroit to provide a long-term emergency stand-by service if the new system fails.
The new water system has affected the talks between the city and the three counties that the city hopes will create the new regional authority, according to Peter Provenzano, finance director for Macomb County.
Like Oakland County, which is also reluctant to enter into a deal, Macomb officials say part of the problem is the lack of information provided by the city and its investment bank, Miller Buckfire.
"We haven't been able to do the level of due diligence that we'd like to," Provenzano said. "And part of that would be to calculate the impact of Flint and Genesee, and what the impact would be on all the remaining ratepayers."
The KWA's full impact on DWSD won't be felt until 2016, when Genesee County's contract with Detroit expires.
That two-year delay helps ease any immediate credit impact, said Scott Garrigan, an analyst with Standard & Poor's.
"The revenue stream isn't changing until 2016, so there's a little bit of time for DWSD to adjust its rates and charges," Garrigan said. "When the shift happens, we'll review it at that point."
DWSD revenue bonds have all sunk to junk-level underlying ratings.
Standard & Poor's rates the new KWA bonds A-plus.
Moody's Investors Service assigned an initial rating of A2 to the bonds. As with Standard & Poor's, Moody's rating is based on the limited-tax GO credit quality of Genesee County.
"Moody's assessment of Genesee County's ability to absorb the full amount of debt service is a key rating factor given ongoing financial distress within the City of Flint," analysts said in their ratings report on the deal. "The A2 rating also reflects solid security features incorporated into the financing and underlying water supply contracts including provisions for monthly capital set asides and a debt service reserve fund."
A retail order period is set for March 31 with institutional pricing on April 1.
The bonds mature in 30 years and are payable from the contracts as well as the LTGO pledges of Flint and Genesee.
In the investor presentation, the finance team touted the debt's double-barrel pledge and Genesee's step-up provision to cover any shortfall from Flint.
Genesee is responsible for paying roughly 66% of the debt service and Flint 34%, according to bond documents. Their contracts with the KWA include both debt-service payments and a separate annual fixed capital fee.
Proceeds will also finance a debt service reserve account.
The system is expected to ultimately supply raw water for a three-county area consisting of more than 2,232 miles and 500,000 residents, according to bond documents. It will initially provide water only to Flint and Genesee, but additional governments in the area may sign on in the future.
The system features construction of a 63-mile pipe from Lake Huron to Flint, an intake facility, and two pump stations.
Michigan has given the KWA a permit to withdraw 85 million gallons of water a day from Lake Huron, and the permit does not need to be renewed during the life of the bonds.
The KWA expects the pipeline system to be up and running by May 2016. The first debt-service payment is due on May 2017.
The preliminary official statement warns of investor risks that include the ability of Flint and Genesee to charge and collect revenues from the system as well as system completion risk.
The possibility that Flint would file for Chapter 9 is another risk, according to the documents.
"If Flint fails to fulfill its payments obligations under the contract for any reason, including a bankruptcy filing by Flint, Genesee will be required to pay Flint's share of the debt service on the system bonds," the POS says.
"While this provides protection for the issuer, such payments could cause significant financial strain on the general fund of Genesee and the net revenues of the Genesee System, potentially limiting the extent of this protection."
Bond payments are expected to average $23 million annually, assuming an interest rate of 5% on the $220 million of bonds and 5.25% on the $80 million of debt, according to bond documents.
JPMorgan is the senior manager on the deal, and Wells Fargo Securities and Stifel, Nicolaus & Co., Inc. are the co-seniors. Stauder, Barch & Associates Inc. is the financial advisor and Miller, Canfield, Paddock and Stone PLC is bond counsel.
