HomeMy Public PortalAboutExhibit MSD 3F - Direct Testimony, Bethany Pugh, PFMMSD Exhibit No. MSD 3F
2015 Rate Change Proceeding
BETHANY PUGH
Direct Testimony
Metropolitan St. Louis Sewer District
February 26, 2015
Table of Contents
Page
Witness Background and Experience ........................................................................................... 1
Financial Plan Assumptions .......................................................................................................... 4
Direct Testimony of Bethany Pugh, PFM February 26, 2015
Witness Background and Experience 1
Q1. Please state your name, business address, email address, and telephone number. 2
A. My name is Bethany Pugh. I am a Managing Director at Public Financial Management, 3
Inc. (“PFM”). My address is 7251 Engle Road, Suite 115, Cleveland, Ohio, 44130. My 4
email address is pughb@pfm.com. My phone number is 440-239-7070. 5
Q2. By whom are you employed and in what capacity? 6
A. I am a Managing Director at Public Financial Management, Inc. PFM’s Managing 7
Directors own the firm and set the firm’s strategic direction. My primary responsibilities 8
include leading PFM’s Ohio regional practice and serving as a senior financial advisor 9
and engagement manager for PFM’s clients across the Midwest. 10
Q3. Please describe your firm’s experience in public finance? 11
A. The PFM Group, including PFM and its affiliates, is the nation’s leading municipal 12
financial advisor, as well as a foremost provider of independent and fiduciary financial 13
and investment advisory services. As of December 31, 2014, the PFM Group comprises 14
512 employees and 37 locations nationwide. In the Midwest, there are 9 locations 15
including an office in St. Louis. In 2014, and for the 17th consecutive year, PFM was 16
ranked by Thomson Reuters as the #1 financial advisor in the nation, based on par 17
volume of transactions. Last year PFM advised on 783 transactions totaling over $48.5 18
Billion in par amount. Based on par value, PFM was also ranked as the leading advisor 19
for transactions in the Midwest, for transactions with revenue-based credits and 20
transactions placed on a negotiated basis. PFM was also ranked as the leading advisor 21
with respect to Water, Sewer and Gas related issuances, based on par value. In addition 22
to the Metropolitan St. Louis Sewer District (MSD, or the District), PFM’s utility clients 23
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 1
Direct Testimony of Bethany Pugh, PFM February 26, 2015
include The Metropolitan Sewer District of Greater Cincinnati, District of Columbia 1
Water and Sewer Authority, Orlando Utilities Commission, Des Moines Metropolitan 2
Wastewater Reclamation Authority, and Hampton Roads Sanitation District, among 3
numerous others (a full listing is available upon request). As a financial advisor to our 4
clients, PFM assists in the financial planning, debt transaction management and 5
execution, and on-going debt monitoring and management for our clients across the 6
nation. 7
Q4. Please describe your educational background, work experience and your personal 8
experience advising issuers of municipal bonds? 9
A. I graduated from Harvard College in 1998 with a Bachelor of Arts degree in Economics. 10
I have worked for PFM for more than 16 years. In that time I have worked with a variety 11
of state-level, municipal and not-for-profit entities, managing publicly offered and 12
privately placed debt transactions backed by various revenue streams including utility 13
revenue, sales tax, non-tax revenues and other sources in addition to general obligation 14
credits. These transactions have included fixed and variable interest rate; and short and 15
long-term obligations. In 2014 alone, I advised on a total of 17 transactions with a 16
principal value of over $1.3 billion. In addition I have developed several financial plans 17
evaluating the economic, policy and risk implications of myriad financial alternatives. 18
These plans have served as the foundation for funding various projects including, public 19
utility facilities and infrastructure, professional and collegiate sports stadiums, museums, 20
parking facilities, highways and other public infrastructure. I currently serve as the lead 21
financial advisor for PFM clients including the Metropolitan St. Louis Sewer District, 22
Saint Louis Art Museum, State of Ohio Treasurer of State, Ohio Turnpike and 23
