2016 Mass Investor Conference (Part 3): the MWRA

The Massachusetts Water Resources Authority (MWRA) was created by the Massachusetts Water Resources Authority Act, Chapter 372 of the Acts of 1984 of the Commonwealth of Massachusetts.  Its operating territory covers 61 communities (i.e. cities, towns and special purpose entities) in eastern and central Massachusetts.  Within that territory, it serves 5,500 industrial businesses and 2.5 million people, more than 40% of total population of Massachusetts.  51 communities receive the Authority’s water service; while 43 communities connect their local sewer systems to the Authority’s regional sewer collectors and treatment facilities.  The MWRA supplies 215 million gallons of water and treats 315 million gallons of sewage per day.

In fiscal 2016, 95.7% of the MWRA’s revenues came from wholesale rates and charges to served communities.  The city of Boston accounted for 31.2% of the MWRA’s combined water and sewer charges.  These rates and charges are a general obligation of each community, supported by its full faith and credit and payable from all available revenue sources, including retail user charges, real and personal property taxes and local aid from the Commonwealth.  Since its inception, the MWRA has collected all of its rates and charges in the fiscal year when due.

The MWRA is required by law to set its rates and charges at a level sufficient to cover current expenses and debt service.  Under the general resolution authorizing its issuance of debt, it is also required to set rates that provide 1.2 times debt service coverage of senior bond obligations and 1.1 times debt service coverage of total debt (including subordinated debt).  Rate setting is the responsibility of the MWRA’s Board of Directors and rates are not subject to limitations.  Over the past five fiscal years, the average annual increase in rates and charges was 3.4%.

The MWRA recently marked its 30th anniversary, so this was a good time to take note of its accomplishments over the years.

Prior to the MWRA’s formation, there were serious deficiencies in both the water and sewer systems in its operating territory.  In 1982 and 1983, various parties filed civil suits against the MWRA’s predecessor alleging violations of the Massachusetts Clean Water Act due to daily discharges of raw and partially treated sewage into Boston Harbor from Nut and Deer Islands.  The aging pipelines of the MWRA’s water system were leaking millions of gallons of water daily.  On top of this, the water system had little redundancy, leaving it more vulnerable to a service failure in the event of problems with a single pipeline or aqueduct.  Most of the water supply was kept in unprotected reservoirs, with very little covered storage.  Disinfection practices were also crude and inconsistent.

To address these problems, the MWRA embarked on a capital improvement program.  Through 2016, the Authority has spent more than $8 billion on more than a dozen major projects.  About $4 billion was spent to clean up Boston harbor, modernize the Deer Island treatment facility and construct a 9.5 mile tunnel to discharge treated water outside the harbor.  Today, the Boston area’s beaches are as clean as those located in resort areas.

In 2003, the MWRA completed the $0.8 billion MetroWest supply tunnel, a 17.6 mile tunnel that brings water from reservoirs outside Route 495 to Route 128 on its way to Boston metro area communities.  The tunnel replaced an open air aqueduct, which is now being used as a back-up.  Additional projects undertaken by the MWRA over the past three decades include other water system redundancy projects, upgrades and modernization of water treatment plants, construction of seven covered storage tanks (to replace open reservoirs), watershed protection initiatives and the installation of combined sewer overflow (CSO) systems (to provide relief during peak wet weather periods for those systems that handle both sewage and rainwater runoff).

With most of the large system upgrades complete, the Authority began in fiscal 2014 to shift its primary focus to maintenance and long-term water redundancy projects.  Even so, it plans to spend $0.8 billion over the next few years on capital improvements.

The Authority is seeking to head off a potential problem with corroding lead pipes by extending up to $100 million of no-interest loans to communities to remove any remaining lead service lines.  It has also increased lead testing in schools.

The MWRA projects that it will spend $250 million over the next five years to replace older parts of the Deer Island treatment facility.  It would like to add long-term redundancy to portions of the Boston metropolitan tunnel system by building a new tunnel network from around Route 128 into the city of Boston at a cost of $1.4-$1.7 billion over the next 17-23 years.

In recent years, the MWRA has been recognized for improvements in the quality of water and its water operations.  For example, Boston’s tap water was deemed the “best of the best” by the American Water Works Association.  In 2015, the EPS gave the Charles River a grade of “B+.” , up from “D” in 1995.  Its Deer Island Treatment Plant has received the Platinum Peak Performance Award from the National Association of Clean Water Agencies (NACWA) for five consecutive years.  The Platinum award goes to facilities that have maintained pollutant discharges within permitted limits for five consecutive years.  (Thus, Deer Island has not had any permit violations for nine consecutive years.)

