Fitch Rates New York City Muni Water Finance Auth's $450MM Revs 'AA+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA+' rating to the following New York City Municipal Water Finance Authority (NYW) bonds:

--$450 million water and sewer system second general resolution revenue bonds, fiscal 2011 series EE.

The fiscal 2011 series EE bonds are scheduled for negotiated sale on Jan. 18, 2011. Proceeds of the 2011 series EE bonds will retire outstanding commercial paper notes and provide funds for the authority's ongoing capital program.

In addition, Fitch affirms NYW's outstanding bonds as follows:

--$10.2 billion first general resolution revenue bonds at 'AA+';

--$15.5 billion second general resolution revenue bonds at 'AA+';

--$200 million extendible municipal commercial paper (CP) notes, series eight, at 'F1+'.

The Rating Outlook is Stable.

RATING RATIONALE:

--NYW's primary credit strength is its unique legal structure, including its status as a bankruptcy-remote issuer, providing substantial protection to bondholders from utility system and city municipal operating risks.

--The combined system provides an essential service to a large and diverse service area and benefits from an abundant, high-quality water supply exempt from expensive filtration requirements and transmission costs.

--Sophisticated capital planning efforts have helped achieve compliance with large, costly mandated regulatory projects and enables the full capital plan to proceed in a timely manner.

--Strong financial management and a proven ability to independently raise rates are reflected in consistently solid financial results, despite some volatility in demand.

--Debt levels are high with substantial additional borrowing plans over the medium term to comply with required environmental mandates.

--The 'F1+' rating on the extendable CP notes, series eight, reflects NYW's demonstrated market access and stable underlying credit characteristics.

KEY RATING DRIVERS:

--Maintenance of the combined system's current financial position given the size of the capital improvement plan (CIP) and the growing debt burden is necessary at this rating level.

--Continued improvement with regard to below-average collection rates is expected.

--Execution of rate flexibility will be critical as debt levels continue to rise.

SECURITY:

--The second general resolution (SGR) bonds are special obligations of NYW, payable solely from and secured by a subordinate lien on gross revenues of NYW. First general resolution (FGR) bonds are secured by a first lien on gross revenues of NYW. The bonds will not have a debt service reserve fund.

--Note interest is secured by moneys and investments in the FGR subordinated

indebtedness fund, on parity with $800 million in outstanding CP notes and $15.5 billion of outstanding SGR bonds. Note principal is also secured by moneys and investments in the FGR subordinated indebtedness fund, and ultimately the authority pledges the sale of first resolution bonds or SGR bonds to the payment of principal on the notes. The original maturity on the notes was 1 to 90 days; however, NYW has the option to extend the maturity of any note by an additional 180 days, and redeem notes at any time during the extension period.

CREDIT SUMMARY:

NYW bondholders benefit from solid legal protections that include:

--Revenues are collected in a lock box controlled by the trustee and are used to pay debt service of FGR and SGR bonds before operations and maintenance (O&M);

--The bankruptcy-remote, statutorily defined nature of the issuer;

--Ownership of system revenues by the bankruptcy-remote board that sets rates without city council approval;

--Annually required adjustment of water rates to a level to provide 1.15 times (x) coverage of FGR bond annual debt service and 1.0x coverage on SGR bonds and operating expenses.

These layers of protection serve to shield bondholders significantly, but not entirely, from the operational risks of the city's massive water and sewer enterprise as well as other city government operations. NYW SGR bondholders benefit from similar legal protections afforded FGR bondholders. SGR bondholders' claim on gross revenues is subordinate only to FGR debt service deposits, NYW administrative costs, and the FGR debt service reserve fund (DSRF). Following such deposits, revenues flow from the subordinated indebtedness account of the FGR directly to the SGR revenue account to pay SGR debt service deposits. Only after monthly required deposits under the SGR are satisfied are funds released from the trustee-controlled lock box to pay operations and maintenance.

