Fitch Rates El Paso, TX $16.3MM Water & Sewer Rev Rfdg Bonds 'AA+'; Outlook Negative

AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned a rating to the following City of El Paso, Texas (the city) bonds:

--$16.3 million water and sewer revenue refunding bonds, series 2011, rated 'AA+'.

The bonds are expected to price via negotiation the week of July 11, 2011. Proceeds will be used to refund certain outstanding obligations, and pay costs of issuance.

In addition, Fitch affirms approximately $498 million in outstanding water and sewer parity revenue bonds at 'AA+'.

The Rating Outlook is Negative.

RATING RATIONALE:

--The Negative Outlook reflects a recent trend of decreased debt service coverage below the city's financial policy and inconsistent with the 'AA+' rating level. Although the city posted improved coverage levels in fiscal 2011 due to higher water sales and lower operating expenditures, Fitch believes a longer trend of improvement is necessary to stabilize the Outlook.
--Management has demonstrated extensive financial, capital, and water resource planning.
--Financial results historically have been strong, although wet-weather events combined with limited rate adjustments have not kept pace with increased costs of service, resulting in a lower debt service coverage trend.
--Liquidity levels are below average for the rating level but credit concerns are offset by the city's flexibility to delay largely cash-funded capital projects or finance them with debt.
--Debt levels are moderate with rapid amortization, and capital needs are manageable.
--Rates and charges remain competitive and affordable.
--The service area is diverse and growing, fueled by growth in military personnel.

WHAT COULD TRIGGER A DOWNGRADE?

--Failure to demonstrate sustained debt service coverage levels and adequate financial flexibility commensurate with the rating level and consistent with the city's policy goals will put downward pressure on the rating.

SECURITY:

The bonds represent senior lien obligations of the combined water and sewer system (the system), payable from net system revenues.

CREDIT SUMMARY:

Extensive financial, capital and water resource planning has enabled the city to secure an ample and diverse water supply despite its arid climate while maintaining adequate financial flexibility and a very competitive rate structure. Major projects completed in recent years include a water reuse system for irrigation and a desalination plant to treat brackish water from the Hueco Bolson aquifer. However, these long-term water management efforts, along with weather conditions, have pressured system financial performance in recent years.

The system has typically maintained sound debt service coverage of 1.9 times (x) or better from fiscals 2002-2006, but wet-weather conditions in fiscal years 2007 and 2008 affected sales and reduced annual debt service (ADS) coverage to 1.7x each of those years. Rate hikes in fiscal 2008 (4%) and fiscal 2009 (7%) coupled with drier weather enabled the system to generate debt service coverage closer to historical results. However, for fiscal 2010 debt service coverage declined to 1.6x on rising debt service costs and the lack of a rate increase for the year. ADS coverage rebounded in fiscal 2011 to 2.0x, but this was due to increased water sales resulting from dry weather along with operating expenditure savings from fuel surcharge refunds as opposed to an increase in user charges.

With Fitch's last rating the city's preliminary plan was to increase rates in 2013. However, the most recent financial plan indicates a modest 4% rate hike deferred to fiscal 2014. The financial forecast projects ADS coverage to range from 1.8x in fiscal 2012 to an average 1.9x from fiscals 2013-2017, which is slightly below the city's 2.0x target. Newly-implemented impact fees, while not factored into the city's financial policy, should afford at least a modicum of additional financial cushion, but failure to take corrective action to demonstrate sustained debt service coverage levels consistent with the city's policy would be viewed negatively.

In addition to rising debt costs, cash reserves have been used for capital funding efforts thereby reduced liquidity levels. Overall, system days cash and days of working capital totaled just 143 days and 181 days, respectively, for fiscal 2011. Although these levels have improved over the last few fiscal years, they remain well below average for the 'AA+' rating level and below the level maintained as recently as in 2006. While the relatively low amount of reserve balances is a credit concern, somewhat offsetting this concern is the significant amount of ongoing pay-go funding built into the capital improvement program (CIP), which, if diverted to reserves in any given year would more than double the system's cash balance. Nevertheless, improvement in liquidity metrics is also a driver for maintenance of the rating.

The system's current CIP for fiscals 2012-2016 totals a manageable $332 million, the majority of which focuses on repair and replacement. Funding of the CIP from ongoing revenues and grants is estimated at approximately 60%. The planned CIP is comprised primarily of repair and rehabilitation projects and provides ample flexibility to defer projects. The system's moderate debt per customer level is comparable to other utilities in the rating category and its rapid pace of principal amortization is favorable.

The system's service area consists of the city (general obligation bonds rated 'AA' by Fitch), with a current population estimated at around 751,000 plus several outlying residential areas. While income levels are below those of the state and U.S., the system has managed to keep the cost of service low despite expansion projects that led to increased capital expenditures in recent years. Currently, the average monthly residential bill is only 1.3% of the local median household income. The area's economy is based on international trade and manufacturing, copper mining, and ore smelting. Stability is also provided by the large military presence (Fort Bliss and Biggs Army Airfield) and educational institutions (the University of Texas at El Paso).

Additional information is available at www.fitchratings.com.

In addition to the sources of information identified in Fitch's 'Revenue-Supported Rating Criteria', this action was additionally informed by information from IHS Global Insight.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 6, 2008.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
Water and Sewer Revenue Bond Rating Guidelines
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=395918

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