NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms its 'A' rating on the following North Hudson Sewerage Authority, NJ's (the authority) obligations:
--Approximately $350 million in outstanding gross revenue pledge senior lien lease certificates, series 2012A, 2012B, and 2012C.
The Rating Outlook is Stable.
SECURITY
The certificates are secured by fixed monthly rental payments payable by the authority pursuant to a master lease agreement. All revenues of the authority are irrevocably pledged to the payment of the rental payments, which are an unconditional obligation and are not subject to appropriation. Such pledge is a first lien on the authority's gross system revenues, and includes all fees and charges for service and annual charges, if any, received from the municipalities served by the authority pursuant to the terms of an existing service agreement (ESA).
Under the ESA each municipality is obligated to fund any shortfall in authority revenues based on pro rata usage. This characteristic of the ESA provides some additional bondholder security, although the operations of the authority provide the basis for the rating.
KEY RATING DRIVERS
ESSENTIAL SERVICE PROVIDER: The authority provides an essential service to a demographically mixed, but stable service area proximate to New York City. The system remains in regulatory compliance and the operating profile is sound.
VERY HIGH DEBT BURDEN: Debt ratios are well above average compared to similarly rated utility systems. Near-term capital needs focus on system renewal and replacement thereby alleviating future debt pressures. But the debt profile is projected to remain high as a result of slow amortization of existing debt.
ADEQUATE FINANCIAL PERFORMANCE: Fiscal 2013 results were better than expected. Fiscal 2014 results, which are preliminary, also show better than expected debt service coverage levels. However, with ascending annual debt service, pro forma results are weaker and appear adequate for the current rating.
RISING RATES, AMPLE LIQUIDITY: Rates have been on a steady ascent and are projected to increase further raising affordability concerns and potential rate fatigue. However, liquidity is very strong, providing a significant offset to the current rate trajectory and modest expected financial margins going forward.
RATING SENSITIVITIES
FINANCIAL PERFORMANCE: The rating is sensitive to shifts in various credit fundamentals including financial metrics and rate flexibility. If the authority's financial metrics decline below expectations, negative rating action could result. On the other hand, if results are consistently positive, upward rating action could develop.
DEBT BURDEN: A significant shift in capital needs to address regulatory requirements from current expectations that causes a rise in the debt burden could lead to a rating downgrade.
CREDIT PROFILE
AUTHORITY CREATED TO PROVIDE ESSENTIAL SANITARY SEWER SERVICES
The authority was established in 1988 to provide sewer conveyance and treatment services to four cities located in the northern part of Hudson County, NJ (general obligation debt rated 'AA-' by Fitch). Prior to the creation of the authority, the sewer systems of the four cities had fallen into substantial disrepair, resulting in the need for significant capital investment upon the authority taking ownership and control of the assets. The substantial capital spending left the authority's combined system highly leveraged but at a favorable point in its capital renewal and replacement cycle.
The four municipalities served by the authority include Union City, which accounts for about 35% of annual flows; Hoboken (29%); West New York (29%); and Weehawken (7%). Each municipality is located along the Hudson River, directly across from New York City, NY. The system serves approximately 22,100 retail accounts, many of which are multi-family units spread out over the four densely populated cities. The customer and revenue bases are diverse with no single customer accounting for more than 1% of demand or revenue. The authority serves an estimated resident population of approximately 185,000.
The system is divided into two geographical areas with assets consisting of about 100 miles of sewer mains and two wastewater treatment plants (WWTP). Combined treatment capacity totals nearly 31 million gallons daily (mgd), which leaves about 30% excess capacity on a combined basis (based on 22 mgd current flows). Given the limited growth expectations, treatment capacity is sufficient for the long term.
WEAK HISTORICAL FINANCIAL PERFORMANCE LED TO DEBT RESTRUCTURING
The authority's financial profile has been weak historically with below-average operating margins and low debt service coverage (DSC). Improved performance in fiscals 2009-2011 reflected a debt restructuring and not a result of improved financial or operating performance.
The 2012 certificates were issued to complete the restructuring. The certificates refinanced all of the authority's outstanding debt and further smoothed (lowered) near-term annual debt service obligations. The certificates mature fully in 2044, which is 10 years later than the original revenue bonds.
While the certificates contain a gross pledge of revenues, Fitch calculates debt service coverage using net revenues after payment of system operating costs. Financial results in fiscal 2012, on a net basis, were solid with 2.2x coverage on the senior bonds and 1.2x coverage of all debt. However, while there was revenue growth, improved financial results are attributable more to the lower scheduled debt service payments that resulted from the debt restructuring, as was the case in the preceding two fiscal years.
