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Summer 2013 Legal Corner

New industry trends include monetization, consolidation

            Many municipalities, both in Pennsylvania and across the country, are monetizing their water and/or sewer systems in an attempt to offload excessive debt and satisfy other outstanding financial liabilities, such as underfunded pension plans. At the same time, municipalities and other political subdivisions have begun to consider the consolidation of their systems into joint-municipal and regional authorities, allowing them to increase system efficiencies through economies of scale while at the same time bringing some measure of rate relief to their customers. This parallels a consolidation trend seen among privately held water companies. While both trends raise issues that must be thoroughly  evaluated, they both are being utilized as solutions to a number of problems faced by municipalities with growing debt obligations and deteriorating critical infrastructure.

 

Allentown concession

            The most recent example in Pennsylvania of the trend towards monetization of municipally-owned water and sewer assets comes by way of Allentown, in Lehigh County. After an extensive, multi-round competitive bidding process, the city awarded a 50-year lease of its water and sewer systems to the Lehigh County Authority for $220 million, edging out offers from several investor-owned entities. In addition, the Lehigh County Authority will pay Allentown an inflation-adjusted royalty payment of $500,000 per year. The city had been seeking royalty payments as high as $2.5 million. Major considerations prompting Allentown to offer its system up for lease include outstanding water and sewer bonds and the city’s pension plans, woefully underfunded by as much as $170 million.

            Allentown’s decision to monetize its water and sewer systems was not without controversy. Concerns were expressed by Lehigh county commissioners and even Allentown city council members regarding what was perceived by some as a “bailout” for Allentown that would tie up valuable city assets and in turn burden the Lehigh County Authority with excessive debt. While Allentown chose to bid out a long-term lease of its assets, it is not uncommon for municipalities to sell the entirety of their utility assets.  Common concerns in these arrangements include the retention of local jobs, the ability to control rates, service quality and the maintenance of operational and technical standards, all of which must be thoroughly anticipated in any well executed plan.

            In choosing to monetize its water and sewer system, Allentown joins the ranks of other communities that have taken a similar approach, including Bayonne, New Jersey and Rialto, California. Bayonne, for example, granted a concession of its water system to a joint-venture between an investor-owned utility and a group of equity investors, which in turn awarded an operations and maintenance contract to the investor-owned utility. This approach allowed for the dual leveraging of outside capital and extensive operational experience to greatly improve the existing system. Rialto has a similar arrangement relying on a public-private concession model. In Texas, the city of Fort Worth recently appointed a task force to address the cost of water service and is considering amongst its options a potential lease of city water system assets.

 

System consolidation

            Not all communities need (or want) to directly monetize their water and sewer assets to pay down current obligations, but many have recognized the efficiencies that may be gained through economies of scale and the combining of operational expertise. This is particularly true in a capital intensive industry that is seen by some as highly fragmented and plagued by inefficiencies. This has led to increased interest in regional consolidation of water and sewer systems, either through the acquisition of small developer-owned community systems or the combination of multiple municipal systems into a single regional authority. In Maryland, for example, Harford County and several municipalities have undertaken extensive studies in considering whether and how to create a joint authority to own and operate the water and sewer assets of the member political subdivisions. By combining their systems and dramatically increasing the overall number of customers, it is hoped that ratepayers will see a decrease in rates, or less than otherwise projected rate increases, while providing better access to the capital needed to invest in system improvements. The Board of Supervisors for Fulton County, New York is also considering a consolidation into a cost-effective regional water and wastewater collection and treatment system as a way to promote economic growth for its constituents.

 

Trends to continue

            Monetization and consolidation of utility assets present numerous significant issues, many of which are highly complex, and each of which must be carefully and thoroughly addressed in the multiple stages of planning and implementation, typically done through a progressive series of coordinated legal, technical and financial assessments. This is especially true when dealing with political subdivisions as opposed to the private sector. In all cases, early stakeholder engagement is essential. Despite the complexities, municipalities are continuing to opt to monetize and/or consolidate their systems. Because it is not expected that the financial plight of municipalities will improve anytime soon, this trend should continue and grow in the future.

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