By Mike Matichich
The one-two punch of a depressed economy and lower consumption are challenging all water and wastewater utilities.
But they've been particularly hard on small- and medium-sized utilities — in general, those that serve 100,000 or fewer customers — given their tighter staff resources and more limited funding options.
The additional scrutiny lenders are deploying to avoid another credit crisis makes accessing the municipal bond market, even through a new instrument like the Build America Bonds, problematic or possibly too expensive. Some small utilities qualify for low-interest loans and grant equivalents through state revolving loan programs or have managed to tap stimulus monies, but many others haven't been as fortunate.
As a result, their managers are increasingly exploring and, where the numbers prove out, utilizing other options for projects that add capacity and improve treatment to meet current and anticipated regulatory requirements.Faster due diligence
Like municipal bond investors, manufacturers know the potential for a utility to default is very limited because most operate as enterprise funds with dedicated revenue streams in the form of user fees and other charges. More than 20 years ago, for example, Siemens Water Technologies began offering financing as part of its service package.
“Providing support like long-term, tax-exempt lease-purchase arrangements is a natural complement to sister companies that supply equipment,” says Siemens Financial Services Inc. Vice President Gene Rogero. “Interest rates are very comparable to what the utility might be able to achieve in the municipal bond market. But they realize financial savings in a number of ways, including avoiding the costs of going to the market.”
When a current or potential customer expresses interest, the company evaluates the operation based on three primary elements:The monetary value of Siemens equipment to be used in the projectSource of repayment; for example, will utility managers have to raise rates to repay the loan? What, if any, measures must they implement to ensure repayment?Overall financial condition; for example, reviewing recent audit reports.
The latter two criteria parallel the due diligence required for a municipal bond offering or state revolving loan fund application. But instead of looking only at metrics like debt service coverage, vendors also consider historical and projected balances and whether managers have and will continue to be able to secure fee increases necessary to meet financial obligations. And the process takes less time and effort.
Traditional due diligence involves a bond counsel, independent consulting engineer, financial adviser, underwriters, and credit rating agencies. The utility pays these fees — typically 1% to 3% of the total loan amount — upfront or rolls them into the borrowed amount. Engineering, legal, management, and finance employees invest considerable time and effort supporting the process.
Coordinating the contributions of the internal and external team members often takes months.
In addition, the utility often must set aside a full year's payment (or more) in a debt service reserve fund, causing funds that could be used elsewhere to sit idle. Or managers must raise rates to satisfy coverage requirements on net revenues imposed by bond covenants.
Conversely, a vendor's evaluation typically takes two to four weeks depending on project size and complexity and financing context. Getting monies more quickly than usual enables managers to move important projects forward when time is of the essence.
Once the evaluation is finished, the vendor develops and presents a financing packagethat includes length of loan and interest rate. If acceptable, the utility's governing body executes it. The process may include negotiations on points of interest to the parties, such as length of the loan and the final interest rate.
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Questions or comments about why these managers decided to finance replacements through an equipment vendor? Here's how to reach them.
Doug Baker, PE, Brown & Gay Engineers Inc. for Municipal Utility District 418: firstname.lastname@example.org.
Larry Ohm, Kankakee River Metropolitan Agency: email@example.com.
Dave Thompson, Public Utilities Commission: firstname.lastname@example.org.
Todd Mueller, president, AUC Group: email@example.com.
Siemens Financial Services Inc.: http://finance.siemens.com/financialservices/global/.
Accelerating required improvements
WHO: Kankakee River Metropolitan Agency; Kankakee, Ill.
SIZE: 60,000 wastewater customers in four communities
EQUIPMENT: Siemens IntraLift enclosed screw pump for 25-mgd treatment plant
TERMS: 7 years at 4.5%
VENDOR: Siemens Water Technologies
Usually the Kankakee River Metropolitan Agency funds capital improvements, at least in part, through Illinois' revolving loan program. But faced with failing equipment, there wasn't time to go through an application process that can take up to two years without a guarantee of success.
Outside Finance Director Larry Ohm would've liked the payback period to more closely approximate the equipment's anticipated service life of 15 to 20 years. But, he says, seven years was preferable to paying for the pump upfront or delaying replacement until longer-term borrowing could be arranged.
The vendor's analysis of agency financials took about a month, and the deal probably will have been executed by the time you read this.
Addressing additional project costs
In 2005, the Public Utilities Commission in Princeton, Minn., issued a revenue bond at 4.875% to build a 2-mgd iron removal pressure filter water treatment plant with fully automated chemical feed and control. As often happens once construction begins, it was determined that $2 million more was necessary to meet the needs of the commission's growing service area.
Refinancing the existing bonds through a new issue would've delayed project completion and forced the commission to pay borrowing costs again.
WHO: Public Utilities Commission; Princeton, Minn.
SIZE: 1,657 connections
PROJECT: Design and build a 2-mgd water treatment plant
A significant amount — but not all — of the specified equipment was Siemens'. The company worked with the commission and the City of Princeton to structure a private placement general obligation bond through Siemens, which is permitted by state law, to meet the commission's criteria: $4.9 million to be repaid over 20 years at an effective interest rate of 3.57% with principal and interest payments due semiannually.
That was a competitive rate at the time of closing in 2006, according to Commission General Manager Dave Thompson. He likens the process to going to a bank for a business or equipment loan, and would "strongly consider" the arrangement again if offered comparably favorable terms.
In addition to being less hassle than a bond, he appreciated avoiding the costs associated with traditional borrowing — $100,000 to $150,000, possibly more, for a bond of this size — by dealing directly with Siemens. The company also didn't require him to hold the equivalent of a year's worth of payments — an estimated $300,000 to $400,000 — in a nonproductive reserve fund for the two-decade repayment period.
Interim short-term financing
The point of entrée for vendor financing sometimes arises through consulting engineers.
Initially, Municipal Utility District 418 in Harris County, Texas, was going to meet the needs of a planned community by building a 0.6-mgd secondary activated sludge treatment plant. But at $8 million, the lowest bid was too costly for an operation with an annual operating budget of $950,000.
The district's consulting engineer asked AUC Group L.P. of Houston to think of other ways to expand treatment capacity. Though the company's equipment hadn't been included in the $8 million bid, Brown & Gay Engineers Inc. of Houston knew through other projects that AUC Group leases interim facilities, provides financing for permanent treatment plants, and owns an inventory of portable, modular treatment components that can be assembled in stages.
WHO: Municipal Utility District 418; Harris County, Texas
CHALLENGE: Treat wastewater generated by an 11,400-acre planned community
SOLUTION: Design and build a 0.6-mgd treatment plant
COST: $8 million
ALTERNATIVE: Developer leases treatment facilities through vendor
COST: $1.17 million
VENDOR: AUC Group L.P.
The company suggested the developer lease a temporary facility and phase construction to time expenses to flow requirements. The five-year lease will cost The Howard Hughes Corp. $234,000/year for a total investment of less than $2 million.
"The parent holding company was able to direct savings from this project to other capital projects to continue to maintain overall development in the initial growth phases of the development,"says Project/Construction Engineer Christopher Gilbert, PE.
When the lease expires, the developer can extend it, convert it to an ownership arrangement, or terminate it and convert to a different, permanent treatment solution.
—Matichich (firstname.lastname@example.org) is global technology leader, Financial Services, for CH2M Hill in Washington, D.C.