Fitch Rates New Orleans, Louisiana's $251MM Water & Sewerage Revs 'BBB'

AUSTIN, Texas--()--Fitch Ratings has assigned the following ratings for the following New Orleans, LA (the city) utility bonds issued on behalf of the New Orleans Sewerage and Water Board (the board):

--Approximately $115 million water revenue and refunding bonds, series 2014 'BBB';

--Approximately $136 million sewerage service revenue and refunding bonds, series 2014 'BBB'.

The bonds are scheduled to price the week of June 16, 2014 via negotiated sale. Proceeds will refund all outstanding water revenue and sewerage system revenue bonds and fund a portion of the capital needs expected in 2014.

Fitch also affirms the following ratings on the outstanding bonds expected to refunded in their entirety from the 2014 proceeds:

--$27.6 million water revenue bonds 'BBB';

--$135.6 million sewer revenue bonds 'BBB'.

The Rating Outlook on all bonds is Stable.

SECURITY

The sewerage service revenue bonds are secured by a net pledge of revenues of the board's sewer utility system. The water revenue bonds are secured by a net pledge of revenues of the board's water utility system. The bonds will have debt service reserve funds equal to maximum annual debt service.

KEY RATING DRIVERS

POSITIVE CUSTOMER RECOVERY TREND: Economic recovery from the recession as well as Katrina and the 2010 Gulf of Mexico oil spill continues. Customer connections, sales tax revenues, and employment all continue to trend up. The customer base has returned to 86% of its pre-Katrina level.

OPERATIONAL CHALLENGES: Water supply is ample but a 72% water loss rate remains a challenge for the system. The sewer system received some timing relief from the March 2014 Third Modified Consent Decree.

MASSIVE CAPITAL NEEDS: Capital needs for both systems are extremely large following decades of deferred investment in addition to repairs needed after Hurricane Katrina (Katrina). Debt levels are expected to increase rapidly as the Board begins supplementing federal capital spending on the system with its own debt issuance.

APPROVED RATE INCREASES THROUGH 2020: A series of eight (2013-2020) 10% annual rate increases for both the water and sewer utilities should begin to fund prudent operations and the most critical of capital needs. However, rate levels are already high.

ADEQUATE FINANCIAL MARGINS; PRESSURES REMAIN: Each system exhibits modest but adequate financial margins but faces capital and operating pressures. Management is projecting both systems to achieve at least 1.5 times (x) revenue bond coverage.

STRONG LEGAL COVENANTS: The Board is issuing the series 2014 bonds under new master resolutions for each system. The resolutions have strong traditional bondholder protections.

INTERDEPENDENCE OF TWO SYSTEMS: Fitch's maintenance of the same rating on the two separately secured bonds reflects a common governance structure, rate setting process, customer base, bill, and management team. In addition, the two systems have a close financial relationship as demonstrated by past intra-fund borrowings between the systems.

RATING SENSITIVITIES

CONTINUED FINANCIAL DISCIPLINE: Fitch views positively the progress in the last couple years to build the financial health and discipline of each of the funds on a stand-alone basis. If the Board is able to achieve the financial metrics outlined in its forecast while executing its large capital plan, Fitch may upgrade the rating.

CREDIT PROFILE

The New Orleans Water and Sewerage Board (the Board) is an independent legal entity from the City of New Orleans. However, both the New Orleans City Council and the Board of Liquidation have approval responsibilities over the Board's debt issuance and rate setting. The population of New Orleans (around 370,000) is 82% of the population prior to Hurricane Katrina (Katrina), up from a low point of around 30% of the prior population immediately following the storm. Economic recovery in the city continues.

The Board provides water and sewer service to around 123,000 customers in the City of New Orleans. Customer growth has averaged around 3% annually over the past five years but is projected to be more modest in the future (2%). The customer base is predominantly residential (91% of customers), though water demand is more balanced with residential customers only accounting for 53% of water sales. Customer concentration is not a concern with the largest customers accounting for only around 5% of revenues for each system.

