AUSTIN, Texas--()--Fitch Ratings assigns an 'F1+' rating to the following Louisville and Jefferson County Metropolitan Sewer District, Kentucky's (the district) obligations:
--$226.3 million sewer and drainage system subordinated bond anticipation notes (BANs), series 2012A.
The BANs are expected to be issued competitively on Nov. 15, 2012. Proceeds will be used to pay and retire the district's outstanding series 2011B BANs.
At this time, Fitch also affirms the following ratings on the district's outstanding debt:
--$1.2 billion in outstanding sewer and drainage system revenue bonds, series 2001A, 2004A, 2005A, 2006A, 2009C, 2010A, 2011A at 'AA-';
--$226.3 million in outstanding sewer and drainage system subordinated BANs, series 2011B, at 'F1+'.
The Rating Outlook is Stable.
The BANs are payable from pledged property, which includes the proceeds of a future bond or note sale as well as a subordinate lien on net revenues from the sewer and stormwater drainage system (the system), including assessment charged against new connections. The bonds are payable from net system revenues on a senior lien basis.
KEY RATING DRIVERS
SOUND FINANCIAL PROFILE: Financial performance is adequate and has improved in recent in years.
DEMONSTRATED RATE-RAISING ABILITY: The governing body has demonstrated a strong commitment to raising rates as necessary.
REGULATORY-DRIVEN CAPITAL NEEDS: Debt levels are high at over 2 times (x) the level for the rating category and may increase further as the district addresses required regulatory issues. Given the district is nearing the end of its major construction phase, capital pressures should alleviate over the medium- and long-term.
STRONG SERVICE AREA: The large and diverse service area is the economic engine for the state.
LONG-TERM RATING DRIVES SHORT-TERM RATING: The 'F1+' short-term rating considers the strong credit quality of the district's long-term rating and the district's anticipated market access to issue bonds whose proceeds would be used to retire the BANs.
WHAT COULD TRIGGER A RATING ACTION
LACK OF FINANCIAL GAINS: Failure to maintain and ultimately improve financial metrics over the course of the forecast period would likely lead to negative rating action on both long and short term ratings given the district's high debt load. While current projections call for a dip in debt service coverage (DSC) from current levels, immediate concerns are mitigated by the district's out-performance of projections and improved financial profile in recent years.
The district provides wastewater collection, treatment, and disposal service as well as stormwater drainage service to around 720,000 people within the boundaries of the Louisville/Jefferson County Metro Government (Metro) and certain outlying areas. Like many large urban wastewater utilities, the district's wastewater system has encountered periodic sanitary sewer overflows (SSOs) and combined sewer overflows (CSOs) during wet weather events, which has led to regulatory action against the district. These actions have culminated with the district entering into an amended consent decree in 2009 with the U.S. Environmental Protection Agency, which superseded a prior consent decree and which outlines various actions for the district to accomplish in order to achieve compliance with its discharge permits.
CAPITAL NEEDS DRIVEN BY REGULATORY REQUIREMENTS
The consent decree provides the framework for district actions over a 20-year period and is estimated to require capital spending of around $850 million. Upon completion of the consent decree milestones, the district expects to capture and treat 96% of all CSOs and eliminate a significant amount of SSOs. The bulk of all capital projects associated with the consent decree are expected to be implemented over the next couple of years (by fiscal 2014). As the district completes major projects, capital expenditures are expected to decline significantly and be much more manageable.
For fiscals 2013-2017, the district's capital improvement program calls for capital spending and project management of around $438 million (down from $545 million for fiscals 2012-2016), most of which is directly related to consent decree projects. Funding for these outlays is anticipated to be derived primarily from prior borrowings, as well as $80 million and $60 million issuances expected in fiscals 2014 and 2015, respectively. Ongoing rate hikes to offset the rising debt carrying costs will be necessary to maintain stable financial metrics.
RATE-RAISING WILLINGNESS A SIGNIFICANT CREDIT STRENGTH
The district's board has raised both wastewater and drainage charges almost continuously since 1991 in an effort to ensure necessary resources for capital spending. In addition, to raise the wastewater rate base sufficient to fund required regulatory capital items, the board (with the approval of the Metro council) implemented a special surcharge in fiscal 2008, effectively boosting charges by 34%. Since that time the board has adopted additional hikes of 6.5% for fiscals 2009-2013. While combined wastewater and drainage charges are slightly elevated, total utility charges (including water) remain below Fitch's affordability benchmark of 2% of median household income.
SOUND FINANCIAL PERFORMANCE
Financial margins narrowed as the district's debt service costs increased in recent years. By fiscal 2007 total DSC had fallen to the district's 1.1x rate covenant after approaching 2x earlier in the decade. However, the implementation of the rate surcharge in fiscal 2008 and subsequent hikes have improved DSC. For fiscal 2011, senior DSC was 1.8x while total DSC was 1.6x. Liquidity was adequate but somewhat low in fiscal 2011 at 164 days cash.
For unaudited fiscal 2012, the district's financial profile remained largely unchanged. Senior DSC held at 1.8x for the year but all-in DSC slipped slightly to 1.5x. Offsetting the weakened DSC, liquidity improved for the third straight year, rising to a respectable 222 days cash.
PROJECTED DECLINES TO DSC
The district's latest forecast for fiscal 2013-2017 anticipates DSC at levels below those for unaudited fiscal 2012. The district projects overall DSC at 1.3x for fiscals 2013-2014, followed by a drop to 1.2x in fiscal 2015 before improving to 1.4x by fiscal 2017. These coverage levels are below prior forecasts and reportedly are due to a reduction in capitalized operating and maintenance costs from prior forecasts which causes these expenses to appear in the income statement as opposed to flowing straight to the balance sheet.
Fitch is concerned about the proposed reduced margins and notes that declining coverage commensurate with the district's projections could result in negative rating action. However, somewhat mitigating this concern is the district's favorable actual performance relative to previous forecasts, which included projected total DSC for fiscals 2011 and 2012 at just 1.2x.
STRONG AND DIVERSE SERVICE TERRITORY
Metro (general obligation bonds rated 'AAA' by Fitch) serves as the major economic engine of the state. The area's job base has diversified over the last decade from primarily manufacturing to include a strong service component. Wealth levels are above the state average but about 10% lower than the nation's. The area has shown strong job growth in recent months, which has narrowed the gap between Metro's unemployment rate (8.9% in July 2012) to the state and national averages of 8.5% and 8.6%, respectively.
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 the Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', Jun. 12, 2012;
--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 3, 2012;
--'2012 Water and Sewer Medians', Dec. 8, 2011;
--'2012 Outlook: Water and Sewer Sector', Dec. 8, 2011.
Applicable Criteria and Related Research:
2012 Outlook: Water and Sewer Sector
2012 Water and Sewer Medians
U.S. Water and Sewer Revenue Bond Rating Criteria