CHICAGO--()--Fitch Ratings assigns an 'AAA' rating to the following Henrico County, Virginia (the county) bonds:
--$64.9 million water and sewer system refunding revenue bonds, series 2013.
Bond proceeds will be used to advance refund the county's series 2006 water and sewer system bonds for debt service savings.
In addition, Fitch affirms the following ratings:
--$168 million outstanding water and sewer system revenue bonds at 'AAA'.
The Rating Outlook is revised to Negative from Stable.
The bonds are secured by a senior lien of net revenues from the county's water and sewer system (the system).
PLANNED LEVERAGING DRIVES OUTLOOK CHANGE: While debt ratios are currently consistent with 'AAA' rating category median levels, the aggressive capital improvement plan (CIP) will result in ratios that greatly exceed median levels over the next five years. Planned leveraging without commensurate improvement in financial results would likely lead to a negative change in the rating.
STRONG FINANCIAL PROFILE: Financial performance in terms of debt service coverage (DSC) and liquidity remain solid. However, metrics have diminished from previous highs.
DECLINING RATE AFFORDABILITY: Continued projected above-average rate increases will result in rate pressure, with the average monthly utility bill expected to approach Fitch's affordability threshold of 2% of median household income (MHI) by fiscal 2015. However, user charges are currently comparable to other regional providers.
AMPLE COMBINED SYSTEM CAPACITY: While aggressive, management's long-term capital planning will help sustain the system's strong supply, storage and treatment capacity for several years.
STRONG ECONOMY: The service area exhibits sound economic underpinning and includes low unemployment and above-average wealth levels.
WHAT COULD TRIGGER A DOWNGRADE
INCREASED LEVERAGING WITHOUT OFFSETTING CONSIDERATIONS: Absent a scaling back of the CIP and planned leveraging, commensurate increases in financial performance will be necessary in order to maintain the current rating level.
PLANNED GROWTH IN DEBT LOAD LEADS TO OUTLOOK CHANGE
The system's five-year CIP for fiscals 2013-2017 totals $585 million, of which 65% is expected to be debt-funded. The county plans to issue approximately $100 million in spring 2013, followed by additional issuances of $140 million in 2015 and 2017.
While the current debt per customer ($952) is comparable to Fitch's 'AAA' category medians, projected debt per customer is expected to far exceed the medians for the rating category over the next five years ($2,880 vs. $1,224). The county has noted some flexibility in the timing and sizing of the CIP which may lead to a smoothing of capital expenditures, but the current planned rapid increase in leverage ratios is of concern. Such deterioration in the debt profile without offsetting improvement in other credit characteristics - particularly in the financial profile - will likely result in a downgrade of the credit.
SOLID LONG-TERM PLANNING TO ENSURE AMPLE SYSTEM CAPACITY
Capital planning is strong and remains focused to help sustain solid supply, storage and treatment capacity for several years. Approximately 38% of the current CIP spending is earmarked for the Cobbs Creek Reservoir project, which will significantly increase the county's water supply. The project is a river flow augmentation facility that will discharge raw water into the James River during periods of low flow. The addition of the new reservoir will position the county to have ample water supply through 2055. The total cost of the reservoir project is estimated at $280 million, of which $220 million is included in the current CIP. Construction on the reservoir and associated facility is scheduled to begin in 2015, with an anticipated completion date of 2019. The reservoir should be completed and ready for use by 2021, as it will take approximately two years to fill.
The remaining portion of the CIP is aimed at maintaining regulatory compliance, improving assets and expanding service. By the spring of 2014, the system expects to have completed the expansion of its 55 million gallon per day (mgd) water treatment plant to 80 mgd. The plants' expansion coupled with a treated water supply contract (through 2040) with the city of Richmond, VA, provides ample treatment capacity for the next several years.
SOLID FINANCIAL RESULTS
Financial performance remains healthy as evidenced by sound liquidity and strong DSC levels. While days cash on hand totaled a favorable 338 days in fiscal 2012, cash levels have declined over the last five fiscal years to fund capital items. Based on planned pay-as-you-go capital funding through fiscal 2017, liquidity levels may decline slightly but should remain adequate.
For fiscal 2012, total DSC was a strong 2.1x, in line with prior years' performance. However, as the system's fixed costs rise with anticipated debt issuances, DSC may be pressured. To offset the increased costs of the upcoming $100 million spring debt issuance and preserve coverage, the county is forecasting rate hikes averaging 5% annually through fiscal 2015.
FUTURE RATE HIKES MAY LIMIT AFFORDABILITY
Additional rate hikes beyond fiscal 2015 will be necessary to support out-year CIP borrowing and maintain DSC levels, but have yet to be identified. Historically, the county has raised rates on a consistent basis to offset capital costs. Nevertheless, user charges have risen to a relatively high 1.7% of MHI compared to 1.0% for other 'AAA' category credits and are expected to rise to Fitch's affordability threshold of 2.0% by fiscal 2015 based on planned adjustments. With future CIP borrowings in 2015 and 2017, it is likely that necessary rate hikes will push user charges well above Fitch's affordability threshold. Positively, current rates are in line with other regional providers.
SOLID SERVICE TERRITORY
Henrico County surrounds the state capital of Richmond on the north side of the James River and continues to show solid economic growth. The unemployment rate at 5.2% as of October 2012 is well below the national (7.5%) average for the month. The county's local employment base is substantial and residents have additional job opportunities in the vital government and commercial centers of the neighboring capital city. Median household income levels in the county are good at 97% and 116% of state and national averages, 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 U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally 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;
--'2013 Water and Sewer Medians', Dec. 5, 2012;
--'2013 Outlook: Water and Sewer Sector', Dec. 5, 2012.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2013 Water and Sewer Medians
2013 Outlook: Water and Sewer Sector