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 2
Direct Testimony of Bethany Pugh, PFM February 26, 2015
Infrastructure Commission and the City of Toledo Department of Public Utilities, among 1
others. 2
Q5. How long has your firm been engaged with the Metropolitan St. Louis Sewer 3
District and what is your role as Financial Advisor? 4
A. PFM has served as financial advisor to MSD since 2000. During this time PFM has 5
worked with the District to develop the master indenture that defines the security 6
provisions and flow of funds for payment of MSD’s senior and subordinate lien (state 7
revolving fund program) revenue bonds. PFM developed the initial credit rating strategy 8
and presentation materials for introduction of the MSD’S new revenue credit in 2004. 9
PFM also worked with District staff to develop a comprehensive debt management policy 10
that was adopted by the District’s Trustees in 2004. Subsequently, PFM has been 11
involved advising on the financial planning, credit discussions, ratings presentations and 12
pricing of all MSD senior lien Wastewater Revenue Bonds as well as the structuring and 13
sale of the subordinate revenue bonds through the Missouri EIERA sewer revolving loan 14
fund program. On an on-going basis, PFM keeps MSD informed as to current trends in 15
the public finance marketplace, reviews investment banking proposals, and develops 16
responses to periodic inquiries from the rating agencies. 17
I began working with the District in May of 2012 and have advised on every aspect of 18
three District senior lien revenue bond transactions, including the structuring of debt, 19
presentations to the rating agencies and price negotiations with the District’s 20
underwriting syndicates. Most recently, PFM staff and I have worked with the District to 21
develop a financial plan in consideration of this Rate Proposal to the Commission. In 22
consideration of operational and capital funding needs, as well as credit rating metrics 23
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 3
Direct Testimony of Bethany Pugh, PFM February 26, 2015
associated with maintaining credit ratings in the AA-category, PFM has recommended 1
the amount of proposed senior lien debt issuances and mix of debt to pay-as-you-go 2
(PAYGO) capital funding for MSD’s projects through FY20. 3
4
Financial Plan Assumptions 5
Q6. How was the amount of CIRP to be financed as opposed to cash funded 6
determined? 7
A. The District and PFM developed a financial planning model to assess the District's ability 8
to fund the CIRP in consideration of operational obligations as well as necessary 9
parameters relative to its financial covenants with existing and future bond holders. The 10
model also assumed the District managed its financial obligations to maintain AA-11
category credit ratings. Based on these parameters, we then analyzed the District's 12
historical ratio of debt to cash funding for CIRP (60%/40% debt to equity from FY2004-13
FY2012) and attempted to maintain a ratio consistent with this, in light of future CIRP 14
funding needs and revenue increase parameters. Consequently, PFM has targeted a debt 15
to cash ratio of approximately 70% debt to 30% cash. This ratio includes both revenue 16
bonds and any state revolving fund ("SRF") obligations of the District. 17
Q7. How much is being assumed to be borrowed from the SRF? 18
A. $50 MM in FY15, $30 MM in FY16 then $25 MM annually through FY20. 19
Q8. What interest rates were assumed? 20
A. PFM assumed interest rates and yields for future District borrowings based on current 21
market rates commensurate with an AA-rated utility revenue credit. To mitigate interest 22
rate risk associated with future issuances, PFM added additional spreads to the yields 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
assumed ranging from approximately 0.40% for the FY2016 issuance to 1.25% for the 1
projected bond issuance in FY2020. 2
Q9. What is the debt service coverage target for senior bonds? 3
A. Based on the District’s historical performance and expected required coverage to 4
maintain ratings in the AA-category, senior lien bonds have a projected minimum 5
coverage target of 2.50X while the minimum total coverage (including senior lien bonds 6
and subordinate SRF obligations) is targeted at 1.60X. 7
Q10. How were the debt service coverage targets developed? 8
A. Projected minimum coverage targets of 2.5X (senior lien bonds) and 1.6X (inclusive of 9
