Fitch Affs Brownsville Util Sys & Southmost Reg'l Water Auth, TX Bonds at 'A+'; Outlook to Negative

NEW YORK--()--Fitch Ratings assigns an 'A+' rating to the following revenue bonds issued by the City of Brownsville, TX on behalf of Public Utilities Board (BPUB or the board):

--Approximately $114,505,000 utilities system revenue refunding bonds, series 2013A.

The bonds are expected to price via negotiated sale on April 3. Proceeds will be used to refund outstanding series 2005 bonds for savings, fund a debt service reserve and pay the costs of issuance.

In addition, Fitch affirms the 'A+' rating on the following bonds:

--$303.3 million of utilities system revenue improvement bonds, series 2005A, 2005B, 2008, 2011 and 2012;

--$36.6 million of Southmost Regional Water Authority (SRWA) water supply contract revenue bonds.

The Rating Outlook on all the bonds is revised to Negative from Stable.

SECURITY:

The senior lien BPUB bonds are secured by net revenues derived from the combined utility systems. Outstanding junior lien bonds are secured by net revenues of the combined utility system after satisfying senior lien debt service.

The SRWA bonds are secured by contract payments made pursuant to water supply agreements with the authority's participants, including the Board. The contract payments are unconditional and senior to BPUB's debt service.

KEY RATING DRIVERS:

UNCERTAINTY OVER NEW PROJECT: The Outlook revision to Negative reflects BPUB's planned purchase of a 25% ownership interest in a new 800 mega-watt (MW) natural gas generating facility (the Brownsville Project). BPUB's participation, if completed, would essentially double current leverage and diminish future net operating margins and financial metrics according to the Board's latest financial projections. A final decision to proceed with the Brownsville Project is expected later this year.

HISTORICALLY SOUND FINANCIAL PERFORMANCE: Operating results have been strong historically with Fitch calculated debt service coverage (DSC) averaging 2.4x over the prior five years, and available cash and reserves equal to nearly 240 days of operating expenses since fiscal 2009.

AFFORDABLE RATES POISED TO RISE: Fitch views positively BPUB's affordable rates, the employment of a fuel and purchased power adjustment charge which is adjusted monthly, and the Board's ability to adjust base rates by up to 5% over a five-year period. However, sizable rate increases needed to fund planned capital needs, including those related to the Brownsville Project, and meet debt service requirements will diminish financial flexibility.

DIVERSIFIED POWER SUPPLY: The Board maintains a diverse power supply with an equal mix of coal, natural gas and purchased power. Owned generating assets are split between natural gas-fired (62%) and coal-fired (35%) facilities. The additional capacity derived from the proposed natural gas facility would result in significant excess generating capacity, but ensure a reliable power supply sufficient to meet projected needs through 2028.

WEAK SERVICE AREA DEMOGRAPHICS: The rating factors in the service area's weak income levels, chronically high unemployment and economic dependence on cross-border economic activity. Despite the challenging demographics, utility collections have remained strong with minimal annual write-offs.

SRWA's RATING LINKED TO BPUB's: The credit quality of SRWA is linked to that of BPUB given its 92.9% ownership share in SRWA and the unconditional take-or-pay contract provision with an unlimited step-up requirement in the event that other participants are unable to meet their respective obligations.

RATING SENSITIVITY

FINAL PROJECT COMMITMENT: Fitch plans to evaluate the final terms and conditions of the BPUB's participation in the Brownsville Project when available. However, BPUB's participation as currently proposed will likely lead to a rating downgrade, reflecting the anticipated weakening of BPUB's financial metrics and higher debt burden.

CREDIT SUMMARY:

Material Change in Size and Scope of Capital Needs

BPUB's pending decision to purchase a 200 MW ownership interest in the 800 MW Brownsville Project, a natural gas-fired combined cycle electric generating plant, represents a substantial and unexpected increase in its capital expenditure program since Fitch's last review. Planned capex through fiscal 2017 was previously estimated at slightly less than $200 million. However, the costs associated with the proposed generating facility would reportedly add an estimated $282 million to the overall size of the capital program and be funded entirely with long-term debt.

Under the terms of the development and purchase agreement BPUB and Tenaska entered into in January 2013, Tenaska will construct the generating facility and BPUB will purchase a 25% undivided ownership interest in the plant. The agreement also requires BPUB to construct, own and operate a gas transmission pipeline and a water pipeline. While Fitch recognizes BPUB's proactive strategy to ensure an adequate power supply to meet projected load growth, the additional capacity will increase total available resources (550 MW) to well in excess of projected total requirements (459 MW). Fitch notes that the projected total requirements include a targeted planning reserve margin of 13.75% approved by the Electric Reliability Council of Texas' (ERCOT).

Construction of the plant, which is estimated to take approximately 24 months, will not commence until all required permits are received and additional off-takers for the remaining power supply are identified and contracted. Fitch will evaluate BPUB's potential inclusion in the project further once its commitment is finalized, and the remaining terms of the relevant contracts are known.

