Fitch Rates Philadelphia, PA's Water & Sewer Rfdg Revs 'A+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A+' rating to the following Philadelphia, PA (the city) revenue bonds:

--Approximately $300 million water and wastewater revenue bonds, series 2015A;

--Approximately $100 million water and wastewater refunding revenue bonds, series 2015B.

The city expects to sell the bonds in a negotiated sale on March 31. Proceeds of the series 2015A bonds will fund a portion of the city's water and wastewater system's ongoing capital program. Proceeds of the series 2015B bonds will refund portions of the city's water and wastewater system outstanding parity debt (series 2005A and a portion of the 2007A bonds, depending on market conditions)) for cost savings with no extension of bond maturity dates.

In addition, Fitch affirms the following rating:

--$1.78 billion in outstanding water and wastewater revenue bonds at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds and outstanding parity bonds are secured by a senior lien on combined net revenues of the Philadelphia Water Department (PWD or the system) water and sewer system. Both the series 2015A and 2015B bonds will also be secured by a debt service reserve fund equal to.

KEY RATING DRIVERS

SOUND MANAGEMENT GUIDES STABLE OPERATIONS: Financial performance of the PWD is satisfactory for the rating category. Operations typically generate narrow, but consistent debt service coverage levels that are somewhat mitigated by a sound level of liquidity and affordable rates.

ELEVATED DEBT LEVELS TO INCREASE: Debt levels are moderately high and sizeable additional borrowing plans are expected over the medium term. Leverage concerns are heightened by the imposition of a new ratemaking board, which will determine PWD's future ability to fund capital needs from a healthy mix of equity and long-term debt.

LARGE CAPITAL PLAN: The capital program remains sizeable and will continue to be elevated for some time as a result of required consent order projects and sizeable maintenance costs associated with the city's aging infrastructure.

ECONOMIC CHARACTERISTICS REMAIN MIXED: The service area is highly diverse and well anchored by a broad economy. However, weak income levels persist, contributing to chronically below-average collection rates and high water loss.

AMPLE CAPACITY: Water supply and overall system treatment capacity are sufficient for the foreseeable future.

RATING SENSITIVITIES

ACCELERATING CAPITAL AND DEBT PLANS: Continued escalation of debt levels to meet rising capital costs beyond what is currently included in the six-year capital improvement plan (CIP) could ultimately pressure the rating.

POLITICIZATION OF RATE RELIEF: Difficulty in achieving rate relief under a new ratemaking board could lead to negative rating action.

CREDIT PROFILE

LARGE, DIVERSE CUSTOMER BASE

The water system serves all of the 1.55 million residents of the city as well as an additional 57,000 people in neighboring Montgomery and Delaware Counties. The system's customer base is highly diverse, comprised predominantly of residential users with the 10 largest customers accounting for just 11% of fiscal 2014 total billings. The wastewater service area, which serves greater portions of the surrounding counties, includes a larger population estimated at nearly 2.3 million.

PWD maintains 10 wholesale agreements for wastewater service and one wholesale contract for water service to customers outside of the city. In total, wholesale revenues accounted for a nominal 5.5% of total system revenues in fiscal 2014. All wholesale agreements except for one are long-term, extending through at least fiscal 2023. Only PWD's smallest wholesale customer has a contract that expires prior to 2023 (in 2017).

SUFFICIENT CAPACITY

Average daily water demand is comfortably below permitted water supply and treatment capacity at all facilities, and daily wastewater flows are well within treatment plant permit limits. Available water supplies from the Delaware and Schuylkill rivers are sufficient for the foreseeable future, although significant water loss through the city's delivery system persists. Unauthorized consumption was reduced significantly during the 1990s, but progress has since stalled as non-revenue water has averaged about 32% annually over the last five years.

The system continues to struggle with below average collection rates with an estimated 90% of budgeted revenues collected on a current basis. The inclusion of delinquent collections brings total collections to a more acceptable 96% (estimated) of budgeted revenues each year. Nevertheless, the amount of operating revenues in accounts receivable is consistently high at about 90 days.

SOUND FINANCIAL MANAGEMENT LEADS TO CONSISTENT OPERATING RESULTS

Fitch believes the system's financial operations are well managed, despite historically narrow debt service coverage levels. Management budgets to meet a satisfactory 1.3x debt service coverage (DSC) target, which in some years requires transfers from PWD's rate stabilization fund (RSF) to balance lower projected cash flow amounts.

Depending on yearly consumption, collections and containment of operating expenditures, the RSF is utilized to augment operating revenues. However, rate revenues have historically covered debt service obligations by a satisfactory margin without the use of the RSF. Financial projections have historically shown sizeable annual drawdowns of the RSF, although actual results have either reduced or eliminated the need for the planned transfers.

