The City of Allentown, Pennsylvania (City) and the Lehigh County Authority (LCA or Concessionaire) currently operate adjacent utilities responsible for providing water and sewer services to their respective customer bases. LCA provides drinking water services and wastewater services to suburban communities outside of the City through LCA’s existing water and wastewater systems (Existing LCA System). LCA currently obtains potable water from its own wells and also purchases potable water from the City. The majority of LCA’s wastewater is ultimately treated at the City’s Kline’s Island Wastewater Treatment Plant (KIWWTP). The Existing LCA System is currently a water and sewer customer of the City.
The Allentown Water and Sewer Utility System Concession and Lease Agreement between the City and LCA (Concession Agreement) dated as of May 1, 2013, provides for the long-term lease and concession of the Allentown Water Plant and Distribution System and the Allentown Sewer Utility System (Concessioned System) by LCA. LCA, as the Concessionaire, will generally provide all services related to the operation, maintenance, replacement, improvement, administration and management of the Concessioned System for a period of 50 years (subject to earlier termination or extension as provided in the Concession Agreement), pay the City an up-front concession payment of $220 million1, and pay the City an Annual City Payment of
$500,000 (beginning in 2016 and thereafter adjusted annually for inflation in accordance with the Concession Agreement). Management of the City’s storm water system and Retained Water Supply System will remain with the City and is not part of the Concessioned System.
LCA has requested that Malcolm Pirnie Inc., a wholly owned subsidiary of ARCADIS US Inc. (ARCADIS) prepare this Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession (Report). This Report provides an independent review of technical and financial aspects of the Concession Agreement and Sludge Agreement, a Condition Assessment (as defined in Article V) of the Concessioned System, a financial review of the proposed lease transaction, and a
1Preliminary, subject to adjustment.
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
summary of the key conclusions from the Phase I Environmental Assessment performed by ARCADIS. For a complete understanding of the assumptions upon which the opinions in this Report are based, this Report should be read in its entirety.
This Report has been prepared at the request of LCA in connection with the issuance of its Water and Sewer Revenue Bonds, (City of Allentown Concession) Series 2013A, Water and Sewer Capital Appreciation Revenue Bonds, (City of Allentown Concession) Series 2013B, and Water and Sewer Revenue Bonds, (City of Allentown Concession) Series 2013C (Federally Taxable) (collectively the Bonds) to fund the up-front concession payment to the City, fund certain anticipated capital improvements to the Concessioned System, make deposits into reserve and other funds, and fund transaction costs and expenses. Specifics regarding the Bonds can be found in the Preliminary Official Statement issued by LCA. ARCADIS is being paid by LCA to prepare this Report, but payment is not contingent on Bonds being sold or issued.
Section 1.02 Scope and Limitations of Report
The scope of this Report includes:
1. Review of the key technical, engineering and business/financial terms of the Concession Agreement, Sludge Agreement, and operating permits listed in the Concession Agreement (industrial waste permits not reviewed).
2. A description of the Concessioned System, including enumeration of significant components.
3. A Condition Assessment of the Concessioned System based on four days of site visits to the Water Filtration Plant, including the Little Lehigh Creek and the Lehigh River intake structures, Schantz Spring, the KIWWTP, the Federal flood control project in the vicinity of the KIWWTP, 3 reservoirs, 4 storage tanks, and 4 booster pump stations. Site visits performed as part of the Condition Assessment included only limited visual observation of facilities and did not include any engineering analysis of the original designs, surveying, sampling or testing of equipment or water quality, or inspection of retaining walls or tank internals.
4. A review of the operation and maintenance of the Concessioned System, including an assessment of LCA’s approach to operating and staffing the Concessioned System, a review of LCA’s operation and maintenance (O&M) budgets, and assessment of LCA’s capability to operate the Concessioned System.
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
5. A review of the capital improvements included in the Allentown 2013-2017 Capital Improvement Plan (City’s CIP), LCA’s approach to budgeting for capital improvements, key terms of the Concession Agreement related to capital improvements, and potential impact of future regulations on the capital needs of the Concessioned System.