The MWRA’s elevated level of capital spending has caused its total debt to increase significantly over the years.  In fiscal 2012, its total debt outstanding peaked at $6.1 billion; but it has since declined to $5.7 billion at the end of fiscal 2016 (June 30).  Since fiscal 2014, the Authority has pursued a policy of reducing its debt by more than its annual capital spending.  Even so, more than 60% of its operating budget is still devoted to debt service.

Through defeasance, refinancings and utilization of reserves, the Authority has limited the growth in its debt service obligations, which in turn has allowed it to limit its rate increases to less than 4% over the past five years.  Despite the high proportion of the budget dedicated to debt service, the MWRA’s outstanding senior debt issues are rated Aa1 by Moody’s, AA+ by Standard & Poor’s and AA+ by Fitch, which are equivalent to those of the Commonwealth.

At June 30, 2016, the MWRA had $5.32 billion of long-term debt outstanding, not including $366 million of net unamortized premium and discounts.  That debt was comprised of the following bond types and issuers:

None of the bonds issued by the MWRA is guaranteed by the Commonwealth of Massachusetts or any of its subdivisions.  Consequently, neither the full faith and credit of the Commonwealth nor its taxing power is pledged for the benefit of the bonds.

The MWRA is also obligated on bonds issued by the Massachusetts Water Pollution Abatement Trust (MWPAT).  MWPAT issues state revolving fund (SRF) bonds under a 1993 program to finance water pollution abatement and drinking water projects.  Proceeds from the issuance of SRF Bonds are loaned to cities and towns within the Commonwealth and also state agencies, such as the MWRA.  All of the MWRA’s debt issued by MWPAT is subordinated to MWRA’s outstanding senior debt.

Most of the MWPAT bonds are backed by pools of community and state agency loans.  Investors in those bonds do not have recourse to the Trust; but rather their recourse is to the borrowers in the pool, including the MWRA. The borrowers in the pool are obligated only for their own loans.  For example, of the $468.4 million of loans backing MWPAT’s State Refunding Bonds, Series 15, which were issued in July 2010, the MWRA accounts for and is obligated on $49.4 million or 10.6% of the total loan pool.  As of June 30, 2016, the MWRA was obligated on $1.04 billion of loans that it had received from MWPAT.

In the general resolution authorizing the issuance of its bonds, MWRA is permitted to pledge as security for those bonds (1) its revenues, (2) any money or securities held in reserve funds (with a few exceptions) and (3) all other monies received by it.  Subordinated bondholders receive the same pledge, except for the debt service and the debt service reserve funds, which are available solely for senior bondholders.  The security interest of the subordinated bondholders is also subordinated to the claims of senior bondholders  Subordinated bonds are rated Aa2 by Moody’s and AA by Fitch, one notch below the ratings on MWRA’s senior debt.

A significant proportion of MWRA’s variable-rate bonds are multi-modal obligations which are subject to repricing in several modes – daily, weekly, commercial paper (1-270 days) and term rate (270+ days).  The remarketing agent on each issue attempts to set a rate that will cause the bonds to trade at par.  In the event that a remarketing is unsuccessful, these multi-modal variable rate bonds often have a fallback interest rate (e.g. 110% of the SIFMA swap index rate).  MWRA also maintains backstop liquidity facilities to repurchase the bonds.  I have not reviewed all of the terms of MWRA outstanding variable-rate bonds.  Potential purchasers should review the remarketing and repricing mechanisms as well as other terms contained in the Official Statements (and related documents) to understand fully the mechanics of MWRA’s variable-rate obligations.

MWRA’s debt levels are high and its debt service requirement covenants are low for AA-rate bonds.  Nevertheless, that higher leverage is mitigated by the high quality of the water and wastewater system (following three decades of capital upgrades), the existence of reserves to cover temporary budget shortfalls and the Authority’s ability to call upon the credit capacity of its customers to meet its operating budget and debt service obligations.  Consequently, the credit risk on MWRA’s outstanding debt is low.

Links to related articles:
Notes and Analysis from the 2016 Mass. Investor Conference – Part 1
2016 Mass Investor Conference (Part 2): the MBTA

Yet, like most high quality municipal water and wastewater systems, the yields on MWRA’s outstanding bonds are quite low, which raises downside risk, especially on the longer-term bonds, in a rising interest rate environment.  MWRA’s variable rate bonds have little or no interest rate risk, but they bear higher credit risk than the senior bonds due to their subordinated position.

February 20, 2017

Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
(908) 448-2246

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