Combined Utility System Pledge

BPUB is a component unit of the city of Brownsville, TX (GO bonds rated 'AA-' with a Stable Outlook by Fitch). The Board operates a combined utility system that provides electric, water, and wastewater service to residential and commercial customers within the city and in certain areas of Cameron County outside of the city limits. Outstanding debt attributable to each utility service is jointly secured by a pledge of total revenue from the combined utility system.

BPUB serves a customer base of approximately 46,000 accounts. Utility system assets are owned by the city but operated, maintained, and managed by BPUB. Total revenues of the combined system are comprised of approximately 73% electric, 14% water, and 13% wastewater. Each of the utilities included in the combined system are financially self-supporting and not reliant on transfers from other funds.

Approved Rate Increases

Electric, water and wastewater rates are established by the city commission based on a petition by the Board. Favorably, the city commission has granted authority to the Board to adjust electric, water and wastewater base rates by up to 5% over a five-year period. The Board's rate structure also benefits from a fuel and purchased energy adjustment charge, adjusted monthly, used to recover variable costs in a timely manner. For fiscal 2012 the Board implemented a modest 5% increase in electric, water and wastewater rates, marking the first time rates had been increased since fiscal 2006. The relationship between the Board and the city commission is reportedly constructive, as evidenced by the commission's recent approval of a series of annual rate increases through fiscal 2017 needed to meet rising capital needs and additional borrowing plans, largely associated with the Brownsville Project. Cumulative increases for electric, water and wastewater rates will total 36%, 20% and 6%, respectively.

Sound Financial Profile

Financial metrics have been strong historically with little deviation. Debt service coverage increased modestly in fiscal 2012 to 2.5x, principally the result of an increase in rates, an uptick in sales and lower purchased power costs. Similarly, coverage of full obligations, including annual transfers to the city's general fund and purchased power obligations, increased to 1.7x in fiscal 2012, comfortably higher than Fitch's rating category median of 1.4x. Liquidity is equally strong with available cash and reserves equal to about 245 days of operating expenses.

Financial metrics are forecast to weaken as a result of BPUB's potentially large capital program and considerable borrowing plans, despite the recent adoption of annual rate hikes. DSC as well as coverage of full obligations are projected to decline to about 1.6x and 1.2x, respectively, following the commercial operation of the Brownsville Project. Projections include the issuance of long-term debt to fund the ownership interest in the Project, the rate hikes already in place and a continuation of the service area's recent trend in customer growth. Assumptions included in the forecast through fiscal 2017 appear reasonable.

Largest Participant in SRWA

BPUB is by far the largest participant in SRWA with a 92.91% ownership share and a capacity allocation of nearly seven million gallons daily (mgd). SRWA has built a 7.5 mgd reverse osmosis water treatment plant. This plant includes a 7.5 million-gallon storage tank and a 0.75 million-gallon clear well. The Board's total water treatment capacity including SRWA is currently at 47 mgd.

Participants in SRWA, including BPUB, have an unconditional obligation to fund SRWA's operating and maintenance costs and debt service obligations on outstanding contract revenue bonds. BPUB is also subject to an unlimited step-up in the event of a non-payment by another participant, which effectively links SWRA's credit quality directly to that of BPUB.

BPUB and the other participants in SRWA are unconditionally responsible for making payments towards SRWA's expenses which includes debt service on the contract revenue bonds. The participant contracts provide for a reallocation of payment obligations based upon a default of a participant with BPUB's contract ultimately requiring BPUB to any unallocated payments. Fitch therefore views SRWA's credit as being directly tied to that of BPUB due to the board's 92.9% participation and the unlimited step-up provision applicable only to the Board.

Growing Service Area with Weak Demographics

Brownsville is located on the north bank of the Rio Grande River with an estimated 2012 population of approximately 178,500, representing an almost 30% increase from the 2000 census. Three international bridges join the city with Matamoros, Mexico.

BPUB's service area center's on the city of Brownsville, which serves as the county seat of Cameron County. The city's position as the only port of entry from Mexico with highway, air, rail and shipping transportation modes provides a good degree of economic activity, although high unemployment and low wealth levels persist. Unemployment through December 2012 remained in excess of 10%, and income levels equal just 60% of state and national averages.

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, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'U.S. Public Power Rating Criteria', Dec. 18, 2012;

--'Revenue-Supported Rating Criteria', June 12, 2012;

--'U.S. Public Power Peer Study', June 20, 2012.

Applicable Criteria and Related Research

U.S. Public Power Peer Study -- June 2012

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681449

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027

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Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler, +1 212-908-0773
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Stacey Mawson, +1 212-908-0678
Associate Director
or
Committee Chairperson
Dennis Pidherny, +1 212-908-0738
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler, +1 212-908-0773
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Stacey Mawson, +1 212-908-0678
Associate Director
or
Committee Chairperson
Dennis Pidherny, +1 212-908-0738
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com