Modern Financing Methods of Water Companies
Financing With View to the Future—Must Be Able to Keep Up With Growth of Community—The Open-End Mortgage a Big Factor in Problem
IN company with similar movements, the science of water works financing has advanced, and the methods of today are far ahead of those of yesterday. The following article deals with an important phase of this matter, that of the methods by which private water companies are enabled to expand and improve, without subjecting themselves to impossible financial burdens. The “open end” mortgage is the means to this end, and its operation is thoroughly described:
It is only within recent years that bonds of privately owned water companies have been again gradually coming into their much deserved popularity in the investment world. Various causes have contributed to this new interest, the principal among which has been the successful effort of the companies themselves to better their financial and operating positions, the regulation by state public utility commissions, the nation wide propaganda promulgated by a few banking houses primarily interested in water company financing, and last, but certainly not least important, the modernizing of water company mortgages and their adaptation to the requirements of a growing water company.
Old and New Methods of Financing
The common practice of financing, scarcely more than a decade ago, was to provide only for the requirements of the moment, allowing the future to care for itself. A water company with a bonded debt, say of $1,000,000 might have an authorized issue of $1,500,000 first mortgage bonds, and when this limit was reached, by virtue of sale of bonds to partially finance new improvements, it would be necessary to call the issue or resort to second mortgage financing, either of which procedure is always costly. In cases of extraordinary growth of a community, necessitating additions or improvements to a plant, second and even third mortgages were sometimes resorted to.
For instance, in the case of the Birmingham Water Works Company, serving Birmingham, Ala., this company had a total funded debt of $5,025,000, which was represented by four different bond issues put out at various times to partially finance the extraordinary development of the property required to properly serve Birmingham. During the past year, these issues were all called and refinanced by one bond issue secured by one mortgage of a modern type, designed to meet the future developments of the property as well as to take care of the additions to plant and equipment needed at the moment.
This type of mortgage is commonly called “open end” because it permits from time to time, under conservative restrictions, the issuance of bonds under the already existing mortgage to partially cover the cost of new improvements. In this manner it supplants the “closed” type of mortgage, under which bonds only in a fixed authorized amount may be issued. It gives a water company a permanent vehicle for the financing of additions and improvements to property, and is designed to take care of all contingencies. The structure of the closed mortgage is simplified and as a consequence the fixed charges are reduced.
The following companies are among those that have in the past few years “cleaned house,” so to speak, and are to-day equipped with open end mortgages: the Indianapolis Water Company, Birmingham Water Works Company, Huntington Water Company, Spring Valley Water Company, The Wichita Water Company, Spring Brook Water Company, Terre Haute Water Works Company, City Water Company, of Chattanooga, Commonwealth Water Company of N. Jamaica Water Company, East St., Louis & Interurban Water Company, and many others.
Advantages of “Open End” Mortgages
Because of the natural growth of the country within such a short time, together with the high costs during the war, water companies, during the past few years, have found it very difficult to finance necessary improvements. After a period of stagnation, however, water bonds have come into their own. Through the concerted efforts of some of the larger water companies, the bankers, and their determination to build a flexible vehicle of finance, the adoption of the modern open end mortgage has been an advantage to all concerned, company, consumer, and investor.
The company is afforded a method by which it may finance additions and improvements permitting it to keep pace with the ever-increasing demands of the growing community it serves. As this vehicle assumes greater magnitude it becomes more economical, inasmuch as it has been proved that the modern open end mortgage issue of $1,000,000 will command a higher price than will even a first closed mortgage of $500,000 followed by a second mortgage of $500,000.
The consumer benefits in that the water company is equipped to finance economically all additions and improvements such as larger mains, new water supply, and softening or filtration plants, all of which in the long run mean better and cheaper service.
The investor profits in that the company can continue to develop and expand unimpeded by the necessity of refinancing, thus increasing its earnings and being assured, through the rendering of better service, of the continued good will of the consuming public. Instead of financing being accomplished through several small issues with a limited market the open end issue continues to grow in size and marketability and always to the full protection of the investor.
Provisions of Open End Mortgage
The terms of the new open end mortgage usually permit the issuance of bonds under the same mortgage in series often designated as series “A”, series “B”, or as the series of the year of issue, such as series of 1924, or series of 1925. It is possible under this type of mortgage to arrange various series having different interest rates, maturity dates, call features, and tax features to meet market conditions at the time of offering, all having the same security.
The modern mortgage provides that additional bonds may l>e issued for 75% to 80% of the cost or market value, whichever is the lower, of additions and improvements to the property. Additions and improvements can be either in the form of additional equipment to the property or can consist of the acquisition of an entire water property contiguous to that already owned. In the latter case the provisions are usually liberal enough to take care of contingencies such as the acquisition of the property subject to outstanding bonds or non-callable preferred stock. The farseeing operator and banker makes every effort to keep the financial structure as simple as possible as this creates higher credit. It is usually required that net earnings of the property for the preceding twelve months must have been at least 1 3/4 times interest charges .on all bonds outstanding and those proposed to be issued. The net earnings are usually defined as after making conservative deductions for maintenance and taxes (other than Federal).
The mortgage also requires that the issuing company spend, or reserve, for maintenance and improvements “depreciation fund), an amount equal to a fixed percentage of the annual gross earnings. This is usually from 8% to 12%. In the calculation of net earnings it is often required that a certain amount usually from 5% to 7% of gross earnings, be charged to maintenance.
The average open end mortgage provides for the refunding of all underlying bonds (if any outstanding), also those of any other series under the same mortgage; for instance series “B” 6 1/2% bonds may have been issued in 1921 hut could now be replaced in 1925 with 5 1/2% bonds under the same mortgage and to the distinct advantage of the company. These features tend to make the mortgage more secure and flexible.
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Modern Financing Methods of Water Companies
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The Federal Income Tax up to 2% is, in almost all cases, withheld at the source and in a great many bond issues there is a provision for the refunding of such taxes as the Pennsylvania and Connecticut four mills tax, Maryland four and one-half mills tax, the Massachusetts Income Tax not in excess of 6%, to holders upon proper and timely application. This refunding of state taxes is an added selling feature. The expense to the company because of this refunding is slight, as proper and timely application is necessary and often troublesome to the investor.
With falling interest rates high call features have become of less importance. Usually they are placed high enough to insure the investor a fair premium in the event his bonds are called, but at the same time are arranged so that they do not become a burden or a hindrance to the company in its refunding operations. Non-callable public utility bonds are rarely, if ever, issued; the call features vary with the demands of the bond market at the time of issuance. In this connection it is also interesting to note that a great many water bond mortgages provide that in the event that the companies property is purchased by the city, the bonds may become callable at par and interest.
The above provisions are elastic, efficient and economical from the point of view of the company, and still remain a bulwark of safety to the investor. The conservative and enlightened investment banker has the single desire to be of the greatest service to the water company and also to afford every protection to the investor. In the final analysis the interests of the company and the investor are to a great extent identical and under the supervision of competent lawyers and bankers, experienced in the field of water company financing, the utility company, the consumer, and the investor may all be well served.