MSD Exhibit No. MSD F 0 Rate Change Proceeding BETHANY PUGH Direct Testimony Metropolitan St. Louis Sewer District February, 0 Table of Contents Witness Background and Experience... Financial Plan Assumptions... Page
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 Witness Background and Experience Q. Please state your name, business address, email address, and telephone number. A. My name is Bethany Pugh. I am a Managing Director at Public Financial Management, Inc. ( PFM ). My address is Engle Road, Suite, Cleveland, Ohio, 0. My email address is pughb@pfm.com. My phone number is 0--00. Q. By whom are you employed and in what capacity? A. I am a Managing Director at Public Financial Management, Inc. PFM s Managing Directors own the firm and set the firm s strategic direction. My primary responsibilities include leading PFM s Ohio regional practice and serving as a senior financial advisor and engagement manager for PFM s clients across the Midwest. Q. Please describe your firm s experience in public finance? A. The PFM Group, including PFM and its affiliates, is the nation s leading municipal financial advisor, as well as a foremost provider of independent and fiduciary financial and investment advisory services. As of December, 0, the PFM Group comprises employees and locations nationwide. In the Midwest, there are locations including an office in St. Louis. In 0, and for the th consecutive year, PFM was ranked by Thomson Reuters as the # financial advisor in the nation, based on par volume of transactions. Last year PFM advised on transactions totaling over $. Billion in par amount. Based on par value, PFM was also ranked as the leading advisor for transactions in the Midwest, for transactions with revenue-based credits and transactions placed on a negotiated basis. PFM was also ranked as the leading advisor with respect to Water, Sewer and Gas related issuances, based on par value. In addition to the Metropolitan St. Louis Sewer District (MSD, or the District), PFM s utility clients 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 include The Metropolitan Sewer District of Greater Cincinnati, District of Columbia Water and Sewer Authority, Orlando Utilities Commission, Des Moines Metropolitan Wastewater Reclamation Authority, and Hampton Roads Sanitation District, among numerous others (a full listing is available upon request). As a financial advisor to our clients, PFM assists in the financial planning, debt transaction management and execution, and on-going debt monitoring and management for our clients across the nation. Q. Please describe your educational background, work experience and your personal experience advising issuers of municipal bonds? A. I graduated from Harvard College in with a Bachelor of Arts degree in Economics. I have worked for PFM for more than years. In that time I have worked with a variety of state-level, municipal and not-for-profit entities, managing publicly offered and privately placed debt transactions backed by various revenue streams including utility revenue, sales tax, non-tax revenues and other sources in addition to general obligation credits. These transactions have included fixed and variable interest rate; and short and long-term obligations. In 0 alone, I advised on a total of transactions with a 0 principal value of over $. billion. In addition I have developed several financial plans evaluating the economic, policy and risk implications of myriad financial alternatives. These plans have served as the foundation for funding various projects including, public utility facilities and infrastructure, professional and collegiate sports stadiums, museums, parking facilities, highways and other public infrastructure. I currently serve as the lead financial advisor for PFM clients including the Metropolitan St. Louis Sewer District, Saint Louis Art Museum, State of Ohio Treasurer of State, Ohio Turnpike and 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 Infrastructure Commission and the City of Toledo Department of Public Utilities, among others. Q. How long has your firm been engaged with the Metropolitan St. Louis Sewer District and what is your role as Financial Advisor? A. PFM has served as financial advisor to MSD since 000. During this time PFM has worked with the District to develop the master indenture that defines the security provisions and flow of funds for payment of MSD s senior and subordinate lien (state revolving fund program) revenue bonds. PFM developed the initial credit rating strategy and presentation materials for introduction of the MSD S new revenue credit in 00. PFM also worked with District staff to develop a comprehensive debt management policy that was adopted by the District s Trustees in 00. Subsequently, PFM has been involved advising on the financial planning, credit discussions, ratings presentations and pricing of all MSD senior lien Wastewater Revenue Bonds as well as the structuring and sale of the subordinate revenue bonds through the Missouri EIERA sewer revolving loan fund program. On an on-going basis, PFM keeps MSD informed as to current trends in the public finance marketplace, reviews investment banking