NEW BOARD OF DIRECTORS SHOULD BE CREDIT NEUTRAL

A new Board of Directors will be seated in summer 2014. The governance changes were recommended as part of the 2012 rate package to reform the governance of the utility by including professional qualifications of board members, shortening the terms, reducing the number, and imposing term limits. The changes were approved by voters, city council and the state legislature. Six of the 11 new Board nominees are either currently serving or had served previously on the Water and Sewerage Board of Directors, providing some level of continuity. Fitch believes the new Board will continue to support the existing financial plan given the extensive process that occurred over the past few years to agree upon the rate package.

WATER SYSTEM - AMPLE SUPPLY AND TREATMENT CAPACITY; LARGE UNACCOUNTED FOR WATER LOSS

New Orleans has ample water supply provided by the Mississippi River, with four raw water intakes and two water treatment plants (one located on each side of the river). The Board participates with state and regional entities that monitor water quality along the Mississippi. The combined treatment plant capacity is 256 million gallons per day (mgd) and the intake pumping capacity is 365 mgd. The treatment plants are in need of renewal and replacement investments. The capacity is well in excess of the system average daily demand of 38 mgd but flows through the plants are much higher given the very high amount of unaccounted for water loss in the distribution system.

Water losses were high prior to Katrina at around 56%, reflecting an aging system of water mains and distribution pipelines, underground pipes below sea level, and years of deferred investment in the system. Many additional leaks and ruptures have occurred post-Katrina, bringing the rate up to 72%. This represents a cost to the water system in terms of water treatment and delivery (pumping) costs. However, it also represents a significant cost to the Board's drainage utility that must continuously pump all excess water out of the city's service area. The Board, along with FEMA funding, continues to detect and repair leaks and replace distribution pipelines.

SEWER SYSTEM - CONSENT DECREE DRIVES CAPITAL SPENDING

The sanitary sewer system also consists of two plants; one on the west bank of the Mississippi (40 mg) and one of the east bank (122 mgd). Similar to the water system, the treatment capacity is in excess of current flows (combined flow was 31.9 mgd in 2013).

The sewer system is under a Consent Decree from the Environmental Protection Agency (EPA) to reduce sanitary sewer overflows. The original consent decree dates back to 1998. The scope and timeline have been modified since then but not the overall issues. The Board received its Third Modified Consent Decree in March 2014, which pushed out certain dates of compliance. Five of its ten basins are still part of the consent decree (four are complete and one is not part of the consent decree). Major projects required include pump station investments to prevent overflows, inspection and repair of collection lines, and development of a preventative maintenance program.

EXTREMELY LARGE CAPITAL NEEDS; DEBT LEVELS WILL INCREASE

Estimated capital costs for the water system (2014-2023) total around $836 million, while costs for the sewer system during this period total $601 million. Much but not all of the spending on the sewer system is related to the consent decree. The Board has been spending on the systems since Katrina but much of the money has been federal dollars. The management and staff processes should be in place to ramp up to the level of capital spending assumed in the forecast.

Management expects that based on its approved 10% rate increases for both systems through 2020, it can support the issuance of around $60 million annually in water system bonds and around $50 million in sewer system bonds. The sewer system is expected to generate additional revenue-supported funds for capital, while the water fund is not. Based on these issuance levels, debt per customer is expected to increase to around $3,000 for each system within five years. Capital needs extend beyond the current five- and ten-year capital plans and continued debt increases are likely.

CAPTIAL SPENDING SUPPORTED BY EIGHT YEAR RATE PACKAGE

The Board received approval in November 2012 for an eight-year rate package for the water and sewer systems. The package was approved after extensive community discussion and consideration by the Board's multiple layers of rate regulation. Annual rate increases of 10% for each system were implemented beginning on Jan. 1, 2013 and will continue each year through Jan. 1, 2020.