subordinate obligations) have been identified as the optimal coverage levels needed to 10
maintain AA level bond ratings, thereby ensuring cost effective market access for the 11
District’s large capital program. The three major rating agencies that assign ratings to 12
government issuers have communicated expectations related specifically to MSD’s future 13
financial performance regarding debt service coverage. 14
Moody’s Investors Service has said “In MSD's multi-year forecast, projected senior lien 15
debt service coverage ranges between 2.91 times and 2.41 times, and debt service 16
coverage on all debt ranges between 1.73 times and 1.62 times. . . . Our rating outlook 17
assumes that future declines in debt service coverage will be far less than current 18
projections. Further narrowing of coverage and/or increases in capital requirements could 19
pressure credit quality.” Source: Moody’s Investors Service New Issue Report, 20
“Metropolitan St. Louis Sewer District, MO, $150 million Wastewater System Revenue 21
Bonds, Series 2013B,” dated November 19, 2013 (Exhibit MSD 49). 22
23
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 5
Direct Testimony of Bethany Pugh, PFM February 26, 2015
From Standard & Poor’s, “The stable outlook reflects Standard & Poor's expectation that 1
MSD will adjust rates as necessary to maintain strong debt service coverage as it issues 2
additional debt, as well as to generate at least good net revenues to support its large 3
capital program. The strength of the district's service area provides additional rating 4
stability, as does the district's ability to adjust rates as needed. While not expected during 5
the current two-year outlook period, we could lower the rating if the district is not able to 6
maintain at least its good financial position, particularly as it begins to address its capital 7
needs with additional debt.” Source: Standard & Poor’s Credit Profile Report, 8
“Metropolitan St. Louis Sewer District, Missouri; Sewer; $150.0 million Wastewater 9
System Revenue Bonds, Series 2013B due 05/01/2034,” dated November 15, 2013 10
(Exhibit MSD 48). 11
Finally, Fitch Ratings states: “Due to the planned borrowings associated with the CIRP 12
and consent decree, total coverage on all outstanding and anticipated debt is projected to 13
be in the 1.7x - 1.8x range and coverage on senior lien debt is projected to be in the 2.4x - 14
2.9x range for fiscals 2014 - 2016. Fitch's rating incorporates the weaker DSC, although 15
any deterioration in financial performance beyond projected levels could result in 16
negative rating action.” Source: Fitch Ratings New Issue Report, Metropolitan St. Louis 17
Sewer District, Missouri Sewer System Revenue Bonds, dated November 18, 2013 18
(Exhibit MSD 50). 19
Q11. Besides debt service coverage what other credit rating metrics impacted the 20
proposed debt financing amount? 21
A. The financial planning model was also developed to ensure a minimum amount of days 22
cash on hand of 550 days at a minimum. Days cash on hand is a liquidity metric that 23
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 6
Direct Testimony of Bethany Pugh, PFM February 26, 2015
measures an entity's ability to meet short-term needs and contingencies. Days cash on 1
hand is calculated by dividing cash and relatively liquid investments by operating 2
expenses (less depreciation) and then dividing by 365 days. 3
Q12. Are there any examples of comparable metropolitan sewer utilities experiencing 4
deterioration in bond ratings due to increasing CIRP regulatory requirements? 5
A. On June 30, 2014, Moody’s Investor Service (Moody’s) issued a special comment report, 6
“Most US Sewer Utilities Can Weather Costs of Federal EPA CDs,” highlighting key 7
observations on the impact of CDs on sewer utilities. In the report, Moody’s noted that 8
utilities under CDs often remained highly rated even when the costs were substantial. 9
One of the reasons why ratings remain high is that the Environmental Protection Agency 10
(EPA) takes into consideration the utilities’ ability to fund upgrades in its settlement 11
agreement. The second reason is that the implementation of the CD is spread out over a 12
period of time thereby giving the systems time to embark on capital improvements and 13
incorporate additional costs into rates. However the report notes that CDs can also 14
sometimes play a role in credit deterioration. 15
