Fitch Ratings assigns an 'AA-' rating to the bank notes corresponding to Houston, Texas (the city) Combined Utility System's (the system) commercial paper notes as follows: -- $100 million bank notes corresponding to series B-1 commercial paper notes The city will be substituting the current liquidity agreement for the commercial paper notes effective on or around December 16 . In addition, Fitch upgrades the following system-related debt: -- $57.3 million junior lien water and sewer system revenue bonds (senior to the first lien revenue bonds) to 'AA+' from 'AA'; -- $4.2 billion first lien revenue bonds to 'AA' from 'AA-'; -- $428.3 million bank bonds in aggregate corresponding to the first lien revenue refunding bonds, series 2004B bonds to 'AA' from 'AA-;' -- $275 million bank notes in aggregate corresponding to commercial paper notes series B-3, B-4, and B-6 to 'AA-' from 'A+'. The Rating Outlook is Stable. SECURITY The bank notes are secured by a third lien on net revenues of the system. All bonds are special obligations of the city, payable from and secured by a pledge of the net revenues of the system. The junior lien water and sewer system revenue bonds are senior to the first lien revenue bonds and have a closed lien. Reflective of its first priority position in the flow of funds and its closed lien, these bonds are assigned a higher rating. KEY RATING DRIVERS SOUND FINANCIAL METRICS: The rating upgrade reflects an improvement in the system's financial position. A series of recent rate hikes have produced solid operating margins and above-average working capital and liquidity. Flexibility also was enhanced with the recent implementation of a separate fee to support drainage operations. RATES ADJUSTED AUTOMATICALLY: The provision for minimum annual automatic rate adjustments, determined by population growth and inflation measures, provides ongoing revenue increases to keep pace with cost of service. Despite these annual adjustments, rates remain affordable and provide flexibility for additional revisions. SIGNIFICANT CAPITAL NEEDS: The system's capital improvement plan (CIP) remains extensive but is relatively manageable given the system's size and the broad service area. HIGHLY LEVERAGED: The system is highly leveraged and expected to remain so given its large capital plan, which was developed to actively manage the system's ageing infrastructure and growing service area. Despite debt issuance plans, debt per customer and per capita levels are projected to remain relatively stable (although they are considered high). AMPLE WATER SUPPLIES: The system's ample water supplies positioned the service area well during the extreme drought of 2011; operating and financial performance was not adversely affected by the drought. EXPANSIVE SERVICE AREA: The service area has broad and diverse economic underpinnings. RATING SENSITIVITIES FINANCIAL PROFILE BALANCES LEVERAGE: Maintenance of the system's strong balance sheet and adequate coverage ratios are key credit components of the rating given some concern related to the system's high leverage. CREDIT PROFILE The system serves the Houston - Sugar Land - Baytown metropolitan statistical area (MSA), the sixth largest metropolitan statistical area (MSA) in the U.S. and second largest in Texas with an estimated population currently at 6.2 million. Service is provided either directly or indirectly through wholesale contracts with municipalities, water districts, and water authorities. The area economy fared better than many other large U.S. cities during the recession, as relatively high energy prices and a favorable business climate provided some cushion against other recessionary forces. The MSA unemployment rate decreased to 6.1 percent in August 2013 from 6.9 percent a year prior. The MSA's rate is now just marginally lower than the state (6.3 percent) and well below the national average of 7.3 percent. IMPROVED FINANCIAL PROFILE FACILITATED BY MODERATE ANNUAL RATE HIKES In fiscal 2010 management began implementation of rate hikes to support a shift in capital improvements to a 'best practices' approach. However, the increase in capital investment caused a large spike in debt service costs ahead of the full implementation of the rate hikes, resulting in a reduction of debt service coverage and even the utilization of general purpose funds (as permitted by the master bond ordinance) in fiscal years 2009 and 2010. All-in actual debt service coverage exceeded management expectations for both fiscal 2011 and 2012 as the rate increases took effect. All-in coverage at 1.6x for fiscal 2011 and 1.5x for fiscal 2012 is slightly weaker than that of other 'AA' rated credits, but an offset to this lower coverage is the substantial liquidity that the city has built-up. At the close of fiscal 2012, the system had nearly two years' worth of day's cash on hand and 15 months in working capital. Moreover, the flow of funds ends with the accumulation of monies after all obligations are satisfied in the general purpose fund (GPF). The use of the GPF is restricted for system improvements and a limited portion for city drainage purposes. At the close of fiscal 2012, the GPF had a balance of $479 million , up from $250 million in fiscal 2011. City officials estimate the ending balance for fiscal 2013 will be at $508 million and project all-in debt service coverage will remain at 1.5x, as it was in fiscal 