proposals, and develops responses to periodic inquiries from the rating agencies. I began working with the District in May of 0 and have advised on every aspect of three District senior lien revenue bond transactions, including the structuring of debt, presentations to the rating agencies and price negotiations with the District s underwriting syndicates. Most recently, PFM staff and I have worked with the District to develop a financial plan in consideration of this Rate Proposal to the Commission. In consideration of operational and capital funding needs, as well as credit rating metrics 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 associated with maintaining credit ratings in the AA-category, PFM has recommended the amount of proposed senior lien debt issuances and mix of debt to pay-as-you-go (PAYGO) capital funding for MSD s projects through FY0. 0 0 Financial Plan Assumptions Q. How was the amount of CIRP to be financed as opposed to cash funded determined? A. The District and PFM developed a financial planning model to assess the District's ability to fund the CIRP in consideration of operational obligations as well as necessary parameters relative to its financial covenants with existing and future bond holders. The model also assumed the District managed its financial obligations to maintain AAcategory credit ratings. Based on these parameters, we then analyzed the District's historical ratio of debt to cash funding for CIRP (0%/0% debt to equity from FY00- FY0) and attempted to maintain a ratio consistent with this, in light of future CIRP funding needs and revenue increase parameters. Consequently, PFM has targeted a debt to cash ratio of approximately 0% debt to 0% cash. This ratio includes both revenue bonds and any state revolving fund ("SRF") obligations of the District. Q. How much is being assumed to be borrowed from the SRF? A. $0 MM in FY, $0 MM in FY then $ MM annually through FY0. Q. What interest rates were assumed? A. PFM assumed interest rates and yields for future District borrowings based on current market rates commensurate with an AA-rated utility revenue credit. To mitigate interest rate risk associated with future issuances, PFM added additional spreads to the yields 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 assumed ranging from approximately 0.0% for the FY0 issuance to.% for the projected bond issuance in FY00. Q. What is the debt service coverage target for senior bonds? A. Based on the District s historical performance and expected required coverage to maintain ratings in the AA-category, senior lien bonds have a projected minimum coverage target of.0x while the minimum total coverage (including senior lien bonds and subordinate SRF obligations) is targeted at.0x. Q0. How were the debt service coverage targets developed? A. Projected minimum coverage targets of.x (senior lien bonds) and.x (inclusive of subordinate obligations) have been identified as the optimal coverage levels needed to maintain AA level bond ratings, thereby ensuring cost effective market access for the District s large capital program. The three major rating agencies that assign ratings to government issuers have communicated expectations related specifically to MSD s future financial performance regarding debt service coverage. Moody s Investors Service has said In MSD's multi-year forecast, projected senior lien debt service coverage ranges between. times and. times, and debt service coverage on all debt ranges between. times and. times.... Our rating outlook assumes that future declines in debt service coverage will be far less than current projections. Further narrowing of coverage and/or increases in capital requirements could pressure credit quality. Source: Moody s Investors Service New Issue Report, Metropolitan St. Louis Sewer District, MO, $0 million Wastewater System Revenue Bonds, Series 0B, dated November, 0 (Exhibit MSD ). 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 From Standard & Poor s, The stable outlook reflects Standard & Poor's expectation that MSD will adjust rates as necessary to maintain strong debt service coverage as it issues additional debt, as well as to generate at least good net revenues to support its large capital program. The strength of the district's service area provides additional rating stability, as does the district's ability to adjust rates as needed. While not expected during the current two-year outlook period, we could lower the rating if the district is not able to maintain at least its good financial position, particularly as it begins to address its capital needs with additional debt. Source: Standard & Poor s Credit Profile Report, Metropolitan St. Louis Sewer District, Missouri; Sewer; $0.0 million Wastewater System Revenue Bonds, Series 0B due 0/0/0, dated November, 0 (Exhibit MSD ). Finally, Fitch Ratings states: Due to the planned borrowings associated with the CIRP and consent decree, total coverage on all outstanding and anticipated debt is projected to be in the.x -.x range and coverage on senior lien debt is projected to be in the.x -.x range for fiscals 0-0. Fitch's rating incorporates the weaker DSC, although