SAN FRANCISCO--()--Fitch Ratings assigns its 'AA' rating to the following wastewater system revenue bonds being issued in accordance with the first (senior) bond resolution by the City and County of Honolulu, Hawaii:
--Approximately $133.3 million senior series 2012A;
--Approximately $120 million senior series 2012B.
Bonds are expected to price in a negotiated sale on Sept. 19, 2012. Proceeds of the series 2012A bonds will fund a portion of the system's large, ongoing capital improvement program, a separate debt service reserve fund equal to 50% of maximum annual debt service, and pay costs of issuance. Proceeds of the series 2012B bonds will advance refund outstanding debt for level savings. The 2012B bonds will have a share of the fully funded common reserve fund.
In addition, Fitch affirms the following ratings:
--$1.17 billion in outstanding senior lien revenue bonds at 'AA';
--$422.7 million in outstanding junior lien revenue bonds at 'AA-'.
The Rating Outlook is Stable.
Senior lien bonds are secured by a senior lien on net revenues of the city and county of Honolulu's wastewater system. The junior lien bonds have a subordinate pledge of net revenues. Approximately $150 million owed in state revolving fund loans have a third lien on net revenues.
KEY RATING DRIVERS
SERVICE AREA STABILITY: Honolulu provides wastewater service to 82% of the island of Oahu's population. The system has seen limited impact on revenues or delinquency rates from the economic recession.
LARGE RATE INCREASES CONTINUE: Substantial rate increases have occurred but appear to have broad political and community support, despite high residential rates on a comparative basis. City Council has approved a package of modest rate increases to occur through fiscal 2017 to support planned capital spending.
STRONG CASH FLOW: The wastewater system has had very strong financial metrics in the past few years resulting from double-digit rate increases implemented in fiscals 2009-2011 to prepare for increased capital spending through 2020.
DEBT SERVICE COVERAGE TARGETS: Management expects to maintain debt service coverage on senior revenue bonds of at least 2.0x and coverage of all debt over 1.5x even as annual debt service costs escalate substantially.
EXCEPTIONALLY HIGH DEBT: The wastewater system has exceptionally high debt levels with substantial additional borrowing plans through 2020 to comply with required environmental mandates to address deferred maintenance.
NO RELIEF FROM ONGOING CAPITAL NEEDS: Substantial additional capital needs exist beyond 2020, resulting from the decision by the Environmental Protection Agency (EPA) to require the wastewater system's two largest treatment plants to move from primary to secondary treatment.
WHAT COULD TRIGGER A RATING ACTION
DECLINE IN FINANCIAL FLEXIBILITY: Fitch views maintenance of the system's strong financial margins as necessary at this rating level, given the size of the CIP and increasing debt burden. Any deterioration could result in rating pressure.
DEVIATION FROM REGULATORY REQUIREMENTS: Compliance with the terms and timelines required by the 2010 Consent Decree is critical to the credit profile.
DEVIATION FROM PLANNED RATE INCREASES: Ability to sustain political momentum and community tolerance for future additional rate increases is key to the ratings.
The ratings primarily reflect the financial flexibility, provided primarily by rate flexibility and a strong cash funded capital component in the budget and the proactive steps taken by the political leadership and management team to address many years of delayed spending on system capital infrastructure. As a result, financial performance is expected to remain stable in the next five years despite substantial increased leveraging. Cumulative rate increases totaled 175% between fiscal years 2006 and 2011. Rate increases in fiscals 2012 and 2013 were 4% and remaining approved increases in the next four years will be between 4% and 8%. Rate increases beyond those approved through fiscal 2017 will be needed to continue non-discretionary capital spending.
Sand Island and Honolulu wastewater treatment plants (WWTPs) have operated according to expired 301(h) waivers of the federal Clean Water Act, requiring only primary treatment prior to discharging to deep ocean outfalls. Agreement on a consent decree was reached by the EPA, Honolulu, the State Department of Health, and four environmental organizations that had litigation pending regarding Honolulu's non-compliance with the Clean Water Act; the decree became effective in December 2010. The 2010 consent decree outlines a timeline for Honolulu to bring the two plants up to secondary treatment standard. It also incorporates the terms and requirements of Honolulu's existing 1994 Consent Decree and 2007 Stipulated Order, as well as resolves pending litigation from 2004.
While the capital requirements and cost of compliance are substantial (initial estimates are $1.7 billion for the treatment plant upgrades), the timeline is longer than originally proposed by the EPA and the consent decree brings all regulatory requirements under one document and timeline. Fitch views this as a positive development as the EPA's initial timeline could have potentially diverted capital spending and staff resources away from the much-needed infrastructure investments that make up the bulk of the current CIP through 2020. However, the increased regulatory requirements are negative in that they increase total capital requirements of the system beyond the approximately $3.5 million total cost for infrastructure improvements estimated between 2001-2020 to repair and refurbish an aging system.
The system's financial position is strong, with senior lien debt service coverage above 3.0x and total debt service coverage above 1.5x in the last five years, including estimated results for fiscal 2012. Total debt service coverage includes the system's junior lien bonds, general obligation bonds, and state revolving fund loans. Coverage and liquidity levels continue to be strong as a result of recent rate increases implemented to support debt service that will ramp up over the next several fiscal years. Senior debt service coverage is projected to remain adequate at more than 2.0x through fiscal 2016. Total debt service coverage on all debt obligations is projected to remain above 1.5x. The city's actual performance typically exceeds its projections.
The system's formal policy is to maintain debt service coverage of 1.6x on the senior lien bonds and 1.25x on combined senior and junior lien revenue bonds. However, the current rating anticipates maintenance of 2.0x on the senior bonds and 1.5x total debt service coverage, including system facility charges, which is the level needed to generate approximately $70 million-$80 million annually to go towards capital spending from cash flow. Maintenance of current debt service coverage levels as the CIP as implemented is critical to the current rating level.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Water and Sewer Revenue Bond Rating Criteria, this action was informed by information from CreditScope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', June 12, 2012;
--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 3, 2012.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria