News Column

Fitch Rates Tucson, AZ's Water Revs 'AA'; Outlook Stable

May 16, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings assigns an 'AA' rating to the following bonds issued by the city of Tucson, AZ (the city):

--Approximately $34.3 million water system revenue obligations, series 2014.

The bonds are scheduled to sell on June 10. Proceeds will be used to fund improvements and extensions to the city's water system (the system) and to pay costs of issuance.

In addition, Fitch affirms the rating on the city's outstanding bonds as follows:

--$453.4 million in outstanding water system revenue bonds and obligations at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds and obligations are payable from a first lien pledge on the net revenues of the system on parity with the outstanding water revenue bonds and obligations.

KEY RATING DRIVERS

IMPROVED FINANCIAL METRICS: The financial profile of the city's water system (the system) continues to improve, particularly in terms of liquidity.

ELEVATED DEBT PROFILE: Sizeable debt plans will keep the system's debt profile high over the next five years despite rapid amortization. However, at the expected levels, system leveraging should remain satisfactory.

AFFORDABLE RATES: At about 0.8% of median household income (MHI), system rates are considered affordable by Fitch.

SUFFICIENT WATER SUPPLIES: Extensive planning has resulted in sufficient water supply for long-term needs.

ECONOMIC RECOVERY UNDERWAY: Recovery from the severe recession continues at a moderate pace, as evidenced by a number of economically-sensitive indicators. The regional economy remains diverse and relatively stable, with a good mix of higher education, military and government employment.

RATING SENSITIVITIES

MAINTENANCE OF FINANCIAL PROFILE: Failure to maintain debt service coverage (DSC) or liquidity at the minimum forecast levels would likely result in a rating downgrade.

INCREASED DEBT BURDEN: Increased debt beyond current levels could pressure the rating given the already weak debt profile.

CREDIT PROFILE

Tucson, located in south central Arizona, is the second largest city in the state. Tucson's water system provides potable water to about 713,000 area residents via 230,000 metered connections, or 85% of the population within the metropolitan area. Potable water supplies are derived from both groundwater and Colorado River water delivered via the Central Arizona Project (CAP).

IMPROVED FINANCIAL PROFILE

The system's financial performance continues to strengthen after recessionary pressure and capital outlays in fiscal years (FY) 2008 and 2009 resulted in below average DSC and liquidity margins. To regain its footing, the city imposed rate hikes beginning FY 2009 which have resulted in improved metrics in each subsequent year. FY 2013 finished with senior-lien and all-in DSC of 2.0x and 1.7x, respectively, while liquidity climbed to 145 days of cash on hand (which equates to 145 days of operational expenditures), up from just 11 days in FY 2009. FY 2013 DSC and liquidity were at five-year highs, although they are still slightly below Fitch's median levels for the rating category.

Management forecasts show an 8.3% annual rate increase in each of the next five years with resulting DSC ranging from 1.9x-2.2x on a senior-lien and 1.6x-1.8x on a junior-lien basis. Over the same period, the city is targeting liquidity balances equal to 85-90 days of cash on hand. These levels are thin for the rating level, so any results falling below these ranges would likely lead to a rating downgrade. Fitch notes that the city has a policy of maintaining a minimum of 1.75x senior-lien DSC calculated on a cash basis, in accordance with the master indenture.

ELEVATED DEBT BURDEN

The debt load per customer is expected to remain high as the system implements its comprehensive capital improvement plan (CIP). For FYs 2015-2019, the CIP totals $317 million, roughly the same as the previous two years but a favorable decrease from the $410 million CIP put forth in 2009. The city expects to use both existing and future bond proceeds to fund approximately 60% of the CIP; this coupled with the rapid amortization of debt (64% in 10 years) will help to somewhat preserve liquidity.

RATES TO REMAIN AFFORDABLE

The system will need to implement the planned 8.3% annual rate increases to maintain adequate DSC and liquidity since further declines in water consumption are anticipated and capital expenditures are expected to remain high. Nevertheless, current rates are low for the area and are below Fitch's affordability threshold of 1% of MHI, so Fitch expects rates to remain affordable over the intermediate term.

SUFFICIENT WATER SUPPLY

The large majority of the city's potable water supply is derived from Tucson's Clearwater Renewable Resource Facility (Clearwater), which diverts all of the city's purchased CAP water to recharge basins and then recovers a blend of CAP and native groundwater for treatment and distribution. The city also maintains sizable recycled water distribution capabilities.

The city is currently purchasing its maximum annual allotment (144,172 acre-feet) of CAP water and using surplus amounts, which amount to about 54,000 acre feet per year, to replenish groundwater that has been depleted over many decades. Additionally, nationally-recognized conservation efforts have resulted in a net decrease in per capita water utilization over the last decade. Proactive water supply management practices such as these should keep water supply sufficient over the long term.

SOLID ECONOMY; DIVERSE SERVICE AREA

The economy is anchored by government, including military; higher education; medical; and tourism enterprises. Unemployment levels historically have been below those of the state, and the most recent monthly numbers are consistent with that trend. The March 2014 rate of 7% was down from 7.4% recorded in the same period last year, and was below the state (7.3%) and above the U.S. average (6.8%) for the month. Local employment totals also were up for the 12-month period ending in March, registering a 1.4% increase to roughly 228,300 workers. However, employment totals remain well below pre-recession totals while income levels are below state and national averages.

Additional information is available at 'www.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 and the Municipal Advisory Council of Texas.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 3, 2013);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);

--'2014 Water and Sewer Medians' (Dec. 12, 2013);

--'2014 Outlook: Water and Sewer Sector' (Dec. 12, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830560

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Major Parkhust

Director

+1-512-215-3724

Fitch Ratings, Inc.

111 Congress, Suite 2010

Austin, TX 78701

or

Secondary Analyst

Steve Murray

Senior Director

+1-512-215-3729

or

Committee Chairperson

Karen Ribble

Senior Director

+1-415-732-5611

or

Media Relations

Elizabeth Fogerty, +1-212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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