|DC Clean Rivers Project|
Our challenge is clear. We have a $3.8 billion ten-year Capital Improvement Program (CIP) supported by our retail and wholesale ratepayer base in the Washington, DC region. We are at the peak of spending for our CIP now, driving significant yearly rate increases that are well above inflation.
The largest component of the CIP is the DC Clean Rivers Project: a once-in-several lifetimes project to expand fundamentally the capacity of our combined sewer system to reduce by 96% the overflow of a mixture of stormwater and sewage that gushes into our waterways during rainstorms. Clean Rivers will drive the construction of huge deep underground tunnels that will capture and transport the overflow to our mammoth treatment facility at Blue Plains.
The combined sewer overflow (CSO) design dates back to the late 1800s. Our solution will last well into the next century. Our ratepayers are asking why the current generation of customers must pay to solve a problem that spans centuries. Fair question.
|CFO Mark Kim|
Innovation is at the core of our solution. During my interview sixteen months ago with an exciting candidate for Chief Financial Officer – Mark Kim, recruited from New York City with deep investment banking experience in the municipal sector on the private and public side – I asked how he could help with this challenge. He promised a range of new ideas and started describing ultra long-dated debt, green bond investors and more. By the way, we were lucky to hire him – and he has been a whirlwind of innovation and skill on almost every aspect of our financial agenda.
Fast forward to a misty morning in July. The morning started early, perhaps 6:30 am, forty-two stories up looking over the Hudson River. Mist was floating off the River, obscuring at times the boats that were crossing to transport folks to work. I was at the office of Goldman Sachs in New York City preparing for meetings with potential investors. Our first call was with an investment fund from England.
CFO Mark Kim and I quickly reviewed our “road show.” We had taped an audio review of the show that matched the power point slides, which was available on-line. Yet potential investors wanted to meet either in-person or by phone. So we started our presentation during the first call, but were quickly interrupted by a blizzard of questions: about the debt offering, about our financials, about our governance, about our business model. This call ended and the next began, one after the other, some on the phone, some in-person, some at Goldman, some at the co-bookrunner Barclays, some at the offices of potential investors. The roadshow lasted for three days.
Mark told me this was far more intense than the typical road show, matching the intense meetings we had with the three rating agencies: Fitch, Moody’s and Standard & Poor’s. Why the scrutiny? Why so many questions?
There are a hundred answers. One hundred years to be specific, or the maturity of the bonds we planned to issue: century bonds! Of the thousands upon thousands of bond deals done in the United States, only a few dozen had been structured with a one hundred year maturity – and all those were in the higher education sphere or corporate markets. Never has a municipal water utility sought to issue a century bond (D.C. Water Considers First-Ever Century Bond by a Public Utility – Governing Magazine, June 20, 2014).
The answer is also green. In parallel to the century bonds, we were also issuing certified “green” bonds. While a few issuers had issued self-declared green bonds in the last few years, we were the first in the United States to seek a third party certification on the green nature of the work the bond would fund. We sought to bring in SRI funds – or Socially Responsible Investment funds – as new investors to DC Water.
Then the answer comes back to taxes. For a variety of reasons, there is no market for tax-exempt investors at such long duration debt. In order to attract investors to a century bond, we also had to enter the taxable market. Municipalities almost always issue tax-exempt bonds. The taxable (corporate) market does not know us.
So our innovative solution had two firsts and one oddity: 100 year maturity, green certification, and the taxable market for a municipal issuer. The first question we had to overcome is why a green century bond? We have four legs to support the table of our answer:
The deep tunnel system at the core of the Clean Rivers Project is unique in our CIP due to its minimum useful life of 100 years. Our own engineering office and an independent engineering assessment confirms that the minimum life of the tunnels is 100 years, and likely much longer. We are planning to capitalize and depreciate the tunnels over 100 years on our balance sheet once they are completed. By financing the tunnels over 100 years as well, we have matched up this huge asset with its corresponding liability and financing plan.
The Clean Rivers Project solves a problem that dates back to the design of the combined sewer system in the 1880s. Our solution is designed to last a minimum of 100 years. Together, this is a project that is resolving a challenge that has a two-century lifespan. Many ratepayers have asked why a group of citizens from a much shorter time frame (30 or 35-years for more traditional bonds) should pay the cost of this once-in-a-several-generation project. Our view is that spreading out the cost of a project to all the ratepayers who will realize the benefits of the project – by design – is simply fairer to the entire group.
Identifying this bond as a “green” bond would bring to the table a group of investors who are limited to investing in projects that are considered socially responsible. We strongly believe that the tunnels will drive the largest improvement to water quality since the building of Blue Plains. So, with such an unusual issuance, we wanted to be sure as many investors could be brought into the deal as possible – including socially responsible investors.
