NEW YORK--()--Fitch Ratings assigns an 'AAA' rating to the following Fairfax County Water Authority, VA (Fairfax Water, or the authority) revenue bonds:
--Approximately $35 million water refunding revenue bonds, series 2013A;
--Approximately $57 million water refunding revenue bonds, series 2013B (federally taxable).
Bond proceeds will be used to advance refund various outstanding bonds, and pay issuance costs.
The bonds are scheduled for negotiated sale the week of Feb. 11.
In addition, Fitch affirms the following:
--Approximately $500 million outstanding water revenue bonds at 'AAA'.
The Rating Outlook is Stable.
The bonds are secured by a senior lien pledge of the net revenues of the authority, including availability fees.
STRONG SERVICE AREA CHARACTERISTICS: Fairfax Water is a large regional water agency providing treated water to a large, mature, and affluent service area. Demographic indicators are well above average and the employment base, which is part of the Washington D.C. metropolitan area, remains strong.
RETAIL AND WHOLESALE SERVICE PROVIDED: The authority serves roughly 234,000 direct retail customers, and an almost equally large number of retail connections on a wholesale basis. The 10 largest wholesale customers comprise 27% of total operating revenues, although no single customer comprises more than 10% of total operating revenues. In addition, most wholesale customers have made (or are in the process of making) considerable payments for capacity ownership in the system, which Fitch believes significantly minimizes incentive to procure water elsewhere.
SIGNIFICANT FINANCIAL FLEXIBILITY: Strong liquidity and significant rate raising capacity helps offset only adequate debt service coverage, and provides strong flexibility. A policy change raising the minimum debt service coverage to 2.0x by 2020 is noteworthy and achievable with a series of planned modest annual rate increases. Retail rates are among the lowest in the region and, despite anticipated increases, are expected to remain very affordable.
MANAGEABLE LONG-TERM LIABILITIES: Sound capital planning and investment has resulted in state of the art treatment facilities and ample and diverse long-term water supply and treatment capacity. Debt ratios are low and capital needs remain manageable. The authority prudently funds the annual required contribution (ARC) for pensions and while likely to rise, given the pension's low funded ratio, should remain manageable.
WHAT COULD TRIGGER A RATING ACTION IMPROVED MARGINS EXPECTED: Fitch believes the current debt service coverage (DSC) margins are adequate but expects incremental improvement of coverage over time in accordance with stated policy goals.
Fairfax Water is a large and independent water agency governed by a 10-member board of supervisors with staggering three-year terms. Day-to-day operations are administered by a strong and seasoned senior management team.
LARGE REGIONAL SUPPLIER; STRONG SERVICE AREA DEMOGRAPHICS
The authority serves an important role as a regional service provider coordinating water resources and delivery at low costs. The authority serves roughly 234,000 direct retail water accounts in Fairfax County (general obligation & sewer utility system bonds rated 'AAA' by Fitch) and several wholesale customers located in or adjacent to the county in the southern and western portions of the Washington D.C. metro area. In total, the authority serves approximately 1.7 million residents, and approximately 465,000 retail accounts. Retail customers are predominantly residential, and no single wholesale customer comprised more than 9.8% of total operating revenues in 2012.
The service area is large (350 square miles), economically diverse, and affluent, benefiting from its location near Washington D.C., with high wealth levels and low unemployment. The employment base is diverse and stable, allowing the unemployment rate in Fairfax County to remain low at just 3.7% in December 2012, which is well below the national average. Proximity to Washington D.C., a highly educated labor force, and extensive transportation network have provided for an established business base of federal contractors and high-tech companies. Breadth in the local job market is evidenced by significant employment in health-related, financial and other professional services, manufacturing, and retail, and median household income is very high at more than twice the national average.
