AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the following ratings for Jefferson County, AL's (the county) warrants:
--$395.0 million senior lien sewer revenue current interest warrants series 2013-A at 'BB+';
--$55.0 million senior lien sewer revenue capital appreciation warrants series 2013-B at 'BB+';
--$150.0 million senior lien sewer revenue convertible capital appreciation warrants series 2013-C at 'BB+';
--$810.9 million subordinate lien sewer revenue current interest warrants series 2013-D at 'BB';
--$50.3 million subordinate lien sewer revenue capital appreciation warrants series 2013-E at 'BB'; and
--$324.3 million subordinate lien sewer revenue convertible capital appreciation warrants series 2013-F at 'BB'
The Rating Outlook is Stable.
SECURITY
The senior lien warrants are secured by a pledge of gross system revenues. The subordinate lien warrants are secured by a pledge of system revenues after payment of the senior lien warrants.
KEY RATING DRIVERS
COUNTY EXITS BANKRUPTCY: The county declared bankruptcy in November 2011 following default on its sewer warrants and general obligation warrants. The chapter 9 plan of adjustment (the plan) was approved by the bankruptcy court on November 22, 2013 allowing the county to exit bankruptcy. Implementation of the plan allowed the county to restructure its defaulted sewer warrants with the senior and subordinate series 2013 warrants.
FINANCIAL SELF-SUFFICIENCY: The plan should return the county's sanitary sewer fund to a sustainable position, with fiscal 2014 revenues expected to be sufficient to pay the county's obligations, including a partial year of debt service. The triggers that led to the county's filing for bankruptcy (costly regulatory requirements, risky financing structures, and corruption) appear to be eliminated or mitigated.
MINIMAL COVERAGE AFTER 10 YEARS: Sewer system cash flows are expected to be sufficient to generate favorable debt service coverage (DSC) and meet capital demands over the initial 10 years of the debt structure. In 2024 and beyond, debt service coverage is projected to be modest at around 1.25x as a result of back-loaded debt service. Management projects that cash flows at that time will be insufficient to support known capital needs.
VERY HIGH DEBT BURDEN: System debt levels are high, even with the substantial reduction in system obligations achieved by the county's plan of adjustment. Further, the very slow pace of debt amortization will result in an elevated debt burden for decades even without additional borrowings.
COMMISSION SUPPORTED RATES: The Approved Rate Structure (ARS) adopted by the county commission in 2013 approved annual rate adjustments through the life of the warrants (2053). Ongoing support of the Commission to implement the annual rate increases already authorized by the ARS, and any additional future rate adjustments that may be required to meet the rate covenant on the warrants, is key to the ratings.
ONGOING LITIGATION: Litigation is ongoing regarding the bankruptcy court's authority to enforce the ARS. A recent judge's decision not to dismiss the case could allow the case to proceed. While Fitch continues to assess the risk of potential litigation to credit quality, the ratings reflect the political will and authority of the County Commission to enforce the ARS and produce sufficient revenues to pay warrantholders. Less rating support is placed on the authority of the bankruptcy court to enforce the ARS in the absence of Commission action to do so in the future.
REGIONAL ECONOMIC CENTER: The county's economy is broad and relatively diverse anchored by its largest employer, the University of Alabama at Birmingham. Key sectors include education, healthcare, retail trade and professional and business services supplementing its traditional manufacturing activities. Employment growth has lagged despite some positive economic developments. Wealth indices are significantly below the national averages.
RATING SENSITIVITIES
HINDRANCES TO CARRYING OUT THE ARS: Any litigation or political action which limits or repeals the ARS would be viewed as a materially weakening of the system's ability to operate and meet is obligation to warrantholders. Downward rating pressure would be expected to follow in turn.
ADDITIONAL REGULATORY DEMANDS: Regulatory actions that add material capital and/or operating requirements to the system likely would result in negative rating action given the system's limited ability to support such additional financial requirements from its strained rate base.
INABILITY TO ACHIEVE PROJECTIONS: Changes in the system's operating profile that make it difficult to achieve at least forecasted financial results over the next 10 years may be viewed as a weakening of the system's credit quality.
CREDIT PROFILE
The county is located in northeastern Alabama and has an estimated population of around 660,000 people, which has been static since at least 2000. The system provides retail wastewater collection, treatment, and disposal service to a 440-square-mile area that includes 23 municipalities within the county (including the cities of Birmingham and Bessemer) as well as unincorporated parts of the county and very small portions of Shelby and St. Clair Counties. The cities of Birmingham and Bessemer bill customers directly for sewer service on behalf of Jefferson County and account for 93% of customers.
EMERGENCE FROM BANKRUPTCY IN 2013
The county filed for chapter 9 bankruptcy protection on Nov. 9, 2011. A plan of adjustment settling most claims against the county was approved by the bankruptcy court on November 22, 2013 allowing the county to exit bankruptcy on December 3, 2013. The series 2013 warrants were issued as a component of the plan and provided $1.7 billion in proceeds that were used to retire and eliminate claims related to the system's previous $3.1 billion in system obligations.
Fitch views the issues that led to the county's bankruptcy filing as either eliminated or mitigated. While credit concerns remain regarding pressures on the system post-bankruptcy, these concerns are not expected to affect system operations or debt repayment going forward beyond what is contemplated at the current rating levels.