6. A review of the projected capital improvements associated with outstanding and unresolved U.S Environmental Protection Agency (EPA) Administrative Orders against the City (Administrative Orders) and other municipalities and municipal authorities dealing with high flows in the Sewer Utility System during severe wet-weather events.
7. An evaluation of the financial feasibility of the concession and lease undertaking and its ability to generate revenues sufficient to pay the costs of operating and maintaining the Concessioned System, to make necessary capital improvements, and to pay debt service on the Bonds and make required deposits into major maintenance and other reserve funds, as needed to assess the reasonableness of LCA’s financial forecast. The Bonds for the Concessioned System and the projected financial results do not include revenue from the operation of the Existing LCA System, which revenues do not secure the Bonds.
In preparation of this Report and the conclusions contained herein, ARCADIS has relied on certain assumptions and information provided by LCA, the City and others with respect to conditions which may exist or events which may occur in the future.
ARCADIS has not independently verified the accuracy of the information provided by LCA and others. While we believe such sources are reliable and the information obtained to be accurate and appropriate for the analysis undertaken and the conclusions reached herein, as is often the case, there will likely be differences between actual and projected results, some of the estimates used in this Report will not be realized, and unanticipated events and circumstances may occur. Therefore, there are likely to be differences between the data and results projected in this Report and actual results achieved, and those differences may be material. To the extent that the information provided to ARCADIS by LCA and others is not accurate, the conclusions and recommendations contained in this Report may vary and are subject to change.
Any statements in this Report involving estimates or matters of opinion, whether or not so specifically designated, are intended as such, and not as representation of fact. This Report summarizes the work completed up to the date of the issuance of the Report.
Changed conditions occurring or becoming known after such date could affect the material presented to the extent of such changes. ARCADIS has no responsibility for updating this Report for changes that occur after the date of this Report. ARCADIS
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
has not performed a review of the legality of the Concession Agreement or other agreements that may be relevant to the operation of the Concessioned System. LCA has retained McNees Wallace & Nurick LLC as transaction counsel for the concession transaction.
Section 1.03 Key Commercial Agreements and Permits
The Concession Agreement outlines the terms and provisions of the lease/concession structure, capital improvements, operating standards, rate/fee structure, reporting, insurance, regulatory compliance, representations and warranties and other legal and risk allocation provisions, including but not limited to indemnification, default, force majeure, uncontrollable circumstances, cures and remedies, among others. The Concession Agreement is generally consistent with documents of similar nature in the industry with respect to water and wastewater system operations.
Based on a phone discussion with a Pennsylvania Department of Environmental Protection (PADEP) representative in April 2013 and a review of available permitting documents, the City has the requisite permits for operating the Concessioned System.
LCA, as the Systems Operator, will be fully responsible for complying with the terms and conditions of the permits. PADEP and the Delaware River Basin Commission (DRBC) have provided written correspondence indicating which permits will remain with the City as sole permittee and which should have LCA added as a co-permittee within 30 days after Closing. See Section 3.05 of this Report for a discussion on risks related to the issuance of permits.
Section 1.04 System Description
The City owns and operates both a water system and a wastewater system that forms the Concessioned System and currently serve approximately 34,000 customers within the City on a retail basis, as well as much of Lehigh County through various inter-municipal agreements, including inter-inter-municipal agreements with LCA to supply water and provide sewage services to the Existing LCA System.
Water treatment, supply and distribution services are provided directly to City customers. Treatment and supply is also provided to serve most of Salisbury Township, a portion of the water supply for the Existing LCA System, and portions of the water supply for Bethlehem, Whitehall, South Whitehall, and Hanover townships.
The City of Bethlehem has notified the City that it wishes to terminate its municipal service agreement and transition to an emergency interconnection agreement in the
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
fall of 2013. These municipalities and municipal authorities are separately responsible for the distribution systems within their jurisdictions. The City’s water supply system is estimated to serve a total population of approximately 180,000. The City’s water supply consists of a combination of spring and surface water sources. The City operates a water filtration plant to treat water from its surface water sources. The water system includes potable water reservoirs and storage tanks.
The City’s wastewater system serves a population of over 200,000, including the City and, through inter-municipal agreements, the communities of South Whitehall, Salisbury, Coplay Whitehall, Emmaus, and Lower Macungie, as well as the Existing LCA System. The City is responsible for the wastewater collection system within its boundaries and accepts wastewater flow, by agreement, from the inter-municipal communities for transport to and treatment at the City’s KIWWTP. The inter-municipal communities are separately responsible for the wastewater collection systems within their municipal boundaries.
The KIWWTP discharges treated effluent to the Lehigh River. The sewer systems that contribute flow to the KIWWTP allow rain-derived inflow and infiltration (RDII) to leak into the sewers. During certain severe wet-weather events, the amount of RDII that enters sewers can exceed the hydraulic capacity of the sewer system and result in sewage overflows into the environment. This condition has resulted in the EPA issuing to the City two separate Administrative Orders dated September 28, 2007, and September 28, 2009. Both Administrative Orders relate to by-passed flow at the KIWWTP, and sanitary sewer overflows (SSOs) in the collection systems operated by the City and by the adjacent municipalities whose sewage flows to the KIWWTP.
The Concessioned System also includes flood control structures in the vicinity of the KIWWTP, consisting of dikes, levees and floodwalls. These consist of the Federal Flood Protection Project, as well as another levee that surrounds the KIWWTP.
Section 1.05 Condition of Concessioned System
ARCADIS has assessed the condition of the Concessioned System by performing a Condition Assessment that included a limited visual inspection of major components of the Concessioned System (identified in Article V of this Report) over a period of four days in May 2013, reviewing pertinent and available City records, and interviewing key City staff. The purpose of this Condition Assessment was to identify the overall condition of the facilities to determine if they have been operated and maintained in a
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
manner to achieve their intended function and to determine if LCA’s projected capital improvement budgets are aligned with identified needs.
For buried infrastructure (i.e. water distribution pipes and sewage collection system), no field investigations were performed; the Condition Assessment was based on certain performance indicators (i.e. occurrence rate of leaks and overflows) and rates of piping replacement.
Based on the visual observations during the field visits and available data as provided by the City, the majority of the Concessioned System consists of aging components that have been adequately maintained to serve their intended function. All major equipment was in service and functional at the time of the field visits. As noted in the individual sections of this Report, some components of the system require maintenance or replacement in the short term in order to preserve their integrity and proper function.
Section 1.06 Operation and Maintenance Review
ARCADIS performed review of certain City performance metrics against published benchmarks, the Condition Assessment results and available documents related to compliance with permits and drinking water standards. Based on a review of available documents over the 2009 to 2012 time period, the City’s operation of the Concessioned System has been in compliance with permit limits and drinking water standards. The Concessioned System assets have been maintained sufficiently to allow their proper function, and major equipment is operational.
The American Water Works Association (AWWA) has collected benchmarking data from water and wastewater utilities throughout the U.S. and Canada. Table I-A provides a comparison of the City’s metrics (and in some case’s LCA’s proposed metrics) to several key benchmark performance indicators. Current City water and sewer accounts to employee ratios were not included in this table because many City staff currently listed in the City’s Water and Sewer Department are performing activities unrelated to the operation of the water and sewer system; therefore, it would not be appropriate to compare those metrics to the benchmarks. See Section 6.02 of the Report for further explanation.
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
Table I-A: Benchmarking Summary Table
Benchmark
Category Utility Category Top
Quartile Median Bottom
100,001 - 500,000 27.7 52.1 94.2 FY2008: 63.1 FY2009: 62.5 FY2010: 59.4 FY2011: 55 FY2012: 49.4 Combined W & WW 24.1 50.8 112.3
All Utilities 22.9 43.6 78.7
Sewer
All Utilities 629 467 322
Wastewater
All Utilities 749 532 328
Source: Benchmarking Performance Indicators for Water and Wastewater Utilities: 2006 Annual Survey Data and Analyses Report, AWWA
The City’s unaccounted for water has ranged from 24% to 33% over the 2008 to 2012 period. The Pennsylvania Public Utility Commission considers unaccounted for water greater than 20% to be excessive.2 The above performance indicators indicate that the City’s operation of the Concessioned System is in alignment with many utilities in most categories, and there are some potential opportunities for improvement. LCA’s proposed staffing levels are in line with the benchmarks for wastewater and somewhat aggressive with respect to the operation of the water system, indicating LCA may need to re-allocate staff between the water and wastewater systems or add more staff to operate and properly maintain the water system.