Three trends have made this type of transaction possible. First, absolute interest rates have fallen to historically low levels. Second, the market is not requiring much of an extra yield premium for taxable bonds. (Of course, DC Water has to pay a higher interest rate in a taxable transaction than tax-exempt, because the bondholder has to pay taxes on the income they receive from us.) Third, the market is also not requiring much of a yield premium to seek a 100-year bond. These characteristics, which are both highly variable and highly unusual, make a 100-year taxable issuance an opportunity in this particular market.
Despite our confidence in the decision, many were initially skeptical about whether we could succeed. Extending a bond out to 100 years has been done perhaps a dozen times recently, but never by a water utility. We also wanted to issue a green bond. Only six bond issuances in the United States have been issued as green bonds – and all were self-declared, which has caused some negative feedback in the media and from environmental groups. We decided to seek a third party certification of the green nature of our bonds. Once again, no municipal issuer – in fact no issuer of any kind – had even pursued a certification for a green bond issuance in the United States!
DC Water’s plan was then to achieve several firsts for the industry: a 100-year bond, a certified green bond, and a municipal 100-year green bond! We had no idea how the market would react, because this was a first in the United States.Our first obstacle was to overcome any skepticism by our rating agencies (Moody’s, Fitch, and Standard and Poor’s). Rating agencies are asked to provide a credit rating covering any new debt by an issuer. When rating agencies provide a rating, though, it is not just for the new debt, but all other outstanding bonds of an enterprise. When a credit rating is lowered, or an issuer is put on notice for a potential downgrade, it is much harder, or at least more
expensive, to borrow money under any terms and conditions.
During the months of April and May, DC Water traveled first to New York City to meet with the rating agencies to discuss our financial plans. We then hosted the agencies at Blue Plains to describe the deal specifically. While we had telegraphed we were interested in a long-dated debt last year, the agencies were still not sure how to evaluate such an unusual issuance. One of the agencies even seemed fairly hostile to the idea, at least at first.
Fortunately, CFO Mark Kim and his team, including our excellent financial advisors at Public Financial Management and our bankers at Goldman and Barclay’s, moved into overdrive and had dozens of conversations with the agencies over several weeks. In the end, the agencies were convinced by the explanation we outline above, and by the financial safeguards and performance we have delivered over the last decade. Just a week or two before we planned to go to market, we had received stable ratings by all the agencies – maintaining our strong credit even in relation to a green century bond!
I must say, I am impressed by the professionalism of the rating agencies and how thorough they are in their work. Our course, I am ultimately pleased they
maintained our strong ratings (third best that is possible for any issuer). But they appropriately evaluated this deal and our financial performance carefully, and were ultimately open to new ideas as long as we could provide sufficient explanations.
Our next step was detailed and exacting work developing a preliminary offering statement (pos) – which is the document investors review to decide whether to invest. We then reviewed our plans with several committees of our Board of Directors, leading to a formal review by the Board at a special retreat and then a final vote. After all these steps, we were ready to go to the market. I must say, DC Water is blessed with a thoughtful and careful Board – which like the rating agencies, engaged with careful due diligence – but was also open to new ideas.
Like a sales plan for any product, we had to market our century bond in a “road show” to potential buyers. Mark and I scheduled this road show for the first week in July, flying out on Sunday evening to Boston to start bright and early Monday morning to meet one-on-one with investors.
Most of these investors are associated with life insurance companies, pension funds or other investment vehicles – and all are experienced and focused on delivering value to their customers. We knew we had a challenge before us to sell a product with no precedent to investors who might not know us – for we had meetings with three investor categories who likely had not considered DC Water before: investors in taxable bonds, investors in century bonds, and investors in green bonds.
Over three days, Mark and I held more than 20 one-on-one meetings with investors, and at times, groups of investors. These meetings were set-up by our crack team from Goldman & Sachs and Barclay’s – joint “bookrunners.” The term comes from the practice, now almost forgotten in the midst of time, of recording potential buy orders from green or blue buy slips in the “book” for the transaction. Of course, this process is electronic now. Goldman and Barclay’s have huge sales forces, working the phones and the internet to set up meetings with interested buyers.
Goldman, and sometimes Barclay, bankers accompanied us in every meeting with investors. Early in the week, Jeff Scruggs, the amiable, experienced and wise lead for the Goldman municipal banking group, predicted that we were likely to go to the market with the offering the next week – but that there was a small chance we might go earlier. That seemed a pretty remote chance at first.
We presented our case. With enthusiasm, thought and care – over and over. We could feel the momentum start to build. One or two meetings were difficult, but we did not falter – we scheduled follow-ups, responded to written questions, prepared further analysis as needed. By the third day of the road show, we had investors seeking to schedule time with us. The chance of an early sale increased.
