Special-Purpose Corporations: An Alternative Funding Strategy

Cities are facing harsh economic times. Many are faced with mega capital improvement programs and rising budget deficits, exacerbated by the fact that limited help is coming from federal and state governments. The U.S. Conference of Mayor?s Water Council reports that water and wastewater spending will be between $2.5 trillion and $4.8 trillion over the next 20 years, yet federal government spending on local infrastructure has been shifted to other areas ? the continuation of national defense strategies and foreign wars, a massive subsidy spend on shoring up our failing economy, and a major shift in health care subsidies. Cities and other agencies responsible for 95 percent of the nation?s water and wastewater infrastructure will have to find new and innovative ways to fill the funding void.

One of the creative methods will include the formation of special purpose corporations into which the water and sewer assets will be transferred. The corporations will be jointly owned by the sponsoring city and a private sector partner that will share in ownership responsibility as well as its benefits as a true equity partner. Although this model has been used in Europe and Canada, this model has never been used in the United States.

Cities would be rewarded in several ways as a result of creating these true public-private partnerships. First it would be able to isolate the debt associated with the mega water and wastewater liabilities away from the city?s normal credit facility. By creating a stand-alone utility with its own capitalization, it will look very much like an investor-owned utility to the debt and equity capital investor. It will have its own revenue stream and be accountable for its own operating expenses and the credit agencies will measure its credit worthiness based its individual ability to manage its operations in an effective and profitable way. This will afford the cities a reasonable chance of the continuation of other social services without the spillover effect of these massive programs.

Second, the cities will have an opportunity to monetize their water and wastewater assets, which up to this point have provided very little benefit to city?s economic health. Such capital restructuring could benefit the cities? general fund, eliminating some, if not all, of their structured deficits, including under-funded pension liabilities. And finally, cities would share in the same dividend stream that their private investment partner would receive, providing an adequate return for their investment, something that most cities have never realized.

This is not a privatization initiative. If so desired, a city would continue to employ and maintain operational responsibility, receiving cash from the utility to pay salaries and benefits to their employees.

Cities may be concerned about who the equity partner may be and whether it would continue to maintain control. In order to preserve all the attributes of a city-owned utility, including issuance of tax exempt debt, eligibility for grant or low interest government loans, it would be limited in selling only up to 49 percent of the outstanding shares of stock at any time. In addition, it will have the right to choose its equity partner in a private placement. Interestingly enough, the investor pool that is demanding this form of investment opportunity most often are pension plans, including those owned by the same municipalities that are looking for funding options. It would certainly bring about much public good by allowing the underfunded pension plan to invest in its municipal infrastructure.

Our federal tax laws need to be amended to allow the formation of these corporations, although there is some thought that limiting the private investor to municipal pension plans may require may require minimal changes. But even that capital source is limited and we need to expand the investor base to include all potential equity investors. Now is the time for our government agencies to put laws in place that will help our cities help themselves. The proposed special purpose corporation will allow cities to manage their water and wastewater infrastructure as investments that need to be protected, repaired and replaced, not run to the ground for want of funding.

Richard Splete, CPA, is Principal/Financial and Administrative Management for MWH. He has 35 years of financial and management experience focused primarily on municipal water and wastewater utilities. He has provided leadership to strategic planning initiatives, shaping utilities to meet aggressive financial goals.

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