FITCH'S CONCERNS OVER MARGINAL FINANCIAL RESULTS HAVE ABATED
Expectations for very weak financial performance after the issuance of the certificates in fiscals 2013 and 2014 did not materialize, leaving large unrestricted cash and rate stabilization fund balances funded from certificate proceeds largely intact. Furthermore, fiscal 2013 operating revenues increased by more than 7% from the prior year (due mainly to rate increases) and debt service payments were lower than previously anticipated.
Fiscal 2013 DSC was a solid 1.9x all-in with a partial payment of debt service resulting from capitalized interest and approximately $7 million in subordinate state loans. Preliminary results for fiscal 2014, which represent the first full year of senior lien debt service, show DSC of about 2.1x on the certificates and 1.4x on all debt. These results are well above previous expectations of 1.0x all-in DSC for fiscals 2013 and 2014.
Debt service is expected to rise over the next several years, reaching $21.5 million on the senior lien certificates and just over $30 million including the state loans in fiscal 2019. Pro forma results provided by the authority's rate consultant project DSC on the certificates to range between 1.7x-1.8x and coverage of all debt at no less than 1.1x through the fiscal 2019 forecast. These updated projections resemble previous projections provided to Fitch and include many of the same reasonable assumptions regarding rate increases, customer growth and flows, and anticipated future debt.
STRONG LIQUIDITY PROVIDES FLEXIBILITY, RISING RATES A CONCERN
The authority's liquidity position is strong, aided by a combination of capitalized rate stabilization and renewal and replacement balances funded from 2012 proceeds and solid cash flow margins over the past two fiscal years. As of fiscal 2013, which ended Jan. 31, 2013, the authority had $27 million in unrestricted cash and investments and another $11 million in renewal and replacement funds, which was equivalent to over two years cash on hand and nearly three years of working capital. Fitch projects liquidity will decline slightly from current levels through the forecast period but remain very strong (over 500 days cash) given the modest capital needs facing the system.
Rates are set locally by the authority's board and are approved during the annual budget process. Rates have been consistently increased and are roughly 50% higher in fiscal 2015 than fiscal 2007. However, a decline in water consumption offset some of the earlier rate increases, leaving operating revenues relatively stable through fiscal 2011. To help remedy the weaker revenues, management has and will continue to focus the rate increases on the fixed charges, allowing the system to be less dependent upon economic and demand cycles. Fixed charges accounted for about 5% of fiscal 2013 revenues, but by fiscal 2018 the authority projects revenues from fixed charges will rise by about three-fold. Fitch views the increase in base charges favorably.
The rise in rates, while necessary to meet the increasing operating and debt service costs has pushed the monthly residential sewer bill to roughly $63 in fiscal 2015 (based on 6,000 gallons), which is considered high at 1.3% of county-wide median household income (MHI). Forecasted rate hikes of about 6% annually through fiscal 2019 to meet scheduled debt service increases will add additional rate base pressure. Fitch will continue to monitor the authority's ability and willingness to press forward with rate increases.
HIGH DEBT BURDEN A CREDIT WEAKNESS
The authority's high debt burden remains a credit weakness. Outstanding debt, which is principally comprised of the senior lien lease certificates and includes around $32 million in outstanding subordinate lien New Jersey Environmental Infrastructure Trust (NJEIT) state revolving fund loans totals approximately $386 million. A small variable rate portion consisting of the 2012C certificates comprises just over 10% of total debt outstanding, which Fitch believes is manageable. The 2012C certificates are unhedged variable rate demand obligations backed by a direct pay letter of credit facility from TD Bank, N.A. (Issuer Default Rating of 'AA-'/'F1+' by Fitch).
Debt was an elevated 112% of net plant and more than $2,000 per capita in fiscal 2014. Both of these key debt ratios are well above average compared to similarly-rated systems. In addition, debt carrying charges are a burdensome 54% of fiscal 2014 gross revenues. Debt amortizes slowly, with just 18% of outstanding principal retired over the next 10 years, ensuring the authority's debt burden will remain high for the foreseeable future. Favorably though, capital needs appear limited to just system renewal and repairs totaling $25 million over the next five years and are not expected to require significant additional debt issuances.
The authority discharges effluent into nearby surface waters, including the Hudson River (the river). Treatment plant permits are expected to be renewed in fiscal 2014 with requirements to lower pathogen loading into the river and a three-year time horizon to comply (the authority is seeking a minimum of six years). Management expects to meet the requirements with projects that include restoring tidal wetlands and allowing for disinfection of the effluent before it is discharged, both of which are expected to be cost effective. However, if capital needs rise appreciably from current expectations this could lead to additional borrowing, which in turn could pressure the rating.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's 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 2013);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'2014 Water and Sewer Medians' (December 2013);
--'2014 Sector Outlook: Water and Sewer' (December 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
2014 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358
2014 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=825641
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