The initial cause of the county's bankruptcy stems from the system's consent decree between the county and the U.S. Environmental Protection Agency in 1996. Originally estimated to cost between $250 million and $1.2 billion, capital costs ballooned to over $3.1 billion by the time of the filing date.
The escalation in capital costs and the alternative financial products used to pay for such projects were attributable at least in part to corruption by government officials and private individuals and firms, several of which were convicted of criminal offenses. With the collapse in the financial markets in 2008 and because of the county's extensive use of variable-rate products and third-party agreements (including swaps an liquidity facilities), the county experienced rapid increases in interest costs and principal acceleration of numerous obligations which it was unable to pay.
ONGOING COMMISSION SUPPORT FOR APPROVED RATE INCREASES IS KEY
Implementation of the ARS is a key credit factor supporting the ratings on the 2013 warrants. The ARS was adopted by the County Commission (the commission) in October 2013. The October 2013 resolution enacting the ARS approved annual rate increases of 7.89% to become effective on Nov. 1, 2014 and Oct. 1, 2015 -2017. Thereafter, the Oct 2013 resolution provides for annual 3.49% increases beginning Oct. 1, 2018 and continuing as long as the 2013 sewer revenue warrants are outstanding. If the commission wants to make additional rate adjustments, it retains its ability to do so as long as the rate covenant is maintained, through the enactment of adjusting resolutions.
The adoption of the ARS is a credit positive in that it alleviates some political pressure to act on raising rates in the future. Nevertheless, Fitch remains concerned regarding the implementation of future rate hikes given the political backlash that may ensue from the sharp escalation in rates associated with the ARS. In addition, Fitch is concerned that the resulting cost of service from the ARS implementation severely limits the county's ability to increase rates to meet expected shortfalls in capital spending needs during the fiscal years 2024 -- 2041 period through either pay-as-you-go capital or through servicing additional debt.
The ARS was incorporated into the plan of adjustment, at the county's request, in order to allow the bankruptcy court to retain jurisdiction and the ARS reportedly would be enforceable by appropriate orders or relief from the court. Litigation is ongoing that challenges the bankruptcy court's authority to enforce the ARS. However, the ratings are based on ongoing support of the elected County Commission to enforce and uphold the ARS and the rate covenant with warrantholders. Any indication of the Commission's intent to do otherwise would pressure the rating. Fitch views the ongoing community discord regarding the ARS as a concern to credit quality in that it could pressure future support from the Commission to uphold the ARS.
PLAN OF ADJUSTMENT ENABLES RETURN TO FINANCIAL SUFFICIENCY
The plan is expected to position the sewer system to be able to generate sufficient revenues to meet its expenses in fiscal 2014. Revenues are expected to provide solid financial results for fiscals 2014-2023 with DSC on combined senior and subordinate lien warrants of 1.6x - 1.8x through fiscal 2018 and then increase to above 2.0x during fiscals 2019 - 2023. Surplus revenues net of operating fund deposits during fiscals 2014 -2023 are projected to total $670 million. These surplus revenues, combined with $approximatley $238 million in the sewer capital improvement fund at the end of fiscal 2014 (unaudited), are expected to be sufficient to fund capital needs during this 10-year period.
OUT-YEAR PRESSURE
Favorable financial performance through fiscal 2023 is in large part due to a back-loaded debt structure. Debt service increases nearly 70% in fiscal 2024 from the prior year to over $140 million and then continues to escalate 3% annually through fiscal 2040. This large jump in debt service costs is concerning not only because total DSC drops to 1.25x but because the elevated carrying costs significantly erode surplus revenues necessary to fund ongoing system maintenance.
Fitch is primarily concerned about the system's practical ability to increase rates above those contemplated in the ARS to cover the shortfall in meeting basic ongoing capital expenses in 2024 and thereafter. Fitch further believes the risk of enhanced discharge requirements is likely. To the extent these regulations translate into additional capital and/or operating expenses system financial projections will be strained even further.
SIGNIFICANT LEVERAGE REMAINS
System leverage ratios are excessively high despite the tremendous reduction in system obligations negotiated with creditors under the plan of adjustment. Overall, the system's
key debt ratios are 6x - 7x greater than Fitch's national medians for 'A' category and above credits. Other system debt metrics are similarly poor. No additional debt is programmed into the system's forecasted cash flows yet leverage ratios will remain weak for many years into the future given the generally ascending debt service requirements and anemic rate of principal amortization on these warrants - just 12% matures in 20 years.
REGIONAL ECONOMIC CENTER
The system provides retail sanitary sewer collection, treatment and disposal service to county residents as well as a small number of people within two surrounding counties. The service area is broad and has grown over prior decades to become a major regional financial and medical player.
The county's employment base is anchored by the University of Alabama at Birmingham, the largest employer in the county with some 23,000 workers. County unemployment trends are favorable, and in September 2014 the county's unemployment rate was 5.7% compared to 6.6% for the state and 5.9% in the U.S. Somewhat offsetting this positive, personal wealth levels are about 15% weaker than the U.S.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Ratings Research:
--'Revenue-Supported Rating Criteria'(June 3, 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria'(July 31, 2013);
--'2014 Water and Sewer Medians'(Dec. 12, 2013);
--'2014 Outlook: Water and Sewer Sector'(Dec. 12, 2013);
--'Fitch Affirms Jefferson County, AL's Series 2013 GO Warrants at 'BBB-'; Outlook Stable'(Nov. 18, 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria -- Effective June 12, 2012 to June 3, 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
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=927355
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