NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'A+' rating on the following City of Toledo (the city), OH outstanding revenue bonds:
--$3.4 million sewer system (the system) revenue and refunding bonds, series 2005.
The Rating Outlook is Stable.
The bonds are secured by net sewer system revenues, including pledged funds.
KEY RATING DRIVERS
WEAK FINANCIAL MARGINS: Anticipated debt service coverage (DSC) of all-in system debt will stay very slim in the five year forecast but remain above the city's internal coverage target of 1.05x. However, DSC of senior lien debt has stayed strong historically, ending fiscal year 2013 with 11.1x coverage. Liquidity is strong for the rating.
REGULATORY-DRIVEN CAPITAL NEEDS: The sewer system's capital improvement plan (CIP) is heavily dictated by projects necessary to meet the city's consent decree requirements. The city has fully outlined and identified a plan of funding for all required projects in its long-term capital program and has until 2020 to fulfill all of its mandated obligations.
HIGH AND INCREASING DEBT BURDEN: Debt ratios are high relative to comparable ratings and will rise further as projects necessary to meet consent decree requirements are funded. Approximately 70% of the projected debt required for the city's capital program will be subordinate loans from the Ohio Water Development Authority and Ohio Public Works Commission (OWDA and OPWC) and only limited senior lien debt is expected to be issued over the next five years.
LIMITED RATE-SETTING FLEXIBILITY: The average residential monthly sewer charges exceed Fitch's 1% of median household income (MHI) affordability threshold, however are considered regionally affordable.
IMPROVING ECONOMY: Service area economics remain somewhat weak, however unemployment has fallen to historic lows and local economic development is improving after several years of depressed activity.
STABLE FINANCIAL PERFORMANCE AMID GROWING DEBT BURDEN: The ability for management to maintain or exceed current financial margins given escalating annual debt service (ADS) costs will be necessary to preserve rating stability. Deviation from stated financial projections may result in negative rating action.
APPROVAL OF SEWER RATE INCREASES: The system's ability to secure City Council approval of rate increases necessary to maintain current financial performance will lend stability to the rating.
ADEQUATE OPERATING PROFILE, LARGE MANDATED PROJECTS
In 2002 the city entered into a 20-year consent decree with the U.S. Environmental Protection Agency (EPA) in order to mitigate combined and sanitary sewer overflows. The city created the Toledo Waterways Initiative (TWI) Program to actively manage the required $520 million of identified mandated consent decree projects. To date, management has expended 62% of required consent decree/TWI capital outlays. The primary TWI projects driving the bulk of spending are currently underway and include the construction of massive underground retention tanks. These tanks will store excess wastewater flows during periods of heavy precipitation until the city's wastewater treatment plant (WWTP) has capacity to treat the flows. The city has until 2020 to fulfill its consent decree requirements and believes it is on target to meet that goal.
WEAK FINANCIAL PROFILE
Coverage of all-in debt, which is primarily comprised of OWDA and OPWC subordinate lien loans, has averaged at only 1.26x from fiscal years 2008 through 2012. However, all-in coverage in fiscal year 2013 was comparatively strong at 2.0x due to increased wastewater revenues that year. Senior lien debt service coverage (DSC) was a very high 11.1x, consistent with high historical coverage levels since 2008, and largely reflecting higher leveraging on the subordinate lien. This coverage level is expected to fall somewhat over the next five years but remain very high, above 6.0x, as only moderate amounts of additional bonds are issued.
Pro forma projections as of August 2013 predicted coverage for fiscal year 2013 at closer to 1.16x, and all-in DSC within the range of 1.14x to 1.23x through fiscal year 2018. Given the positive coverage outcome of all-in debt in fiscal year 2013, Fitch views the pro forma estimates of slim all-in coverage expectations to be somewhat conservative. However, as the city plans to continue funding its consent decree projects with additional subordinate loans, margins are likely to stay low, limiting any marked improvement in total DSC through the fiscal 2018 forecast period.
Liquidity has varied over time; in fiscal year 2013 the system's days' cash on hand equated to a very healthy 538 days. Though Fitch expects cash to stay at levels more than sufficient to meet the very minimal pay-go portion of the system's capital needs, the continued escalation of all-in ADS costs is likely to diminish cash margins over time. By fiscal 2017, all-in ADS is expected to consume a very high 41% of gross operating revenues (the 'A' median average is 24%).
INCREASING DEBT AND CAPITAL BURDEN
The sewer system's six-year fiscal 2013-2018 CIP totals $302.4 million and is about 99% debt-funded. 77% of the CIP, or roughly $234.3 million, is projected to be funded by low-interest subordinate OWDA and OPWC loans and will solely address the mandated projects necessary to meet the city's consent decree. The balance of the CIP, close to $65 million, will be almost entirely funded by bonds and will support non-consent order projects. Capital spending per capita is high for the rating at nearly $500, and is expected to increase six-fold over the next five years as the city enacts the bulk of its major capital projects.
Leverage ratios are high with debt-to-net-plant at 60% in fiscal year 2013 relative to the 54% 'A' median average. This ratio is expected to rise as the utility continues to issue upwards of $240 million more in debt over the next five years. Debt per customer was very high in fiscal 2013 at $3,398 and is projected at $5,422 over the next five years, exceeding the 'A' category median by over two times. Debt amortization is currently rapid with 94% paid off in 20 years; however, additional forecasted debt issuances will likely slow the current rapid payout pace significantly.
LIMITED RATE SETTING FLEXIBILITY
Sewer rates consist of a fixed service fee, a volumetric usage charge, and in more recent years, an additional fixed TWI fee that directly funds consent decree-related projects. Consistent with a prior four-year rate plan, the service charge and volumetric rates were both raised by 3% for fiscal year 2014. The additional TWI charge has stayed flat at $15.82 each year since fiscal year 2011. The utility is currently undergoing its next four-year rate plan revision process to decide sewer rate increases for fiscal years 2015-2018. These rates will be sized to support ongoing operations, as well as to modify the additional charge dedicated to the TWI program. Based on the successful passage of prior rate plans, management is optimistic that the proposed rate increases and continued dedicated TWI funding will be approved by City Council. Fitch expects that the proposed plan will yield revenue projections sufficient to meet the system's growing debt service costs in line with historical performance.
The typical residential customer spent $146.14 per quarter (or approximately $50 per month) on their sewer bill in fiscal year 2013. This equated to roughly 1.7% of median household income (MHI), which is considered high by Fitch as it exceeds the 1% threshold for a single utility bill's proportion of monthly spending. When charged along with the city's water bill, which comprises 0.6% of MHI, combined utility rates equate to over 2.0% of MHI. As both the water and sewer utility's rates are on the rise to support large debt-funded capital programs, individual rate-setting flexibility may become increasingly strained.
RECOVERING SERVICE AREA
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