“CDs often lead to increased operating costs and higher debt burdens and user rates. 16
Complying with a CD is primarily a management challenge, and occasionally systems do 17
not manage capital upgrades or rate increases well. The systems that have sustained the 18
most credit pressure due to CDs are not the ones with the largest settlements but the ones 19
least willing or able to pay for them.” 20
As a result, credit pressures can follow from a combination of resistance to rate increases 21
and higher debt which in turn weakens debt service coverage. Moody’s analysis of 22
utilities under a CD focuses on an entities’ willingness to increase rates to meet capital 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
needs and maintain adequate financial margins. The rating agency also focuses on rate 1
payers’ ability to pay higher rates and the political will to impose such rates. 2
There have been instances in which wastewater credits have been downgraded because of 3
mandated capital improvement programs and/or because they did not raise rates 4
sufficiently enough to cover capital improvement plans. It is important to note that most 5
of these entities with CDs have managed to maintain strong credit ratings. This is a 6
testament to their ability and willingness to manage their increased operating and 7
financial requirements effectively. The District has experienced a downgrade as a result 8
of the CD implementation’s impact on debt service coverage among other considerations. 9
Other entities that have experienced ratings downgrades include: Miami-Dade County 10
(FL) Water and Sewer Enterprise, East Baton Rouge (LA) Sewerage Commission, 11
Hampton Roads (VA) Sanitation District, the City of Atlanta, GA, and Jefferson County 12
(AL) Sewer Enterprise. 13
On November 29, 2011, Fitch Ratings (“Fitch”) downgraded the District’s revenue debt 14
to AA+ from AAA. The downgrade was as a result of reduced coverage and the 15
likelihood that coverage would remain low because of accelerated capital spending and 16
debt associated with the CIRP and mandated CD. In Fiscal 2010, the Metropolitan 17
St. Louis Sewer District’s total annual debt service coverage (including senior and 18
subordinate SRF debt) fell to 1.6x from 2.6x in 2009. The District’s CD with the EPA 19
was executed in July 2011 and because of the level of planned borrowing, coverage on all 20
outstanding debt and additional borrowing was projected to be in the 1.5x – 1.6x range. 21
Currently, the District’s debt is rated AA+ by Fitch. 22
On June 14, 2013, Miami-Dade County’s water and sewer system revenue bonds were 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
downgraded to Aa3 with a stable outlook from Aa2 by Moody’s. The downgrade was 1
based on the system’s narrowed projected debt service coverage. The rating reflects the 2
implications of a new CD resulting in a capital borrowing program totaling $9.2 billion 3
through 2027. Moody’s stated that, “The System’s credit quality will ultimately be 4
dictated by the ability to fund substantial capital needs while maintaining adequate 5
reserves and coverage levels, and by the county’s demonstrated willingness to implement 6
timely and sufficient rate increases to support this sizable program.” However, Moody’s 7
notes in their June 30, 2014 report, county officials have been reluctant to adjust user 8
rates in a timely and sufficient manner in the past. Consequently, net revenues must 9
nearly double in the next decade to cover projected borrowing costs. In the 2013 ratings 10
report for the county, Moody’s states the stable outlook takes into account the 11
“…challenges of maintaining adequate debt service coverage and system liquidity, while 12
managing a very extensive and comprehensive capital program.” Other issues affecting 13
the system include aging infrastructure and continued compliance with regulatory 14
mandates. 15
On July 20, 2011, East Baton Rouge Sewerage Commission’s debt was downgraded to 16
Aa3 from Aa2 by Moody’s. The downgrade was as a result of decreasing debt service 17
coverage and cash reserve position and an increased debt profile due to additional CD 18
driven borrowing. Moody’s noted that following the issue of the Series 2011A bonds, the 19
system would have 21.8% in hedged variable rate debt as well as significant swap 20
exposure. The Aa3 rating also reflects the system’s expected future borrowing and the 21
use of reserves for the sanitary sewer overflow program developed to address the CD and 22
