Indianapolis Department of Waterworks and Indiana Utility Regulatory Commission and Veolia and Water and Utilities and Government and Government services

Indianapolis Waterworks' rate hike request excessive, critics say

May 11, 2009
Customer groups say an 18-percent rate hike sought by the Indianapolis Department of Waterworks is excessive even for a utility drowning in variable-rate bond debt that's swelled since financial markets collapsed.

The Indiana Utility Regulatory Commission is weighing the department's request filed in February to tap customers for an additional $22 million in the wake of soaring interest costs and penalties tied to variable-rate bonds that were used to complete capital projects in recent years.

While acknowledging the department faces financial strain, both the state's Office of Utility Consumer Counselor and the Indianapolis Water Industrial Group, which includes giant water users such as National Starch and Rolls-Royce Corp., say there are leaks in the department's case for emergency relief.

A consultant for the industrials has opined that the utility isn't justified to more than a 7.7-percent, or $9.4 million, rate increase.

Industrials said in filings with the commission that the department underestimates projections for water revenue in 2009, basing them on the unusually low volumes of last year.

They also argue that the department's essential capital expenditures for 2009, planned at $12.3 million, are higher than in recent years, when the budget for those projects ranged from $6 million to $10 million.

The department said it already slashed its planned capital expenditures and insists that those remaining on the list are critical to ensure system reliability.

Industrials also question a proposed increase in management fees for Veolia, the French company the department hired to operate the city-owned water system. The proposed $2.5 million, or 5 percent, increase in management fees are not necessary, industrial customers say.

Meanwhile, the OUCC argues the water utility's rate-hike request lacks supporting data to determine exactly what level of relief is necessary. It suggests the utility might draw from its $26 million in cash reserves instead of tapping customers.

"It is possible that the department has sufficient cash on hand that could eliminate or substantially reduce the need for emergency relief," wrote Edward R. Kaufman, a senior analyst for the OUCC.

The department counters that it is restricted in the use of its cash reserve fund. If the department cannot tap the cash reserves, then a 3.5-percent rate hike would be more in order, according to one scenario presented by the OUCC.

The utility's proposed 18-percent rate increase would, for the average residential customer using 7,000 gallons a month, increase a water bill by $4.43.

In commission filings, industrial customers did not break out how the rate increase would affect them financially. The amount is substantial for big water users, said Bette Dodd, an attorney at Lewis & Kappes, the law firm representing the companies.

The proposed increase is particularly hard to swallow because it's not necessary for fixing infrastructure or boosting capacity; it's to pay the penalty for a dubious bond strategy.

The effect of that strategy on the water company in 2008: total debt service rose to $57.2 million last year from $31 million in 2007.

In 2005, in what looked like a smart way to free up $45 million in extra cash for capital projects, the department, through the Indianapolis Bond Bank, converted fixed-rate bonds to variable-rate with such abandon that, today, variable-rate bonds account for nearly 60 percent of its $845 million in outstanding bonds.

Bond swaps intended to mitigate the risk of interest rate variations failed to backstop the risk as financial firms involved in the deal collapsed or saw their credit ratings plunge.

The result was interest rates that rose from 3.5 percent to 9.5 percent, triggering accelerated repayments that could cost the water department $51 million this year alone.

To meet that accelerated schedule, water rates would need to rise at least 30 percent—on top of the 18-percent increase sought, according to the utility.

The proposed solution is to convert the variable rate debt to fixed—at a cost of $60 million to $90 million that would be spread over 30 years.

The OUCC contends that the department hasn't adequately explained how or why its intended refinancing is cost-effective given the likelihood current market conditions will ease.

"The department requests the commission provide extraordinary relief and charge the ratepayers more than $100 million without a thorough explanation of the costs to fix its current problems," wrote OUCC analyst Kaufman.

"There are no shareholders to bear the cost of these mistakes, so millions of dollars will now be borne by the ratepayers. Hindsight is 20-20, but the department's excessive use of variable rate debt exposed taxpayers to unnecessary and inordinate risk."

But the stance by the customer advocates brought a warning from Kevin D. Taylor, executive director of the Indianapolis Local Public Improvement Bond Bank.

He told the commission on May 1 that, without the relief, the department faces the possibility of another credit downgrade by Moody's Investors Service. Late last month, Moody's placed the rating of the utility's $845 million of outstanding revenue debt on review for possible downgrade.

"If emergency relief is denied or materially less than requested, the department could suffer catastrophic injury to its financial position, its market perception and its future market access," Taylor said.

"It is necessary to realize that any financing carrying the Indianapolis name, regardless of whether it concerns the department, would be brought into question."

The utility's variable-rate bond debt of nearly 60 percent contrasts with the "general rule of thumb" of 10-percent to 20-percent variable rate for a utility of this sort, Taylor said in filings with the commission.

Yet the riskier, variable-rate bonds "likely were hard to ignore" when the utility was trying to raise cash, said Taylor, who arrived at the bond bank after the deals were struck.

He suggested the water company at the time was under additional pressure to keep expenses low, noting that, as part of the department's 2002 purchase of Indianapolis Water from Merrillville-based NiSource, the department agreed to freeze rates for five years. The variable-rate bonds were issued starting in 2005, during the water rate freeze.

"The department likely was under considerable pressure to keep costs at a minimum and variable rate bonds would have been a good vehicle to keep interest expense as low as possible when the bonds were issued," Taylor said.

Then came the deterioration of credit markets, something that would have been deemed "a very remote risk" when the variable rate bonds were issued, he added. 
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