Thursday early – with the mists rolling off the Hudson – dawned with anticipation. We sat in the Goldman offices with financial data streaming over a huge screen. We met with the Goldman syndicate desk – the folks who actually price the deal – and decided to go to market early. Plus, unrest in the Middle East and a banking problem in Portugal had triggered a “global flight to quality” back into the US treasury market. More demand drives up the price of the treasuries – in the form of lower interest rates. In the bond world, price and yield move in opposite directions! So the higher the price of a bond, the lower its yield. The rate we would set for our bonds is based on a “credit spread” above the US 30 year treasury rate. We started our “price talk” with a credit spread of +155-160 basis points. For those new to the field, each unit of interest rate has 100 basis points. So 160 basis points meant 1 3/5% above the US 30 year rate. We were hovering at or just above 5% for our bonds.
The rest of Thursday was exciting – like a sporting event. Really! The sales forces were contacting buyers, potential investors were indicating an interest of being in the book and at what amount, we were watching treasury interest rates by the minute – changes would drive the cost of the deal up or down substantially. The sale is easier at a higher rate and we can guarantee the interest of investors. But a lower rate would benefit our ratepayers. We calculated that the present value (cost in today’s terms that are spread out throughout the transaction) of each basis point change in interest was approximately $600,000. And remember, there are 100 basis points in every digit of interest.
Finally, in the early afternoon we concluded we had captured the peak of a wave of interest trends and buyer interest and closed the book. The deal was spectacular, better than our highest expectations:
DC Water received almost $1.1 billion dollars in orders for what was originally a $300 million dollar issuance – almost three times the offer. This is a remarkable endorsement. For sober and experienced investors, DC Water is considered a good investment over the time span of 100 years – for its corporate governance, financial management, and operational efficiency. Due to this demand, favorable market conditions, and an awareness of the work that is before us, we decided to increase the transaction by $50 million to $350 million. As noted, DC Water pays an interest rate that is calculated as a premium over the 30-year US treasury rate. Of the few century bond issuers, all in the corporate sector or private universities, the range had been from 140 basis points at the low end to 180 basis points at the high end. We started the day anticipating a 160 basis point “credit spread” over the 30-year benchmark. By the end of the day, we had so many interested buyers that we were able to push down the interest rate by 15 basis points to +145 – equal to the best rates ever achieved for a century bond! Each reduction of a basis point equals about $600,000 in savings for DC Water ratepayers in present value. So 15 basis points saves us nearly $9 million! This rate is also significantly lower than the rate we achieved last year for tax-exempt 35-year bonds, which is extraordinary. DC Water is fortunate to have investors that are new to our credit – from investors in century bonds, investors in taxable bonds, and investors in green bonds. The green bond certification by itself generated almost $100 million in purchase orders.
Wow, what a run! We raised $350 million to finance a project that will yield the most significant water quality improvements to the rivers of the nation’s capital since Blue Plains was built. We saved ratepayer dollars, introduced ourselves to new investors, and spread the cost of a 100 year project over the 100 years of ratepayers who will benefit. We sold certified green bonds.
Yet the most profound messages to me are not just about the sparkling financial attributes. The first is that innovation can, should and must come from every aspect of the water industry. I was fortunate to have the chance to recruit a CFO from outside our industry. Yet Mark has brought a whirlwind of new ideas to DC Water, and in this case, was phenomenal in managing this complex transaction. Second, is that only great teams succeed, for Mark was backed up by Bob Hunt and the entire CFO office, and key employees stepped forward when needed. Carlton Ray stepped up with risk information for a key investor to help win the day. Sarah Neiderer was excellent in helping to shepherd us through the process of a green certification. Third, DC Water and other authorities need the best financial advice available. Dan Hartman and his team at Public Financial Management were absolutely essential and provided wise and steady advice throughout the process.
Finally, the deal is not done without the best investment banking firms. Goldman Sachs and Barclays worked tirelessly to market this transaction to investors. They are good at this – processes refined to a smooth and efficient outcome, managed I must say, by people who are open, friendly, helpful and engaged. And, they know all the investors, and at the critical moment, helped close the deal.
DC Water ratepayers are the most important beneficiary of this innovative financing strategy. DC Water benefits from stars like Mark Kim. DC Water benefits from smarter financing that demonstrates our green credentials.
We have only just begun!
Washington, D.C., “Green” Bond Greeted With Strong Investor Demand – Wall Street Journal, July 10, 2014
D.C. Water Bonds Ride Best Long-Debt Gain Since ’12: Muni Credit – Bloomberg, July 14, 2014
DC Water liquidates green century bonds – Fierce Energy, July 11, 2014