2012. The system's updated projections, through fiscal 2018, reflect all-in annual debt service coverage will hover at around 1.4x, which is marginally better than the forecast from July 2012 . It will be important for the system to meet or exceed these projections given the expected operating and capital pressures associated with the system's sizeable CIP. SUBSTANTIAL BUT MANAGEABLE CIP The system's 2014 - 2018 CIP is large due to the age of the infrastructure, expected growth, and the city's strategy shift to make 'best practices' improvements from a regulatory and health standards compliance approach. The $2 billion CIP is forecasted to be partly funded on a pay-go basis (about 17 percent of total funding sources), compared to prior years' plans that entirely debt financed capital improvements. Nevertheless, the amount of additional debt required to meet the CIP funding requirements is a risk considering the system is already highly leveraged. The high leverage was driven partly by ground subsidence issues that forced the system to shift its water reliance from ground water to surface water. The city has ample water supplies and was well positioned during the drought of 2011. Subsequent heavy rainfalls have restored lake levels to normal, and the city remains in a good position regarding water supply. INCREASING SERVICE RATES The 2004 master ordinance provides for automatic rate adjustments based on the regional CPI, which requires no council action. Based on this provision, water and sewer rates increased an average of 2.5 percent annually from fiscal 2006 to 2009 and a 5.1 percent increase, which also included an adjustment for population growth within the city, was implemented for fiscal 2010. Beginning in fiscal 2011, the city revised the inflation component of the annual automatic rate adjustments and also implemented a series of large rate hikes resulting from a cost of service rate study. The monthly residential bill has increased nearly 58 percent from fiscal 2009 levels as a result. Despite the large rate hikes, average residential bills remain very affordable at 1.4 percent of the MSA median household income (MHI) level, well below the Fitch 2 percent MHI affordability threshold. The city is planning another rate study in fiscal 2015 to ensure rates remain in line with rising service costs. DECLINING CUS SUPPORT FOR DRAINAGE In 2010 city's voters approved a charter amendment that provides for improvements to the city's drainage system by imposing separate charges on property owners receiving drainage services; revenues from water and sewer rates had previously funded drainage needs. The city began assessing and collecting the drainage fee in fiscal 2011. Transfers from water and sewer operations remained sizable in fiscal 2011 to support start-up costs of the drainage system, but a declining trend in the transfers is evident in fiscal years 2012 and 2013. The drainage transfers will continue for a number of years to support debt service of previously issued bonds and some operational support, but the establishment of a dedicated fund evidences a commitment to discontinue the subsidy in the long term. BANK NOTES RATING Fitch has reviewed the interest rates, cure periods and amortization schedules specified in the documents governing the bank notes. Under the terms of the reimbursement agreement, the city is required to amortize bank note amounts over a period of approximately three years. While the terms of potential bank notes could pressure the system's financial performance if the entire commercial paper authorization were to become bank notes for a sustained time period, Fitch believes that the system's financial profile and its implied market access to take out such notes with long-term debt mitigate this concern. Additional information is available at 'fitchratings.com '. In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope. Applicable Criteria and Related Research : --'Revenue-Supported Rating Criteria' ( June 12 , 2012); --'U.S. Water and Sewer Revenue Bond Rating Criteria' ( Aug. 3 , 2012); --'2013 Water and Sewer Medians' ( Dec. 5 , 2012); --'2013 Outlook: Water and Sewer Sector' ( Dec. 5 , 2012). Applicable Criteria and Related Research : Revenue-Supported Rating Criteria http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=709499 U.S. Water and Sewer Revenue Bond Rating Criteria http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=715275 2013 Water and Sewer Medians http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=695756 2013 Outlook: Water and Sewer Sector http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=695755 Additional Disclosure Solicitation Status http://fitchratings.com/gws/en/disclosure/ solicitation?pr_id=811080 ((Comments on this story may be sent to firstname.lastname@example.org ))
Most Popular Stories
- Apple, HP, Intel May Take a Hit from Slowdown in Smartphone Sales Growth
- FDIC Files Lawsuit on Behalf of Banks Allegedly Hurt by Libor Scandal
- Some California Cities Seeking Water Independence
- Motley Crue's Nikki Sixx Marries Model Courtney Bingham
- Jack Daniel's Resists Changes to Tenn. Whiskey Law
- Chinese e-Commerce Giant Alibaba Gears for IPO in U.S.
- Crimea Seeks Financial Integration With Russia
- E.U. Puts Sanctions on Russia, Ukraine Officials
- Will Missing Malaysian Jet Prompt Aviation System Change?
- Chile Shaken by Major Aftershock