With the number of municipalities in the United States facing budget pressures, it has become increasingly popular to consider addressing these issues by monetizing municipal assets through a sale or long-term lease in public-private (P3) or public-public (P2) partnerships. Historically, however, these deals have been difficult to consummate, and those that have closed have a mixed record of performance.
When the City of Allentown (the “City”) decided that its municipal pension underfunding needed to be addressed through a sale or long term lease of its sewer and water system, it faced a number of the traditional impediments to projects of this type: (i) loss of operational revenue from the system that had been used to cover other budget priorities; (ii) opposition from civic and consumer groups concerned about potential rate spikes and loss of local control of environmentally-sensitive operations; and (iii) labor opposition due to potential job losses and/or degradation of benefit packages. Any one of these issues had, in other communities, derailed potential deals. The City also had to deal with an aging system in need of some significant short-term capital investment but with a stable, although not significantly expanding, rate base.
The City of Allentown’s strategy was to preempt these issues through a bid process that required qualified bidders to address contracting issues up-front, before the bid was awarded. This allowed the City to impose a deal structure (in this case a concession/long-term lease) that (i) provided for both a significant up-front payment and a series of annual payments to insure some level of continuous revenue; (ii) resulted in a reversion of the asset to the municipality at the end of the lease term; (iii) required protection for the union jobs in the form of employment and minimum benefit guaranties; (iv) provided for ongoing monitoring by the City of system operation to insure health and safety; (v) required ongoing capital investments by the concessionaire throughout the term of the concession; and (vi) included caps on allowable rate increases.
The City received 9 applications for pre-qualification and pre-qualified 7 bidders. That group was then invited to comment on a pre-drafted concession agreement and pre-drafted schedule of operating standards (the “Operating Standards”). Interestingly, among the pre-qualified were both Public Utilities (P3) and a county authority (P2), the Lehigh County Authority (“LCA”). Ultimately, preparing a hybrid contract that was capable of addressing the different factual circumstances of both private and public bidders became unworkable. The private bidders did not have pension structures that mirrored the public pension system and were unwilling or unable to create them. LCA, on the other hand, intended to place newly acquired employees into the same state pension system that they were members of when employed by the City. LCA also had statutory standards of operation that it was required to comply with in addition to the contractual obligations mandated by the Operating Standards, although Public Utility Commission jurisdiction was determined not to apply to either a public or private operator under the concession arrangement.
Union opposition to the concession was blunted by the mandated job and benefit guaranties. Consumer groups, while voicing concerns, eventually had to concede that the Operating Standards and rate caps addressed their most significant fears.
LCA had some significant advantages in pricing its bid. As with other P2 deals, there was the structural advantage of being able to borrow for the up-front payment at tax-exempt rates. Additionally, LCA, which operates adjacent municipal systems within the same county, happened itself to be a long-term customer of the City’s water and sewer system and thereby had significant operational knowledge specific to the City system and opportunities to build efficiencies of scale through a regionalization approach.
The bid structure allowed bidders to specify both the amount of the up-front and annual payments ( an annual payment in the range of $ $500,000 to $2,500,000 was specified), and the annual payments were “scored” based on a discounted present value calculation. The top two bidders were then offered a second, “best-and-final” round. Both of the top two bidders in this instance chose to raise their bids. Although LCA proved to be the winning bidder, the P3 bidder that finished second offered a financial package valued within 4% of the winning bid.
At the end of the process, the City was able to achieve an up-front payment in excess of the minimum it required to address its pension funding issues, and an annual payment sufficient to offset its ongoing costs of continued monitoring of the Operating Standards. At completion of the concession term, the City will receive back a substantially rebuilt system at the concessionaire’s cost. Because the concession agreement assumes an on going working relationship between the concessionaire and the City, it is too early to determine whether the concession is an unqualified success. At least in the short-term, the City financial outlook and bond ratings have benefited from the consummation of the concession.
Aurel is the Chief Executive Officer at Lehigh County Authority where he has been employed for 40 years in a variety of positions. He is active in a number of community and professional groups including Boy Scouts of America and the American Water Works Association and is a Past President of PMAA. He is a graduate of Ursinus College and obtained an MBA from Lehigh University.