(This is a correction to the release issued earlier today. It provides additional details on the project company.)
Fitch Ratings assigns a rating of 'BBB+' to approximately $69.2 million of tax-exempt sewage sludge disposal revenue bonds issued by the Pennsylvania Economic Development Financing Authority on behalf of Philadelphia Project Finance, LLC. The Rating Outlook is Stable.
The bonds are secured by a pledge of net revenues. The primary revenue source is a monthly service contract payment made by the Philadelphia Water Department (PWD, rated 'A-' by Fitch) through the Philadelphia Municipal Authority (PMA) for services provided by Philadelphia Renewable Bio-Fuels, LLC (PRB). PRB, the project company, is the assignee a precursor entity owned by Len Parker Associates, McKissack and McKissack, and Synagro which was originally awarded the project. PRB is a bankruptcy-remote subsidiary of Synagro. The project sponsor is Synagro Technologies Incorporated. An intergovernmental agreement between PWD and the PMA establishes the service payments as an operating expense of the PWD which is senior to principal and interest payments on its own bonds.
The bonds will finance the construction and commissioning of a municipal sewage sludge (sludge) facility to be owned by PPF and operated by PRB. The facility will dry treated sludge and convert it into pellets classified by environmental law as 'Class A' and suitable for landfill, agriculture and industrial use. Anticipated community benefits include odor reduction, truck traffic reduction, reduced air emissions, and a stable cost profile for the city water department.
The 'BBB+' rating reflects the strength of a 22-year service agreement that matches the life of the bonds and provides a minimum annual volume guarantees from the city. The contract counterparty, PWD, is rated 'A-' and has discretionary rate-making control over its revenues. The drying and pelletization of sludge is a relatively simple process and will be implemented in this instance at a standard scale with proven technology. The project sponsor is experienced but does have a history of community concerns about its plants, as can be expected in the industry. The sponsor has addressed such complaints by upgrading facilities as needed. The debt to equity ratio of 10:1 is moderate for an availability payment-based financing, but the dividend lock-up test of 1.2 times (x) is low.
The most significant risks relate to construction and to potential future regulatory changes. Construction risk is largely mitigated by cash flow from the project company's interim agreement to operate the city of Philadelphia's existing Biosolids Recycling Center. The cash flows from this application are available for application to construction overruns. Annual interim cash flow of approximately $6 million compares favorably with total project costs of approximately $56 million. Construction and equipment contracts also benefit from customary bonding, retainage and liquidated damages provisions. The anticipated operational commencement date of Jan. 1, 2012 is 21 months ahead of the operational commencement date required in the service agreement.
Changes in law regarding pellet utilization, transportation, storage or disposal of sludge could alter the project company's process requirements and cost profile. 'Change in Law' provisions in the service contract that might protect bondholders explicitly exclude changes in local law. Changes in state or federal law may cause disputes between the PWD and the project company regarding payment responsibilities, but are in Fitch's view highly unlikely to interrupt bondholder cash flows.
The minimum guaranteed volume under the service agreement is 49,000 dry tons of sludge per year (DTPY). Historical data indicates likely annual receipt of approximately 60,000 DTPY. The project will earn a fixed capacity charge sized to debt service payments and equity return as well as fixed and variable operating charges. The fixed and variable operating charges are sized to cover all of the plant's anticipated normal operating expenses. The project can, however, incur revenue reductions from PMA if it disposes of any more than 4,000 DTPY without converting it into Class A pellets.
A base case scenario assumes that 60,000 DTPY are processed and that all expenses are passed through according to the formulas in the service agreement. In this scenario, the debt service coverage ratio averages approximately 1.5x during the first 10 years of. In a scenario where the project receives processing revenue from only the contracted minimal volume, the ratio averages 1.4x. An alternative case considers processing revenues from 54,000 DTPY and a 10% operating expense increase that cannot be passed through to the PMA. In this scenario, the ratio falls to 1.2x.
Synagro has focused on the treatment, management, and beneficial reuse of organic residuals for more than 27 years. Synagro owns or operates eight heat-drying facilities, three incinerators, three composting facilities, and more than 60 permanent and mobile dewatering facilities. In 2008, Synagro provided residual management services to more than 600 municipal and industrial customers and generated revenues in excess of $350 million in roughly 35 states, with more than 900 employees. Synagro currently manages in excess of 11,000,000 wet tons of biosolids and other organic byproducts annually. Synagro is a portfolio company of Carlyle Infrastructure Partners, a private equity fund.
A Synagro employee was recently convicted of illegal practices connected with his attempts to win the company a municipal contract in Detroit. The Philadelphia service agreement contains mechanisms for the payment of damages by the company for improper contracting practices but does not specify them as contract termination events.
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