Fitch Affirms New Orleans, LA Sewerage & Water Board Bonds at 'BBB'; Drainage Affirmed at 'A-' [Professional Services Close - Up]
(Professional Services Close - Up Via Acquire Media NewsEdge) Fitch Ratings affirms the ratings on the following New Orleans, LA (the city) utility bonds issued on behalf of the New Orleans Sewerage and Water Board (the board):
--$148.6 million sewerage service revenue bonds at 'BBB';
--$30.1 million water system revenue bonds at 'BBB'.
The Rating Outlook is Stable.
Fitch affirms the 'A-' rating with a Stable Outlook on $17.7 million outstanding drainage system bonds, secured by a limited ad valorem tax. The board is currently reviewing its financial plan for the system, which is likely to include a notable increase in debt secured by the ad valorem tax but also new revenue sources to fund operations. Fitch will review the plan once available which is expected in early 2014 with the first debt issuance under the plan.
The sewerage service revenue bonds are secured by a net pledge of revenues of the board's sewer utility system. The water revenue bonds are secured by a net pledge of revenues of the board's water utility system.
KEY RATING DRIVERS
APPROVED RATE PACKAGE: Annual 10 percent rate increases for both the water and sewer utilities that began in 2013 and are approved to continue through 2020 are expected to support prudent operating levels and begin to fund the most critical of a large array of capital needs.
ADEQUATE FINANCIAL MARGINS; PRESSURES REMAIN: Each system exhibits modest but adequate financial margins but faces capital and operating pressure. Fitch expects annual rate increases and active expenditure management to sustain a minimum of 1.5x revenue bond coverage and restore liquidity to the policy minimum.
MASSIVE CAPITAL NEEDS: Capital needs for all three systems are extremely large following decades of deferred investment prior to Hurricane Katrina (Katrina) in 2005 in addition to repairs needed after the hurricane. The task of funding the needed improvements will remain daunting for an extended period.
POSITIVE CUSTOMER RECOVERY TREND: Economic recovery from the recession as well as Katrina and the 2010 Gulf of Mexico oil spill continues. Customer connections, sales tax revenues, and employment all continue to trend up.
NEW BOARD SHOULD BE CREDIT NEUTRAL: A new board will be seated in 2014 with eight new members of an 11 member Board. The governance changes were recommended as part of the 2012 rate package and were approved by voters, the city council and the state legislature. Fitch believes the new Board will continue to support the existing financial plan given the extensive process that occurred over the past few years to agree upon the rate package.
PLAN MANAGEMENT: The Board's management of planned operating expenditure increases, capital spending, and financial metrics within the parameters assumed in the financial plan and rate package is fundamental to long-term rating stability.
REVENUE SUPPORT PROVIDED BY EIGHT YEAR RATE PACKAGE
The Board received approval in November 2012 for an eight-year rate package for the water and sewer systems. The package was approved after extensive community discussion and consideration by the Board's multiple layers of rate regulation. Annual rate increases of 10 percent for each system will be implemented on Jan. 1, through Jan. 1, 2020.
Fitch views the rate increases positively in that they are expected to restore financial metrics to stable levels, replenish operating reserves, restore operating expenditures reduced dramatically by customer losses after Hurricane Katrina, and support anticipated new debt costs. The rate package also proposed changes to the governance structure of the Board of Directors. The changes reduced the number of Board members, removed City Council members from serving on the Board and added citizen appointments, reduced term lengths, and limited members from serving consecutive terms.
The approved rate package was the culmination of a multi-year effort to identify and implement the appropriate level of rate increases, given the large scope of system needs. Following rate covenant violations in 2008 and 2009, the Board conducted a comprehensive financial plan and rate study. Results of the study were available in late 2011 and included sizable recommended rate increases by consultants (14-15 percent over the next five years) to address system demands. While the 10 percent rate increases are lower than the original rate study recommendations, the revenues will be achieved over eight years of increases by delaying certain capital spending.
Combined water and sewer rates result in a high average bill at 2.5 percent of median household income. High rates, combined with the likelihood that there will be limited political support for additional rate increases within the next eight years beyond the already approved 10 percent, results in limited future rate flexibility.
IMPROVED WATER SYSTEM FINANCIAL PERFORMANCE
A steady return of customers since 2008 and a series of annual rate increases implemented between fiscals 2007 and 2011 and 2013 have bolstered system revenues. Combined with significant cost controls, the financial metrics have improved from very poor levels in 2008 and prior. Water system debt service coverage was over 4.0 times (x) in FY12 and FY11, a marked improvement from years immediately after Katrina. Excess cash flow has been used to repay intra-fund loans from the sewer and drainage funds.
Water system cash levels at FY12 year-end were slightly negative, reflecting full repayment of the cash loan from the sewer fund. However, the overall cash position has improved when the water, sewer and drainage funds are considered together. Reclassification of certain restricted funds as unrestricted in the fiscal 2013 audit will improve reported cash levels significantly. The more appropriate consideration of unrestricted capital funds will allow the utility to achieve the 180 days cash goal in fiscal 2014 with continuous increases to cash balances expected thereafter.
The Board expects to issue between $55-$70 million annually of additional water bonds through 2018. Fitch expects the debt burden to go from low to above average over that period, although additional debt issuance is likely to continue at a rapid pace after 2018, given the magnitude of needs. Management's ability to achieve/ maintain forecasted senior revenue bond debt service coverage at the Board's policy threshold of 1.5x is a key rating factor. No pay-go capital financing is planned for the water system in the next five years with all of the capital needs being debt financed.
HEALTHY SEWER SYSTEM FINANCIAL PERFORMANCE
The sewer system financial profile has stabilized. A lack of rate increases over the past five years and reallocation of administrative costs to the sewer fund resulted in weak performance in fiscals 2008 and 2009. Senior debt service coverage improved to over 1.3x in fiscals 2010-2012, largely based on expenditure reductions. Cash reserves at the end of FY12 were $9.5 million, equal to 77 days. Reclassification of unrestricted capital reserves is expected to increase reserves to above the 180 days cash target in FY13.
The board also plans for significant sewer fund annual debt issuance beginning in FY14. Fitch expects future debt service coverage levels to remain above 2.0x on senior lien debt. Unlike the water system, some pay-go capital spending is planned to fund around 35 percent of capital needs in the next five years.
EXTREMELY LARGE CAPITAL NEEDS
All three systems have a long list of capital needs. The rate consultant used a methodology to prioritize the needed capital spending and placed the most critical elements into the 10-year recommended capital plan. Estimated capital costs for the water system through fiscal 2018 total around $476 million, while costs for the sewer and drainage systems during this period total $324 million and $891 million, respectively.
A portion of the funding for drainage projects will be financed with federal monies. Approximately $135 million of the sewer system five-year total relates to consent decree requirements. Management successfully negotiated with the EPA for an extension of the 2015 deadline of its Consent Decree. Certain project deadlines have been extended to 2018 and 2019.
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