The Great Lakes Water Authority marketed $1.3 billion of muni bonds last week, its first sale of muni bonds since it commenced operations on January 1, 2016. The authority sold bonds backed by water system revenues, and separate issues backed by sewer system revenues. The authority was created as part of the City of Detroit bankruptcy settlement.
The authority inherited $5.5 billion of water and sewer system debt that had previously been issued by the Detroit Water and Sewerage Department. Detroit’s water and sewer bonds had been known for credit characteristics that were much stronger than the credit quality of most other debt issued by Detroit. A key to the strength of the water and sewer bonds has been a much larger and wealthier revenue base that extends beyond the city’s borders into the Detroit suburbs. It is estimated that approximately 75% of annual water revenues are now generated from the Detroit suburbs. The strength of the authority’s revenue stream also made it a target as a potential source of new revenues for the City of Detroit, particularly as the city entered into bankruptcy in 2013. Despite protections in the bankruptcy code for municipal enterprise revenues (such as water and sewer revenues), there were contentious negotiations between bondholders and the city over the ability of the city to tap into the water and sewer revenues. Ultimately, a plan was developed where outstanding debt was redeemed or refunded, including the refunding of debt by the authority.
Great Lakes is now an improving credit due to financial performance exceeding expectations, strong bondholder protections, seasoned and effective management, and a large revenue base serving nearly 40% of the state of Michigan. For example, water system revenues have increased by double digits in the last two years due to restructured wholesale water contracts that provide a more stable source of pledged revenue. Although the authority’s operations began on January 1, the management team has been in place since 2012, and they have been able to achieve significant reductions in operating costs, resulting in debt service coverage that is now approaching 2.0x.
Although the authority has inherited outstanding debt from Detroit’s Water and Sewerage Department, the department still manages retail water and sewer operations within the city. To address concerns over the 25% of pledged water system revenues that are generated within the city, Detroit has irrevocably assigned its right to all water system revenues to the authority, and customer payments are paid directly to the bond trustee, effectively protecting bondholders from any potential city fiscal issues.
The improving credit conditions and the relatively smooth transition of the operations of the water supply and sewer systems to the Great Lakes Water Authority have led to numerous rating agency upgrades since the authority’s financial plan was adopted. In anticipation of the authority’s sale of water system bonds, all three rating agencies have taken positive rating actions. Moody’s upgraded water bonds one notch to A3 after having upgraded water bonds by two notches in February. S&P revised its outlook to positive on its A- rating, and Fitch provided the largest rating jump with a full three-notch upgrade to A from BBB. In addition to a ratings increase, the yield on 12-year senior lien water system bonds was 95 basis points over the MMD scale. Overall, these water and sewer bonds have provided good value for the investors who purchased them.
Source: Bloomberg, the Bond Buyer, Fitch, Moody’s and Standard and Poor’s