CHICAGO -- Detroit expected later this week or early next week to price approximately $166.4 million of limited-tax general obligation tax-exempt and taxable bonds through its Economic Development Corp. for pollution control equipment at the city's waste incinerator.
The long-awaited sale of the bonds will coincide with the sale-/lease-backed transaction that may take place this week of the Greater Detroit Resource Recovery Authority incinerator. The incinerator sale will allow a private investor to own the facility for tax credit purposes, while the city and its contractor continue to operate it.
Detroit will receive an immediate payment of $54 million from the facility sale to erase a carry-over budget deficit from fiscal 1990 and 1991.
The planned ownership of the facility by Philip Morris Capital Corp., a private entity, was the reason the Financial Security Assurance-insured deal was split between taxable and tax-exempt debt -- with $125 million of the bonds tax-exempt and approximately $41.4 million taxable.
Thomas Linn, a partner with the law firm of Miller, Canfield, Paddock & Stone, the city's bond counsel, said the city approached the bond issuance as if the facility were already owned by Philip Morris and thereby making the bonds fall under Michigan's private-activity cap. The city was only able to get $125 million of allocation under the state's 1991 private-activity limit.
The possibility of additional allocation in the coming years will transform the taxable portion of the issue into tax-exempt bonds as the allocation is granted.
"The state has made no binding commitments," Mr. Lin explained. "But the city believes there is a likelihood of obtaining [allocation under the] cap in the next couple of years."
Frank Ingrassia, a vice president at Goldman, Sachs & Co., the senior managing underwriter for the deal, said the taxable bonds, under this so-called Cinderella arrangement, will be sold in a limited public offering only to institutional investors. These investors will be obligated to exchange the taxable bonds for tax-exempt bonds once the additional private-activity cap allocation is received.
According to the preliminary official statement, the city's Resource Recovery Authority will choose the maturities for redemption to a tax-exempt security and if needed, will use a lottery to select bonds within the maturities for redemption if a future cap allocation only covers a portion of the outstanding taxable debt.
The statement shows the taxable issue split into two maturities -- 10-year and 18-year term bonds. The tax-exempt portion of the bond issue, which is subjet to the alternative minimum tax, has about $52 million of serial bonds carrying maturities from 1997 to 2003 and $72.9 million of 18-year term bonds.
Security for both the tax-exempt and taxable bonds is provided by what Mr. Ingrassia termed "a double barrel, plus bond insurance." The double barrel involves Detroit's share of distributable state aid, along with its limited-tax GO pledge. Mr. Ingrassia said the direct source of debt service on the bonds will come from the city's share of state aid.
That money will flow through a number of entities -- the city, the resource recovery authority, the facility's contractual operator, and the new owner -- before it reaches the bond trustee, Mr. Linn said.
Mr. Ingrassia said the underwriters were "very comfortable" that the coverage provided by the state aid would be sufficient for the bonds, despite the fact Michigan has had financial problems of its own and may give local governments an increase of only 1.1% this year, compared to 5% in previous years.
In fiscal 1991, the city received an unaudited total of $266.1 million in distributable state aid and has budgeted for more than $45 million in accrued state revenue sharing as well as a 4% increase over last year to reach $313.9 million in fiscal 1992, which began July 1.
"The distributable state aid pledged for the bonds has a coverage of 8.54-times so there is lots of room for deterioration in that [revenue] before there's any kind of concern," Mr. Ingrassia said.
That coverage level also includes debt service required for the $126.4 million of outstanding distributable state aid GO bonds the city issued in November 1989. Mr. Ingrassia said the city could issue more debt with the distributable state aid pledge as long as total debt serviced by that revenue source meets a three-times coverage level.
As for the city's limited-tax GO pledge, Mr. Ingrassia said the city was at its taxing limit "with no room to grow at this point." If that pledge were to come into play, however, debt service payments would become a first budget obligation, payable by general fund money not pledged for other bond issues or restricted by law, according to the preliminary official statement.
Coverage from distributable state aid was a major factor cited by FSA, which is insuring the entire issue.
"We derived a great deal of comfort from that source of revenue," said Suzanne Finnegan, a vice president at the firm, referring to the high coverage levels for the debt.
Mr. Ingrassia said insuring the issue, which is rated Aaa by Moody's Investors Service and is awaiting a rating from Standard & Poor's Corp., was a cost-effective way to get a higher rating, while "homogenizing" the complicated issue for potential bondholders. The city's unenhanced GO debt is rated BBB with a negative outlook by Standard & Poor's and Baa by Moody's.
Co-managers of the tax-exempt bond issue are Smith Barney, Harris Upham & Co.; PaineWebber Inc.' M.R. Beal & Co.; and Merrill Lynch & Co.
The $654 million sale of the incinerator, as well as the issuance of pollution control bonds to bring the facility into compliance with state and federal laws, have been in the works for well over a year, according to Bella Marshall, Detroit's finance director. She said while the city planned to retrofit the incinerator with the pollution control equipment regardless of the sale, the retrofit became an essential element in the sale because the purchaser had to be assured the facility would be in compliance with the law.
J. Chester Johnson, president of Government Finance Associates Inc., the city's financial adviser, said the completion of the bond issue and sale of the incinerator were "critical to the current budgetary operations" of the city.
Officials from Standard & Poor's and Moody's have cited the $54 million the city will receive from the incinerator sale as an important cash infusion for Detroit, which has been the victim of a lingering recession and depressed auto industry. The city, which has depleted its budget stabilization fund in dealing with deficits incurred over the last two fiscal years, also faces a budgetary imbalance of $30 million to $50 million in its $2.12 billion current year budger, according to a recent Standard & Poor's report.
"I think the successful completion of the transaction and the improved condition of the facility through the retrofit proess, including compliance with state regulations, really does position the city from a management perspective to confront some of the additional budgetary pressures that exist," Mr. Johnson said.
To that end, Ms. Marshall said the administration is in the process of putting together a special committee that may involve the help of Lazard Freres & Co. and Felix Rohatyn, one of its partners, to examine policy issues facing Detroit. She pointed out, however, that Government Finance Associates would continue to serve as financial adviser to the city.
Ms. Marshall added that the $54 million in cash from the sale would eliminate the city's known deficit, adding that, "then whatever fiscal problems we have this year will build up over a base of zero."
The remaining $600 million Detroit will receive from the incinerator sale will be set aside to cover the costs of the transaction and to make lease payments to Philip Morris for the facility.