News Column

Fitch Rates Chandler, AZ Water & Sewer Rev Rfdg Bonds 'AA+', Outlook Stable

May 28, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'AA+' rating to the following city of Chandler, Arizona (the city) bonds:

--Approximately $14,800,000 water and sewer revenue refunding bonds, series 2014.

The bonds will be sold through competitive sale during the week of June 9. Proceeds will be used to refund certain outstanding obligations of the system for debt service savings.

Also, Fitch affirms the 'AA+' rating on the following Chandler, AZ bonds:

--$36.5 million water and sewer revenue bonds (pre-refunding).

The Rating Outlook is Stable.

SECURITY

Revenue bonds are secured by the combined net revenues of the water and wastewater system of the city.

KEY RATING DRIVERS

STRONG REVENUE BONDCOVERAGE: Debt service coverage of revenue bonds has averaged 4.0x over the past three years and is expected to become stronger through the remaining life of the bonds (2020).

MORE MODEST OVERALL MARGINS: Net revenues of the system are used to support approximately $400 million general obligation (GO) and excise tax bonds issued for system-related needs, although those bonds are legally secured by tax revenues. All-in debt service coverage has averaged 1.8x over the past three years and is projected by management to range between 1.0x and 1.4x.

LIMITED RATE ACTION: Rate increases were less than assumed in Fitch's last rating review, reflecting stronger operating performance and the delay of certain capital spending. Wastewater rates were increased 9% in fiscal 2014 and water rates were not increased.

AMPLE SYSTEM CAPACITY: Water supplies and wastewater system capacity are adequate to meet current and medium-term needs given the relatively built-out nature of the city.

NO ADDITIONAL REVENUE BONDS: The city expects to finance future system capital needs from excise tax bonds, including new debt of around $165 million in the next year. Revenue bonds account for only 10% of outstanding system-related debt and are the only bonds with a legal claim on system revenues.

RATING SENSITIVITIES

LOWER OVERALL MARGINS: Declines in overall debt service coverage could result in rating pressure.

CREDIT PROFILE

MATURE SERVICE AREA; SOME CONCENTRATION

Chandler is located in the southeastern part of the Phoenix metropolitan area. The system provides retail water and sewer service to approximately 245,000 city residents and wastewater treatment service to the Gila River Indian Community. Water supplies are derived from surface water via the Salt River Project and Central Arizona Project, and 29 groundwater production wells.

Chandler is 85% built-out, leaving limited space for remaining development. Recently, Intel Corporation (Intel) completed a $5 billion fabrication plant expansion and a $300 million research and development facility, which was hoped to generate investment and growth in the area. However, Intel elected not to open the new fabrication plant and it remains shuttered. System investments to serve the expanded fabrication plant were funded through a developer agreement with Intel. Intel's research and development and other operations facilities in the city remain active and are undergoing upgrades.

Management forecasts did not include additional revenue assumptions based on the Intel expansion. The service area does exhibit some concentration in the technology sector, and the top 10 water customers account for 18% of revenues.

LOWER RATE INCREASES THAN ANTICIPATED

Chandler raised rates in 2009 (24% for water and 13% for sewer) and 2011 (8% for water and 11% for sewer). The additional revenues replaced declines in system development (connection) fee revenues due to the economic downturn and also absorbed increasing debt service costs.

The 2011 rate hike was relatively modest, with higher assumed increases in later years. Water rates have not been adjusted since 2011 and, at present, no additional increases are forecasted until fiscal 2018. Sewer rates were increased 9% at the beginning of fiscal 2014 and reclaimed water rates 18%. Additional sewer rate increases are anticipated.

The lack of rate increases in the past couple of years and lower forecasted increases than anticipated in Fitch's 2011 review reflect better than expected financial performance (primarily through lower expenditures), and the delay of certain capital projects. It also may reflect some rate sensitivity, although the combined charge of $50 for the average 12,000 gallon residential is competitive for the region and a very low 0.9% of median household income. Water rates are primarily volumetric (77% of water revenue), resulting in revenues that are highly sensitive to changes in usage patterns. System development charges are levied on new connections.

STRONG REVENUE BOND COVERAGE; MODEST ALL-IN COVERAGE

Revenue bonds continue to enjoy stronger coverage levels, given management's practice and continued intent to use excise tax bonds to finance system capital needs. Revenue bond coverage was 5.2x in fiscal 2013. Coverage should remain above 4.0x through final maturity in 2020.

Fitch includes outstanding system-related GO and excise tax bonds as obligations of the system, given management's stated intent to support these obligations from system revenues. Coverage of all obligations in fiscal 2013 was sound at 1.7x. With $110 million in additional excise tax bonds issued in fiscal 2014 and another $165 million planned in fiscal 2016, coverage of all obligations will decline to between 1.0x-1.4x. Fitch believes management's forecast is conservative and that all-in coverage will likely hover around 1.2x-1.4x.

Remaining cash flow of the system is modest after payment of all obligations. Free cash flow is consistently lower than annual depreciation levels, leaving limited excess revenues for reinvestment in system infrastructure. As a result, capital spending is largely debt-financed (other than improvements paid for by Intel). While typical of a fast-growth system that is financing assets to serve new customers, Fitch expects to see a transition to a more balanced funding of capital replacement from revenues as Chandler moves to a more mature system with capital needs related primarily to asset replacement.

STRONG LIQUIDITY

Cash reserve levels remain strong. The city ended fiscal 2013 with $50 million in operating reserves, or 399 days cash. Given management's plan to finance system capital improvements with excise tax bonds, liquidity levels are expected to remain healthy.

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.

Applicable Criteria and Related Research:

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

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

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Outlook: Water and Sewer Sector' (December 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

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

2014 Outlook: Water and Sewer Sector

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

2014 Water and Sewer Medians

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

U.S. Water and Sewer Revenue Bond Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=831990

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

Teri Wenck, CPA, +1 512-215-3730

Senior Director

Fitch Ratings, Inc.

111 Congress Avenue, Suite 2010

Austin, TX 78701

or

Secondary Analyst

Rebecca Meyer, CFA, CPA, +1 512-215-3733

Director

or

Committee Chairperson

Steve Murray, +1 512-215-3729

Senior Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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