MSD: DISASTER LOOMING?

A lot of people ask me why I continue to spend so much time on MSD. For me the answer is obvious. We are headng in a bad direction in this City and MSD is a major example of a financial crisis looming. Simply put MSD is heading down the road to financial disaster that WE will all have to pay for.

Take for example my previous story on Jefferson County, Alabama: Louisville News and Politics: EPA Consent decree: Bankruptcy near for Jefferson County . Birmingham, Alabama is one of the first Cities MSD director Bud Schardein always used in prior MSD open public meetings as a model we should follow and were. They have been dropped as a comparsion in recent months since my story came out for obvious reasons.

There is now more to the story according to a report from last month found here: http://money.cnn.com/2008/10/13/news/economy/Birmingham_brink_Whitford.fortune/.

It seems the situation has gotten worse for Jefferson County, Alabama and warrants more oversight of MSD here. Interestingly enough Bud Schardein said that MSD debt was approximately $2 billion in a TV story by Dick Irby http://www.fox41.com/Global/story.asp?S=8274625. The actual debt at that time was closer to $2.8 billion a staggering difference of over $700 million. This is a major oversight by the Director of MSD wouldn't you think?

Accordingly in the most recent MSD meeting at the Southwest Government Center Bud Schardein admitted to $2.4 billion in debt service which is still contradictory to the evidence presented earlier this year. With admitted additional future principal debt of $840 million this would bring the debt service (principal and interest) of over $4 billion.

Jefferson County Alabama got in major financial trouble due to a series of financing gimmicks such as debt swaps, interest rate swaps etc. A quote from the article at CNN:

'Magical stuff'
Why punish yourself, local officials were asked, by paying off high-fixed-rate loans when you can lower your payment with auction-rate and variable-rate securities and hedge your bets with swaps? "Magical stuff," is how David Bronner, CEO of the $35 billion Alabama state pension fund, describes the financing, "You're telling everybody, 'Look how much money you saved,' and you forget the risk side of the equation."

Risk. It is all about the risk. As we are seeing now throughout the Country these shaky risks propositions are causing major financial repercussions not only for us as individuals but as a City as well. And remember when we suffer as individuals where will the money come from to bail out the City? Do we have more to give? I think not.

Another quote from the CNN article:

In the beginning, the people of Jefferson County weren't asking for anything special, just a working sewer system - one that didn't overflow whenever it rained, spilling raw sewage into the creeks that drain the Jones Valley basin where Birmingham lies. Lawsuits by environmentalists forced the issue, and in December 1996, Jefferson County signed a consent decree, agreeing to clean things up within ten years. Early estimates of how much it might cost ranged all the way from $250 million to $1.2 billion. In other words, no one had a clue.

As it happened, even the highest estimates were wildly low.

Sound familiar? You bet. And that is the problem. We must do better than follow the leader and seek new solutions to the upcoming crisis. I leave this for your review from the MSD financial report ended June 30, 2007:

LOUISVILLE AND JEFFERSON COUNTY, KY- METROPOLITAN SEWER DISTRICT (MSD)
COMPREHENSIVE ANNUAL FINANCIAL REPORT
FOR THE FISCAL YEAR ENDED JUNE 30, 2007

Prepared by the Division of Budget and Finance - Marion Gee, Director

( MSD is a component unit of the Louisville, KY Metro Government )

LOUISVILLE AND JEFFERSON COUNTY METROPOLITAN SEWER DISTRICT
NOTES TO THE COMPARATIVE FINANCIAL STATEMENTS FOR THE YEARS ENDED JUNE 30, 2007 AND 2006

http://www.msdlouky.org/aboutmsd/pdfs/cafr2007.pdf

Excerpts:

Page 13
During FY 2007, MSD began offering free wastewater and stormwater service to the Louisville Metro Government. This free service amount to $1.45 million in FY 2007. (The Council approved a 32% rate hike for the rest of us. Free? Nope we pay through an illegal rate scheme to offset the costs.)

Page 17
Other Significant Matters
In April 2005, MSD agreed to enter into a Consent Decree with the Commonwealth of Kentucky’s Environmental and Public Protection Cabinet and the U.S. Environmental Protection Agency. The agreement calls for MSD to design and implement projects within specified deadlines that will eliminate combined sewer overflows in its service area. The cost of the projects has yet to be determined but preliminary estimates range from $500 to $800 million over the next two decades. (Bud Schardein has stated the cost will be $840 million). On August 9, 2007, the Louisville Metro Council authorized MSD to add an EPA Consent Decree surcharge to its bills. Residential customers will pay a surcharge of $6.95 per month

Pages 29 & 41
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
K. Bonds Payable – (Continued)
MSD enters into interest rate swap agreements to modify interest rates on outstanding debt. MSD records the net interest expenditures resulting from these agreements and amortizes gains/losses resulting from the termination of these
(p. 41) The aforementioned swap transactions also expose MSD to basis risk, the risk that arises when variable interest rates on a derivative and an associated bond are based on different indexes.
(NOTE: interest rate swap)
The simplest interest swap is called the "plain vanilla" or "fixed for floating rate swap."
Source: http://richard-wilson.blogspot.com/2006/10/interest-rate-swap-agreement.html
contract in which two counter-parties agree to exchange interest payments of differing character based on an underlying notional principal amount that is never exchanged. There are three types of interest swaps: (1) coupon swaps or exchange of fixed rate for floating rate instruments in the same currency; (2) basis swaps or the exchange of floating rate for floating rate instruments in the same currency; and (3) cross currency interest rate swaps involving the exchange of fixed rate instruments in one currency for floating rate in another. (Source: Dictionary of Banking Terms - http://www.allbusiness.com/glossaries/interest-rate-swap/4944619-1.html)
NOTE 7. BONDS PAYABLE (CONTINUED)

Page 39
The current year retirements of MSD Revenue Bonds totaled $17,250,000.
Amortization of loss on prior refundings totaled $1,420,000.
A schedule of future debt service requirements after June 30, 2007 follows:

Principal Interest Total Year Ending

June 30, 2008 $ 18,190,000 $ 68,923,000 $ 87,113,000

2009 20,825,000 67,890,000 88,715,000

2010 21,795,000 66,898,000 88,693,000

2011 22,770,000 65,892,000 88,662,000

2012 23,815,000 64,824,000 88,639,000

2013-2017 136,950,000 305,702,000 442,652,000

2018-2022 174,665,000 268,935,000 443,600,000

2023-2027 224,835,000 220,880,000 445,715,000

2028-2032 292,450,000 156,533,000 448,983,000

2033-2037 351,635,000 67,607,000 419,242,000

2038 57,355,000 2,845,000 60,200,000

TOTALS $ 1,345,285,000 $ 1,356,929,000 $ 2,702,214,000

$2.7 BILLION Before the Consent Decree is ADDED!

It is interesting to note that in Jefferson County Alabama there have been several indictments over waste and corruption as well. Wonder if the Metro Council and Abramson himself would be indicted since they approve the astronomical rate increases for MSD (32% last year alone!). Could get interesting if no oversight is done soon.

Any questions yet?