NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'A+' rating to the following the Philadelphia, PA (the city) revenue bonds:
--Approximately $71 million water and wastewater revenue refunding bonds, series 2012.
The city expects to sell the bonds in a negotiated sale on Oct. 24. Proceeds of the series 2012 bonds will refund outstanding parity debt (series 2001A and series 2001B) for a net present value savings estimated at 13.5% of the refunded bonds with no extension of maturity dates.
In addition, Fitch affirms the following ratings:
--$1.6 billion in outstanding water and wastewater revenue bonds at 'A+'.
The Rating Outlook is Stable.
The series 2012 bonds and outstanding parity bonds are secured by a senior lien on combined net revenues of the city's water and sewer system. The series 2012 bonds will have a cash funded debt service reserve funded at the maximum annual debt service amount.
KEY RATING DRIVERS
ESSENTIAL SERVICE: The city's combined water and wastewater system (the system) provides an essential service to a large and diverse service area.
SOUND MANAGEMENT AND STABLE OPERATIONS: Financial performance is satisfactory for the rating category. Operating margins generate narrow but consistent debt service coverage levels that are somewhat mitigated by a sound level of liquidity and affordable rates.
ELEVATED DEBT LEVELS: Debt levels are moderately high and sizeable additional borrowing plans are expected over the medium term. Escalation of debt levels beyond what is currently included in the six-year capital improvement plan (CIP) would likely pressure the current rating.
LARGE CAPITAL PLAN: The capital program remains sizeable, although required projects stemming from a consent order do not appear onerous.
PROPOSED CHANGE IN RATING SETTING: Voter passage of a ballot referendum in November 2012 would provide city council with the option of creating an independent board authorized to establish water and sewer rates and charges. While the change would likely add a level of political risk to the rate setting process, Fitch views the shift as credit neutral.
BELOW-AVERAGE ECONOMIC CHARACTERISTICS: The service area exhibits weak income levels and high unemployment, which contributes to chronically below-average collection rates. This weakness is mitigated to a degree by the city's role as a regional economic center.
AMPLE CAPACITY: Water supply and overall system treatment capacity are sufficient for the foreseeable future.
LARGE, DIVERSE CUSTOMER BASE
The water system serves a diverse customer base consisting of the 1.5 million residents of the city as well as an additional 150,000 people in neighboring Bucks, Montgomery and Delaware Counties (Fitch rates Montgomery County's general obligation [GO] bonds 'AAA' with a Stable Outlook). Of the nearly 480,000 water customer accounts, the vast majority are residential (83%) and the 10 largest users account for just 13% of total billings.
The wastewater system serves a more expansive area that includes an estimated population of nearly 2.2 million people. In addition to retail service, the city maintains 11 wholesale agreements for wastewater service and two wholesale contracts for water service with customers outside of the city. In total, wholesale revenues accounted for a moderate 7% of total system revenues in fiscal 2011. All wholesale agreements are current and management does not anticipate future departures of wholesale customers.
Average daily water demand is comfortably below permitted water supply and treatment capacity at all facilities, and daily wastewater flows are well within treatment plant permit limits. Available water supply is sufficient for the foreseeable future, although significant water loss persists. Unauthorized consumption was reduced by a notable 40% during the 1990s, but progress has since stalled as non-revenue water has averaged about 30% annually over the last 10 years.
Below-average collection rates continue to be a key credit concern. On a current basis annual collections typically average 87%. Delinquent collections are recovered through an enforcement process and property tax lien sales, but both are only somewhat effective as total collections approximate 97%. Management conservatively budgets for an 85% collection rate of current year revenues and a nominal percentage of delinquent charges.
SOUND FINANCIAL MANAGEMENT
Fitch believes the system's financial operations are well managed, despite historically tight debt service coverage levels. Management continues to budget to meet its bond-required rate covenant of 1.2 times (x) senior annual debt service (ADS), although actual results typically outperform budgeted expectations. Net revenues covered all-in ADS by 1.4x in fiscal 2011 and available liquidity, which includes a rate stabilization fund (RSF), remained in excess of 250 days cash on hand. Both metrics are acceptable for the rating category.