any deterioration in financial performance beyond projected levels could result in negative rating action. Source: Fitch Ratings New Issue Report, Metropolitan St. Louis Sewer District, Missouri Sewer System Revenue Bonds, dated November, 0 (Exhibit MSD 0). Q. Besides debt service coverage what other credit rating metrics impacted the proposed debt financing amount? A. The financial planning model was also developed to ensure a minimum amount of days cash on hand of 0 days at a minimum. Days cash on hand is a liquidity metric that 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 measures an entity's ability to meet short-term needs and contingencies. Days cash on hand is calculated by dividing cash and relatively liquid investments by operating expenses (less depreciation) and then dividing by days. Q. Are there any examples of comparable metropolitan sewer utilities experiencing deterioration in bond ratings due to increasing CIRP regulatory requirements? A. On June 0, 0, Moody s Investor Service (Moody s) issued a special comment report, Most US Sewer Utilities Can Weather Costs of Federal EPA CDs, highlighting key observations on the impact of CDs on sewer utilities. In the report, Moody s noted that utilities under CDs often remained highly rated even when the costs were substantial. One of the reasons why ratings remain high is that the Environmental Protection Agency (EPA) takes into consideration the utilities ability to fund upgrades in its settlement agreement. The second reason is that the implementation of the CD is spread out over a period of time thereby giving the systems time to embark on capital improvements and incorporate additional costs into rates. However the report notes that CDs can also sometimes play a role in credit deterioration. CDs often lead to increased operating costs and higher debt burdens and user rates. Complying with a CD is primarily a management challenge, and occasionally systems do not manage capital upgrades or rate increases well. The systems that have sustained the most credit pressure due to CDs are not the ones with the largest settlements but the ones least willing or able to pay for them. As a result, credit pressures can follow from a combination of resistance to rate increases and higher debt which in turn weakens debt service coverage. Moody s analysis of utilities under a CD focuses on an entities willingness to increase rates to meet capital 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 needs and maintain adequate financial margins. The rating agency also focuses on rate payers ability to pay higher rates and the political will to impose such rates. There have been instances in which wastewater credits have been downgraded because of mandated capital improvement programs and/or because they did not raise rates sufficiently enough to cover capital improvement plans. It is important to note that most of these entities with CDs have managed to maintain strong credit ratings. This is a testament to their ability and willingness to manage their increased operating and financial requirements effectively. The District has experienced a downgrade as a result of the CD implementation s impact on debt service coverage among other considerations. Other entities that have experienced ratings downgrades include: Miami-Dade County (FL) Water and Sewer Enterprise, East Baton Rouge (LA) Sewerage Commission, Hampton Roads (VA) Sanitation District, the City of Atlanta, GA, and Jefferson County (AL) Sewer Enterprise. On November, 0, Fitch Ratings ( Fitch ) downgraded the District s revenue debt to AA+ from AAA. The downgrade was as a result of reduced coverage and the likelihood that coverage would remain low because of accelerated capital spending and debt associated with the CIRP and mandated CD. In Fiscal 00, the Metropolitan St. Louis Sewer District s total annual debt service coverage (including senior and subordinate SRF debt) fell to.x from.x in 00. The District s CD with the EPA was executed in July 0 and because of the level of planned borrowing, coverage on all outstanding debt and additional borrowing was projected to be in the.x.x range. Currently, the District s debt is rated AA+ by Fitch. On June, 0, Miami-Dade County s water and sewer system revenue bonds were 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 downgraded to Aa with a stable outlook from Aa by Moody s. The downgrade was based on the system s narrowed projected debt service coverage. The rating reflects the implications of a new CD resulting in a capital borrowing program totaling $. billion through 0. Moody s stated that, The System s credit quality will ultimately be dictated by the ability to fund substantial capital needs while maintaining adequate reserves and coverage levels, and by the county s demonstrated willingness to implement timely and sufficient rate increases to support this sizable program. However, Moody s notes in their June 0, 0 report, county officials have been reluctant to adjust user rates in a timely and sufficient manner in the past. Consequently, net revenues must nearly double in the next decade to cover projected borrowing costs. In the 0 ratings report for the county, Moody s states the stable outlook takes into account the challenges of maintaining adequate debt service coverage and system liquidity, while managing a very extensive and comprehensive capital program. Other issues affecting the system include aging infrastructure and continued compliance with regulatory mandates. On July 0, 0, East Baton Rouge Sewerage Commission s debt was downgraded to Aa from Aa by Moody s. The downgrade was as a result of decreasing debt service coverage and cash reserve position and an increased debt profile due to additional CD driven borrowing. Moody s noted that following the issue of the Series 0A bonds, the system would have.