continued consumer growth. In addition to addressing the needs outlined in its CD, East 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
Baton Rouge was also faced with infrastructure needs related to hurricanes. Moody’s 1
expects the system’s financial position will face challenges in the future as a result, which 2
will in turn affect the system’s financial flexibility. Coverage in Fiscal 2010 was 3
approximately 2.73x compared to pro forma coverage of 1.2x in Fiscal 2012. This 4
decline was due to doubling in debt service between 2010 and 2012. According to 5
Moody’s, “The trend of declining coverage as well as additional borrowing expected to 6
further pressure coverage are key considerations in the ratings downgrade.” 7
Similarly on October 27, 2014, Standard & Poor’s (“S&P”) downgraded Hampton Roads 8
(VA) Sanitation District’s debt to AA+ from AAA in anticipation of exposure to a 9
significant amount of debt to be issued to fund mandated projects. The downgrade 10
reflected the district’s agreement to implement a regional wet weather management plan 11
(RWWMP) resulting in projected capital outlays of approximately $1.35 billion in the 12
first 16 years of a 20 year plan. S&P noted the following offsetting credit factors: 13
increased leveraging as well as potentially lower resources available for debt service due 14
to funding certain capital improvements on a pay-as-you -go-basis; diminishing rate 15
raising flexibility due to frequent rate increases for debt service and pay-as-you -go 16
funding that threaten to raise rates beyond affordability levels; and potentially higher than 17
estimated RWWMP costs requiring additional rate increases and debt given its size. As of 18
2014, the district is rated AA+. 19
On December 12, 2003, The City of Atlanta, GA’s water and wastewater revenue bonds 20
were downgraded to BBB+ from A- by Fitch. This rating action followed a downgrade 21
to A- from A two weeks earlier. This further downgrade was due to the city’s inability to 22
implement rate increases in a timely manner sufficient to fund operations, existing debt 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
and CD requirements. Fitch believed it was unlikely for these concerns to be addressed 1
in such a way that would avoid overly burdensome increases to rates. Fitch noted the city 2
council’s rejection of the Mayor’s proposed rate increases which would have tripled rates 3
by 2008. Instead, the city council proposed a smaller increase that would have required 4
an expenditure reduction of about 19% to meet bond covenants. The Mayor vetoed the 5
council’s proposal arguing that such reductions were unsustainable. On April 4, 2010, 6
the rating was revised to A with a stable outlook. On August 16, 2013, Fitch upgraded 7
the city to A+ from A with a stable outlook. Fitch noted as favorable: “Financial metrics 8
exhibited considerable improvement in recent years due principally to a series of sizable 9
rate increases, good cost control, and modest growth in consumption. Consequently, both 10
debt service coverage and liquidity now exceed Fitch Ratings’ rating category medians.” 11
More drastically, Jefferson County (AL) Sewer Enterprise suffered a default on its sewer 12
warrants, caused in part by a complex debt structure, lack of compliance with bond 13
covenants and a lack of willingness to increase user rates. It should be noted that this is a 14
unique case, and the particularly risky bond structures used for most of the debt has 15
resulted in criminal charges for some of the individuals involved. On July 22, 2009, 16
Moody’s affirmed the Caa3 with a negative outlook on sewer revenue bonds to reflect the 17
ongoing risk of losses to bondholders. On February 13, 2013, Moody’s downgraded the 18
county’s obligation to Ca from Caa3 to reflect the expected loss on the sewer warrant 19
from the trustee’s suspension of all payments and insufficient sewer revenues relative to 20
debt service. On January 9, 2014, Moody’s withdrew the Ca rating on Jefferson County 21
debt following the county’s exit from bankruptcy. The withdrawal follows the issue of 22
new sewer revenue warrants on December 2013 to retire all outstanding county sewer 23
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Direct Testimony of Bethany Pugh, PFM February 26, 2015
debt. 1
Q13. Does this conclude your testimony? 2
A. Yes. 3
4
2015 Rate Change Proceeding MSD Exhibit No. MSD 3F 12