STRONG LIQUIDITY AND LOW RATES PROVIDE FLEXIBILITY
Liquidity has historically been strong. Current unrestricted cash and investments totaled approximately $23 million as of year-end 2011, equivalent to 117 days cash on hand. However, coupled with a large $180 million unrestricted non-current investment fund balance provides significant cushion and support for the authority's planned pay-as-you-go capital spending (roughly 1,000 days cash in total). Despite the planned use of cash to fund the majority of the CIP, Fitch expects strong liquidity will be maintained.
Strong liquidity helps offset the declining trend in operating revenues and debt service coverage from fiscal 2009 through fiscal 2011. Management raised rates to help offset the declining revenues, which were anticipated and a result of declining wholesale customer payments for capacity in the system and unusually wet weather. DSC ratios, about 1.55x in 2011 and an expected 1.6x in 2012, are lower than the historical coverage levels, but are considered adequate by Fitch.
Also offsetting the below average DSC is management's stated policy goal of at least 2.0x debt service coverage by 2020, and the significant wholesale service provided by the system (with typically slimmer margins). In order to meet that goal and provide pay-as-you-go resources, management plans to raise rates regularly over the next five years (in the range of 6%-9% annually). Despite the planned rate increases, rates should remain affordable. The average monthly residential bill, assuming 8,000 gallons of use, is just $21, which is very affordable at just 0.2% of median household income, providing ample flexibility for increases.
AMPLE WATER SUPPLY AND SYSTEM CAPACITY; MANAGEABLE CAPITAL NEEDS
Raw surface water is derived from two sources, the Potomac River (about 60% of supply) and the Occoquan River (about 40%), which on a combined basis provides ample water resources for well into the foreseeable future. Water is treated at one of two relatively new and state of the art treatment facilities. The larger of the two, the James J. Corbalis, Jr. plant, treats the Potomac River supply and has a rated capacity of 225 million gallons per day (mgd). Average flow at this plant was 86.1 mgd in 2012. Occoquan River water is treated by the 120-mgd Griffith plant, which is well in excess of 2012 average production of 64 mgd.
Both plants have expansion capabilities, though there are currently no plans to expand, as total treatment capacity is well in excess of average daily flow and the capacity requirements of wholesale customers. Fairfax has an aggressive asset maintenance plan, and a large but manageable capital improvement program (CIP), especially for a system of this size. The 10-year CIP totals $644 million and is consistent with the CIP for the past several years. Major projects include distribution system upgrade and repair, transmission upgrades and expansion, and water main and solids dewatering for the Corbalis plant. The five-year CIP totals $350 million and is expected to be about 80% cash funded. Additional parity bonds totaling around $100 million are anticipated in 2014, 2016, and in 2018.
PAY-GO CAPITAL PROGRAM TO KEEP LEVERAGE LOW
The authority's debt profile is manageable and debt ratios are generally in line with 'AAA' rating medians. Debt per direct retail customer was $2,303 in 2011. However, when incorporating the retail accounts of Fairfax Water's wholesaler customers (about 231,000 accounts), debt was just $1,158 per customer. Debt per capita, which also encompasses a portion of the residential base served by the wholesale customers, was very low at just $315. The planned issuance of additional bonds over the current five-year CIP horizon is not expected to affect debt ratios.
PENSION FUNDING TO SLOWLY IMPROVE
The authority administers and contributes to a single-employer defined benefit pension plan that had an unfunded actuarial accrued liability (UAAL) as of January 2012 of $151 million (or a 51% funded ratio). Retirement plan assumptions are generally conservative and include a 7.5% investment rate of return, large projected salary increases (8% annually for participants under the age of 45), and annual cost of living increases. A combination of investment losses and a lower assumed investment return (was previously 8.5%) led to an increase in the unfunded liability beginning in 2008. Three of the four plans are closed to new entrants.
While Fitch considers this level of pension funding to be low, the authority's practice of consistently funding the actuarially required contribution (ARC) coupled with plan changes including an increase in the retirement age for new entrants should improve the funding status over the longer term. The ARC for fiscal 2011 was $15.3 million, or a moderate 11.3% of total revenues. Continued funding of the ARC, and a closing of the unfunded liability over time will be important for maintaining the highest credit quality.
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