The approved rate package was the culmination of a multi-year effort to identify and implement the appropriate level of rate increases, given the large scope of system needs. Following rate covenant violations in 2008 and 2009, the Board conducted a comprehensive financial plan and rate study. Fitch views the rate increases positively. The rate increases are expected to restore financial metrics to stable levels, replenish operating reserves, restore operating expenditures reduced dramatically by customer losses after Hurricane Katrina, and support anticipated new debt costs.

Current combined water and sewer rates result in a high average bill at 2.5% of median household income or around $90 for a 7,500 gallon monthly bill. However, given limited outdoor water use in the service area, the average use in New Orleans is lower, around 5,300 gallons per month for an average bill of around $63 per month.

FISCAL DISCIPLINE HAS IMPROVED

In connection with the comprehensive study of financial requirements done in 2011, the Board developed financial targets of debt service coverage for each system of at least 1.5x and unrestricted cash reserves equal to at least 180 days at each system. These targets were respected in the rate setting process and appear to be governing the amount of debt issuance planned. No limitation or target exists in regards to the Board's capital structure (debt to equity). In addition to these targets, financial reporting has improved with respect to timing and disclosure with all the material weakness removed that had existed in prior financial audits.

WEAK BUT IMPROVING WATER SYSTEM FINANCIAL PERFORMANCE

A steady return of customers since 2008 and a series of annual rate increases have bolstered revenues from water sales. Overall revenues have declined due to the decrease in federal operating grants in the last couple of years. Combined with significant cost controls, the financial metrics have improved from very poor levels in 2008 and prior. Debt service coverage of water revenue bonds in fiscal 13 was slim but adequate at 1.28x. Coverage of all obligations (including the state debt service assistance loan made in 2006 and repayments due to the city department of public works; DPW) was more modest at 1.10.

Debt service coverage of revenue bonds is projected to reach 1.6x in fiscal 2014 but all-in coverage is likely to fall below 1.0x with the large payments due to DPW. However, these payments only last through fiscal 2016 and are subordinate to debt payments. Management's financial projections indicate that debt service coverage of revenue bonds should remain above the 1.5x target.

Stronger cash flows at the water system in fiscals 2011 and 2012 were used to repay intra-fund loans made over the past few years from the sewer and drainage funds. At the end of fiscal 2013, the water system still owed $9.6 million to the other two funds (primarily the drainage fund), down from $57.4 million in fiscal 2010. Free cash flow was modest in fiscal 2013 (3% of annual depreciation). Management does not expect to support revenue-funded capital. Water system unrestricted cash levels at fiscal 2013 year-end of $16 million, days operating cash of 90 days. Management projects reaching its 180 day target in fiscal 2014.

SLIGHTLY STRONGER SEWER SYSTEM FINANCIAL PERFORMANCE

The sewer system financial profile has stabilized. A lack of rate increases over the prior five years and reallocation of administrative costs to the sewer fund resulted in weak performance in fiscals 2008 and 2009. Senior debt service coverage improved to over 1.3x in fiscals 2010-2013, largely based on expenditure reductions.

Debt service coverage of revenue bonds in fiscal 2013 was 1.63x and coverage of all obligations (state loan and repayments to DPW) was 1.25x. The sewer system produced free cash flow to annual depreciation of 51% in fiscal 2013 and is projected to exceed 100% in management's financial forecast. This is expected to generate funds to contribute to capital at the sewer system. Cash reserves at the end of fiscal 2013 were $12.1 million, equal to 96 days operating cash.

Additional information is available on www.fitchratings.com.

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=831358

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings, Inc.
Primary Analyst
Kathy Masterson, +1-512-215-3730
Senior Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Steve Murray, +1-512-215-3729
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings, Inc.
Primary Analyst
Kathy Masterson, +1-512-215-3730
Senior Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Steve Murray, +1-512-215-3729
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com