252 Pa. Code §65.20(4)
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
Section 1.07 Capital Improvements Program and Future Regulations
Based on information provided to ARCADIS by LCA and the City, ARCADIS reviewed the general scope and budgets for capital projects included in LCA’s financial model to see how well they align with the identified Concessioned System needs and requirements of the Concession Agreement. The projects included in LCA’s financial model include projects listed in the Concession Agreement as Required Capital Improvements, projects that had been listed in the City’s CIP, projects identified by LCA, and projects to address needs identified during the Condition Assessment. In total LCA has included in its financial model approximately $32 million of capital expenditures over the 2013-2017 period. The Concession Agreement also identifies certain projects as Uncompleted Work for which the City shall fund and complete in a timely manner.
Section 1.08 Financial Analysis
ARCADIS reviewed the financial feasibility of the financing related to the Concessioned System as a stand-alone operation without any support from the Existing LCA System.
The analysis was completed to assess the reasonableness of LCA’s financial forecast and the ability of the Concessioned System operations on a stand-alone basis to generate revenues sufficient to provide for the payment of the operating expenses, required maintenance and capital expenses, debt service on the Bonds, and other required deposits under the Concession Agreement, and achieve required financial performance measures, such as debt service coverage and reserves, as well as complying with the Operating Standards set forth in the Concession Agreement. The financial feasibility analysis consisted of:
A review of the financial model and cash flow forecast prepared by LCA for the project, including the reasonableness of LCA’s projected revenues, operating and maintenance costs, and CIP costs.
A review of the key assumptions of the financial model, including system demands, labor costs and proposed staffing, operation and maintenance expenses, planned capital expenditures, capital funding plans, and anticipated lease payments.
A review of LCA’s projected utility rates for the Concessioned System as compared to the rate caps under the Concession Agreement.
An assessment of whether the schedules of Service Charges for each class or type of utility service are affordable and in the generally accepted ranges for such rates.
Independent Engineer’s Report for the Allentown Water and Sewer Utility System Concession
Section 1.09 Conclusions
Set forth below is a summary of the conclusions which ARCADIS has reached regarding its independent review of the Concessioned System, the Concession Agreement, and LCA’s financial model. For a complete understanding of the assumptions upon which these opinions are based and the risks with regard to the Concessioned System that could impact the financial feasibility of the project, this Report should be read in its entirety.
1. The City has the requisite permits to operate the Concessioned System and will remain the sole permitee of the Water and Sewer Systems. LCA, as the Concessioned System Operator, will be fully responsible for complying with the terms and conditions of the permits. PADEP and DRBC have provided written correspondence indicating which permits will remain with the City as sole permittee and which should have LCA added as a co-permittee. PADEP and DRBC may revisit this determination in the future, post-Closing. As part of any future permit re-issuance process, a possibility exists that permit requirements may change.
See Section 3.05 of this Report for a discussion on risks related to the issuance of permits.
2. Based on the Condition Assessment, the Concessioned System assets appear to have been adequately maintained to serve their intended function and the major equipment of the Concessioned System is operationally adequate. As noted in the individual sections of this Report, some components of the Concessioned System require maintenance or replacement in the short term in order to preserve their integrity and proper function. LCA has included reasonable budgets for the costs of these identified short-term maintenance activities in its financial model.
3. Based on a review of available documents over the 2009 to 2012 time period, the Concessioned System consistently produced potable water in compliance with drinking water standards. The Concessioned System is expected to continue to have the capability to produce potable water in compliance with current drinking water standards over the life of the Bonds if operated and maintained in
3. Based on a review of available documents over the 2009 to 2012 time period, the Concessioned System consistently produced potable water in compliance with drinking water standards. The Concessioned System is expected to continue to have the capability to produce potable water in compliance with current drinking water standards over the life of the Bonds if operated and maintained in