Affordable user charges provide the system with ample flexibility. Yearly rate increases have averaged a manageable 5.5% since 2002, leaving the average combined water and sewer bill currently equal to a moderate 1.6% of median household income (MHI). Including the city's stormwater fee (levied according to the amount of impervious area a rate-payer owns), monthly charges rise to what Fitch considers above average at 2.1% of MHI. Nonetheless, the system's charges remain affordable in comparison to regional water and sewer systems.
Projected results through fiscal 2018 appear achievable in Fitch's view. Based on annual rate hikes of 4.5% through fiscal 2016 and 5% thereafter through 2018, debt service coverage ramps up slightly--driven in part by management's revised targeted minimum coverage level of 1.3x senior lien ADS. Financial projections conservatively assume no growth in customer accounts, wage increases ranging from 1%-3% annually, and an average increase in operating expenditures of about 3.5%. Similar to prior forecasts, sizeable outflows from the RSF are projected through fiscal 2016. However, Fitch believes actual results will continue to outperform budgeted expectations, leaving liquidity intact.
ENVIRONMENTAL REGULATIONS DRIVE LARGE CAPITAL PROGRAM
After several years of negotiations, the Pennsylvania Department of Environmental Protection (PA DEP) and the city signed a consent order and agreement (the COA) in June 2011 requiring the city to substantially eliminate combined sewer overflows (CSOs) over the next 25 years. To comply with the COA, the city is employing its Green City, Clean Waters Program (the program), which will utilize largely green technologies to capture rainwater runoff that would otherwise infiltrate and overwhelm the system's sewer system. The program also offers a credit to customers willing to reduce the amount of impervious area on their property in favor of more green space.
Compliance with the COA will require the city to spend approximately $2.4 billion over the next 25 years. The program also includes wastewater treatment facility enhancements and pipe renewal and replacement. Fitch views the program favorably, considering alternative strategies to mitigate CSOs (including the construction of tunnels and storage tanks) would cost substantially more.
Including the COA, projected capital spending through fiscal 2018 totals $1.5 billion, about 80% of which will be debt funded with the current offering and additional yearly borrowings between fiscals 2014-2018. Pay-out of existing debt is above average for a utility system. Descending annual debt service requirements will allow future issuances to be structured in a way that should not prompt a material increase in annual debt carrying costs beyond current levels.
Debt levels are elevated compared to similarly rated systems, although relative to other large, older urban systems debt levels are more in the moderate range. Debt/net plant (90%) and all-in debt service as a percentage of gross revenues (33%) have remained consistent with prior years, but will increase going forward with the expected $1.3 billion in additional borrowing by 2018. Despite the rapid payout rate of existing debt, Fitch expects a roughly 35% increase in the amount of debt outstanding by 2018--based the current CIP and adjusting for principal amortization.
ECONOMIC IMPORTANCE OF THE CITY OFFSETS WEAK SOCIOECONOMIC INDICATORS
Philadelphia, as both a city and county and with an estimated population of almost 1.5 million residents, benefits from its role as a regional economic center with a stable employment base weighted in the higher education and healthcare sectors. The city's August 2012 unemployment rate of 11.5% remains unchanged from one year prior and is notably higher than the broader MSA (9%) and the state (8.2%) averages. The city's poverty rate remains high at close to 25%, and income levels on both a per capita and median household level are just 75% of the state and national averages. Socioeconomic indicators for the surrounding counties are notably stronger.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in the U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and Burton & Associates (Rate Consultants).
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'Water and Sewer Revenue Bond Rating Guidelines' (Aug. 3, 2012);
--'2012 Water and Sewer Medians' (Dec. 8, 2011);
--'2012 Outlook: Water and Sewer Sector' (Dec. 8, 2011).
Applicable Criteria and Related Research:
2012 Water and Sewer Medians
2012 Outlook: Water and Sewer Sector
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
Christopher Hessenthaler, +1 212-908-0773
One State Street Plaza
New York, NY 10004
Andrew DeStefano, +1 212-908-0284
Steve Murray, +1 512-215-3729
Elizabeth Fogerty, +1 212-908-0526
Source: Fitch Ratings