% in hedged variable rate debt as well as significant swap exposure. The Aa rating also reflects the system s expected future borrowing and the use of reserves for the sanitary sewer overflow program developed to address the CD and continued consumer growth. In addition to addressing the needs outlined in its CD, East 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 Baton Rouge was also faced with infrastructure needs related to hurricanes. Moody s expects the system s financial position will face challenges in the future as a result, which will in turn affect the system s financial flexibility. Coverage in Fiscal 00 was approximately.x compared to pro forma coverage of.x in Fiscal 0. This decline was due to doubling in debt service between 00 and 0. According to Moody s, The trend of declining coverage as well as additional borrowing expected to further pressure coverage are key considerations in the ratings downgrade. Similarly on October, 0, Standard & Poor s ( S&P ) downgraded Hampton Roads (VA) Sanitation District s debt to AA+ from AAA in anticipation of exposure to a significant amount of debt to be issued to fund mandated projects. The downgrade reflected the district s agreement to implement a regional wet weather management plan (RWWMP) resulting in projected capital outlays of approximately $. billion in the first years of a 0 year plan. S&P noted the following offsetting credit factors: increased leveraging as well as potentially lower resources available for debt service due to funding certain capital improvements on a pay-as-you-go-basis; diminishing rate raising flexibility due to frequent rate increases for debt service and pay-as-you-go funding that threaten to raise rates beyond affordability levels; and potentially higher than estimated RWWMP costs requiring additional rate increases and debt given its size. As of 0, the district is rated AA+. On December, 00, The City of Atlanta, GA s water and wastewater revenue bonds were downgraded to BBB+ from A- by Fitch. This rating action followed a downgrade to A- from A two weeks earlier. This further downgrade was due to the city s inability to implement rate increases in a timely manner sufficient to fund operations, existing debt 0 Rate Change Proceeding MSD Exhibit No. MSD F 0
Direct Testimony of Bethany Pugh, PFM February, 0 0 0 and CD requirements. Fitch believed it was unlikely for these concerns to be addressed in such a way that would avoid overly burdensome increases to rates. Fitch noted the city council s rejection of the Mayor s proposed rate increases which would have tripled rates by 00. Instead, the city council proposed a smaller increase that would have required an expenditure reduction of about % to meet bond covenants. The Mayor vetoed the council s proposal arguing that such reductions were unsustainable. On April, 00, the rating was revised to A with a stable outlook. On August, 0, Fitch upgraded the city to A+ from A with a stable outlook. Fitch noted as favorable: Financial metrics exhibited considerable improvement in recent years due principally to a series of sizable rate increases, good cost control, and modest growth in consumption. Consequently, both debt service coverage and liquidity now exceed Fitch Ratings rating category medians. More drastically, Jefferson County (AL) Sewer Enterprise suffered a default on its sewer warrants, caused in part by a complex debt structure, lack of compliance with bond covenants and a lack of willingness to increase user rates. It should be noted that this is a unique case, and the particularly risky bond structures used for most of the debt has resulted in criminal charges for some of the individuals involved. On July, 00, Moody s affirmed the Caa with a negative outlook on sewer revenue bonds to reflect the ongoing risk of losses to bondholders. On February, 0, Moody s downgraded the county s obligation to Ca from Caa to reflect the expected loss on the sewer warrant from the trustee s suspension of all payments and insufficient sewer revenues relative to debt service. On January, 0, Moody s withdrew the Ca rating on Jefferson County debt following the county s exit from bankruptcy. The withdrawal follows the issue of new sewer revenue warrants on December 0 to retire all outstanding county sewer 0 Rate Change Proceeding MSD Exhibit No. MSD F
Direct Testimony of Bethany Pugh, PFM February, 0 debt. Q. Does this conclude your testimony? A. Yes. 0 Rate Change Proceeding MSD Exhibit No. MSD F