NYW's strong financial management and conservative budgeting continue to yield solid operating results, despite sizeable growth in annual debt service obligations and recent declines in consumption. Historically below-average collection rates have improved favorably in recent years with the ongoing use of a payment incentive program for delinquent customers, a reduction in the threshold applicable to accounts eligible for termination of service, and the legislative approval to conduct a lien sale program for property owners independent of the existence of property tax liens. The authorization for the lien sale program expired Dec. 31, 2010, although management is reportedly in negotiations with city council to extend the authorization. The financial forecast assumes the continuation of the program. Regardless, Fitch expects continued progress in improving collection rates.

Audited results for fiscal 2010 reflect the impact of an additional 2% drop in consumption compared to actual demand in the prior year. However, the negative trend in demand appears to have abated as consumption in the latter months of fiscal 2010 and through the first six months of fiscal 2011 is up over the same point in the prior year. The overall drop in demand for fiscal 2010 exceeded the 1% decline assumed in the adopted budget, and, despite another sizeable rate hike of 12.9%, resulted in operating revenues coming in below budget. In addition, a one-time payment ($267.4 million) related to a retroactive collective bargaining settlement drove a 26% overall increase in operating expenses. However, the elevated operating costs were positively offset by the release of $99 million from an escrow account, reducing some pay-go for capital projects, cutting $46 million in operating expenses mid-year, and by recognizing $170 million in debt service savings related to favorable short-term interest rates compared to budgeted assumptions. The one-time revenues, mid-year cost cutting, and conservative budgeting translated into favorable annual debt service (ADS) coverage from net operating revenues for senior lien bonds of 2.1x and adequate coverage on an all-in basis of 1.3x.

Another sizeable 12.9% rate increase adopted by the New York Water Board (the board) for fiscal 2011 marks the fourth consecutive year that rates have experienced a double-digit increase, although financial projections through fiscal 2014 show a return to slightly smaller annual increases of 9.8%. The solid increase in consumption through the first part of the current fiscal year has led to a nearly 3% increase in revenue compared to the adopted budget. The financial forecast incorporates significant annual debt issuance and reasonable assumptions that include the aforementioned increases in user charges, and a 1% annual decline in consumption through fiscal 2014 resulting in ADS coverage on all obligations from net revenues staying at about 1.4x. With about 85 days of cash on hand at the close of fiscal 2010, NYW's unrestricted cash position is below that of other utility systems rated 'AA+' by Fitch.

Similar to most large, urban utility systems, NYW's capital needs are significant, primarily the result of state and federally mandated projects. The CIP for fiscal years 2011-2019 includes an estimated $11.7 billion in water and sewer projects, down from a peak of $19.4 billion projected in the fiscal years 2008-2018 CIP. A planned delay in approximately 20% of capital commitments for fiscal years 2010 through 2012 contributed in part to the decline in the size of the CIP from more recent years to its current total. The reduction in planned capital expenditures was prompted by the city's ongoing fiscal challenges related to the current economic slowdown. The relatively smaller CIP is also a result of costly regulatory projects beginning to decline to about one-fourth of total capital spending versus an average of about 75% over the previous five years. Funding of the mandated projects and the overall capital program of the system required a substantial amount of debt issuance over the last several years, leaving the system highly leveraged as a result. Continued escalation in debt levels could pressure the rating over the longer term.

Management expects the release of its 2011-2020 10-year CIP in the early part of calendar 2011. Capital funding is expected to come almost entirely from NYW's extensive CP program and long-term debt issuance. Rate increases are approved by the independent board without approval by the city council. Fitch expects overall debt service coverage levels will remain at an adequate margin given the board's demonstrated commitment to authorizing rate hikes necessary to cover increased costs.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated Oct. 8, 2010;

--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 6, 2008.

--'2010 Water and Sewer Medians', dated April 6, 2010.

--'2010 Water and Sewer Sector Outlook', dated Feb. 10, 2010.

Applicable Criteria and Related Research:

Water and Sewer Revenue Bond Rating Guidelines

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=395918

2010 Water and Sewer Sector Outlook

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=499482

2010 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=509146

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