NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA-' rating on the following City of Toledo (the city), OH outstanding revenue bonds:
--$16.5 million water system (the system) revenue and refunding bonds, series 2005.
The Rating Outlook is Stable.
The bonds are secured by net system revenues, including pledged funds.
KEY RATING DRIVERS
CONTINUED WEAK FINANCIAL METRICS: While current financial margins show improvement over prior years, future coverage levels are projected to remain slim with the onset of an escalating debt profile. Cash levels are expected to stay adequate.
EXTENSIVE ACCELERATED CAPITAL PROGRAM: The city's six-year capital improvement plan (CIP) has increased significantly since 2012. The increase is the result of accelerating projects that address potential regulatory concerns.
ELEVATED DEBT BURDEN: A significant rise in system debt since 2012 has resulted in elevated debt metrics and slow debt amortization, with principal payout at 28% and 71% in 10 and 20 years, respectively.
COMMITMENT TO RATE SETTING: Rates remain affordable with the average monthly bill at just 0.6% of median household income (MHI) in fiscal year 2013. A four-year rate plan approved by City Council to support debt-funded capital needs will result in elevated rates that will gradually approach 1% of MHI.
IMPROVING ECONOMY: The service area is experiencing growth in its primary yet diverse industries of car manufacturing, higher education and health care. The unemployment level has shown a marked reduction in the past few years, and wealth levels are rising.
CONTINUED FINANCIAL PERFORMANCE: Inability to maintain current satisfactory finances in light of a greatly expanded capital program could lead to negative rating action.
HIGHER THAN EXPECTED LEVERAGING: Significant increases in debt beyond current projections would be viewed negatively by Fitch.
NARROW BUT ADEQUATE FINANCIAL PROFILE
In fiscal year 2013, margins were fairly positive, with 1.6x debt service coverage (DSC) of senior-lien ADS, compared to an original projection of 1.2x. This is primarily attributable to improved revenues as a result of a 9% rate increase that year. All-in DSC was also stronger, ending fiscal year 2013 at 1.5x, higher than the predicted 1.09x coverage. The system's liquidity position equated to an adequate 104 days' cash on hand. The system's financial profile is expected to maintain minimum but adequate coverage over the next five years due to increased costs associated with the city's accelerated capital program.
Fitch expects the system to generate sufficient annual surplus operations going forward. A recently enacted four-year rate package included rate increases of 13.2% annually from fiscal years 2014 to 2017, and 4.5% annually beginning in fiscal year 2018. Moreover, the use of debt-financing for the majority of the water system's capital program should result in improved free cash flow for the foreseeable future. The city maintains a solid liquidity policy with two months of next year's projected operating expenses (per its bond indentures), 5% of current year's projected operating expenses and a $10 million unencumbered surplus minimum target.
SIGNIFICANTLY ELEVATED CAPITAL AND DEBT PROFILES
The city's fiscal years 2013-2018 CIP has grown significantly since Fitch's last review. Management accelerated nearly $250 million in projects that address system deficiencies identified by the Ohio Environmental Protection Agency (OEPA) following a sanitary survey in 2012. While the city is not under formal orders by the OEPA, both parties are amenable to immediate action with regards to ensuring continued compliance with state and federal drinking water laws. The most recently revised six-year plan totals $320.6 million, 87% of which is forecast to be debt-funded, 6% to be funded by low-interest loans from the Ohio Water Development Authority, and the remainder to be funded by cash.
The city's largest projects include but are not limited to: significant upgrades and additions to the water treatment plant (WTP) to expand capacity by 40 million gallons per day (mgd) and implement filtration technology, extensive improvements to pump stations, and the continuation of an aggressive steel main and water line replacement program that will address a relatively high level of faulty water mains and breaks. The WTP upgrade project alone will cost about $96 million and account for nearly one-third of the total CIP spending.
Leverage ratios are very high. In 2013 the city issued nearly $200 million in revenue improvement and refunding bonds, more than doubling the existing outstanding debt burden. In fiscal 2013 total outstanding long-term debt per capita was reasonable at $614, however over the next five years this metric is anticipated to increase to a somewhat elevated $1,278. The 'AA' median averages for the current and five-year debt-per-capita metrics are $558 and $584, respectively.
Debt as a percent of net plant in fiscal year 2013 was 148%, however the implementation of capital improvements funded by the recently acquired debt proceeds will temper this metric as the funds match the assets constructed. Regardless, this metric is expected to remain elevated in the five year forecast. Debt carrying costs are currently manageable; in fiscal 2013 senior and total annual debt service comprised 25% and 27% of gross revenues, compared to the Fitch 'AA' median averages that are both 24%. However, this metric is expected to increase to a very high nearly 32% for senior lien ADS and 36% for all-in ADS by 2018 with the onset of future additional debt issuances.
FLEXIBLE RATE SETTING ABILITY
The city bills residential customers on a quarterly billing cycle. The typical residential customers consume roughly 3,000 cubic feet (or about 7,500 gallons per month), and spend about $50 per quarter or approximately $17 per month on their water bill. This equates to roughly 0.6% of median household income (MHI), which is considered affordable by Fitch as it falls below the 1% threshold for a single utility bill's proportion of monthly spending.
The city has approved a four year rate plan that will increase water rates by 13.2% annually from 2014-2017, and by 4.5% in fiscal year 2018 and years beyond. Implementation of this rate increase is positive as, based on pro forma projections, it will generate revenues sufficient to accommodate an escalating annual debt service schedule. Within the five year timeframe, rates will begin to approach the 1% affordability threshold. Water charges have historically stayed well below the affordability threshold; however, when combined with simultaneously raising sewer charges, rate setting flexibility may become constrained over the next five years.
IMPROVING SYSTEM AND REBOUNDING SERVICE AREA
The system's sole WTP and 1,165 miles of distribution piping serve a population of approximately 500,000 and over 125,000 customers both in the city as well as in surrounding areas. Customers outside of the city pay on average 1.4x to 1.75x more for water service than in-city residents. The customer base is somewhat concentrated, as the top 10 customers provide nearly 35% of the water system's revenues. However these customers are primarily stable bulk users, including Monroe County, the City of Sylvania, and Fulton County, each with long-term contracts and therefore likely to remain stable customers of the system. According to management, the system is in general compliance with current federal and state requirements. Much of the current capital program will address many deficiencies that if otherwise deferred could result in regulatory violations. Water supply is ample, being derived from Lake Erie.
Toledo is the county seat of Lucas County, located in northwestern Ohio. The city's economy is driven by manufacturing, health care, education and local government. The city's unemployment rate, measured at 6.2% in April 2014, is at its lowest point in recent history, ranking below both the state (7.5%) and national levels (6.3%). Wealth levels within the county are low; per capita personal income levels in Toledo fall below both the state and national averages.
Additional information is available at 'www.fitchratings.com'.
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:
--'Revenue-Supported Rating Criteria' (June 2013);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2012);
--'2014 Water and Sewer Medians' (December 2013);
--'2014 Outlook: Water and Sewer Sector' (December 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2014 Water and Sewer Medians
2014 Outlook: Water and Sewer Sector