Operating results for fiscal 2014 were positive relative to prior projections. DSC improved to 1.4x, and a sizeable deposit was made from excess cash flow to the RSF, increasing the year-end balance to $184.6 million. Prior projections included a nearly $8 million withdrawal from the RSF to supplement projected cash flow needs. Total available liquidity, which includes the RSF, PWD's residual fund and unrestricted cash and investments also improved, increasing to a more robust 290 days of cash on hand.

Affordable user charges provide the system with sufficient capacity to raise revenues if needed. Yearly rate increases have been modest, averaging about 5% since 2002. Consequently, the average combined water and sewer bill for residential users approximates just 1.7% of median household income (MHI). Including the city's stormwater fee levied according to the amount of impervious area a rate-payer owns, monthly charges rise to what Fitch believes is still a reasonable level at 2.2% of MHI.

Projected results through fiscal 2021 appear achievable with DSC and liquidity continuing at acceptable levels. DSC is forecast to remain at 1.3x, although Fitch notes the targeted DSC level relies on RSF transfers in certain years. Consequently, the projected RSF balance declines modestly from its current level to a still healthy balance of $167 million by fiscal 2021. The forecast shows a slight increase in total liquidity, which should keep the number of days cash on hand intact.

Assumptions built into the forecast appear reasonable, although planned rate increases will depend on board approval. Modest declines in consumption are incorporated into the projections, and no additional growth in customer accounts is assumed.

NEW RATE SETTING BODY

With voter authorization in 2012, the city recently established the Philadelphia Water, Sewer, and Storm Water Rate Board (the board), an independent rate-making body responsible for fixing and regulating water, sewer and stormwater rates. The ordinance requires the five-member board to consider the PWD's financial stability plan and to evaluate the impact of rates and charges on PWD's overall financial performance and the system's bond ratings when setting rates. However, the only absolute requirement of the board is to establish rates and charges sufficient to fund budgeted operating expenses and annual debt service obligations from current revenues.

The establishment of the board raises some concern for Fitch given the system's escalating capital program and growing debt levels. It remains uncertain as to what extent the new regulatory body will be committed to reducing its reliance on debt issuance to fund capital needs and instead support a higher level of capital investment from rates revenue. With the 2012 adoption of a series of rate increases lasting through the current fiscal year, and no plans to raise rates in fiscal 2016, PWD's first rate case filing is not expected to occur until the latter part of 2015, with any rate adjustment taking effect at the outset of fiscal 2017.

ENVIRONMENTAL REGULATIONS DRIVE LARGE CAPITAL PROGRAM

After several years of negotiations, the Pennsylvania Department of Environmental Protection (PA DEP) and the city signed a consent order and agreement (the COA) in June 2011 requiring the city to substantially eliminate combined sewer overflows (CSOs) over the following 25 years. To comply with the COA, the city is employing its Green City, Clean Waters Program (the program), which will utilize largely green technologies to capture rainwater runoff that would otherwise infiltrate and overwhelm the sewer system. The system also offers a credit to customers willing to reduce the amount of impervious area on their property in favor of more green space.

Compliance with the COA will require the city to spend approximately $2.4 billion over the 25-year period. The program also includes wastewater treatment facility enhancements and pipe renewal and replacement. Fitch views the program favorably considering that alternative strategies to mitigate CSOs, including the construction of tunnels and storage tanks, would have cost substantially more.

Projected capital spending through fiscal 2020 totals $1.78 billion. The current CIP represents a slight increase of about 1% over the prior six-year plan, but annual growth over the last several years has been more pronounced at closer to 8%. Management believes the capital program is at a peak level and that a gradual reduction in spending will begin within the next few years. Nevertheless, the cumulative projected capital spending has the potential to place downward pressure on the rating over the medium term, particularly if the system continues to pursue nearly 100% debt financing for the CIP.

LEVERAGED SYSTEM

Debt to net plant (93%) and all-in debt service as a percentage of gross revenues (30%) remained consistent with prior years, but will likely escalate in future years based on planned borrowings to support the CIP. Through fiscal 2019, Fitch expects that total debt outstanding will rise by approximately 18%, and debt issuances through fiscal 2021 will roughly double scheduled principal amortization occurring over the same period, based on the current capital plan. Somewhat offsetting this concern is the slightly above average pay-out of existing debt relative to similarly rated systems as well as a sizeable drop-off in debt service that begins in 2019 that will allow future bond issuances to be structured around existing obligations.

ECONOMIC IMPORTANCE OFFSETS WEAK SOCIOECONOMIC INDICATORS

Philadelphia's large population, sound economic underpinnings and distinct role as the economic driver for the broader metropolitan statistical area ensure the continued stability of PWD's service area. Unemployment continues to trend downward after remaining persistently high during and after the recent economic recession. The city's December 2014 unemployment rate fell to a 6.2% compared to 8.2% at the same point in 2013. Weak income levels persist as median household income approximates just 70% of 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 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2015 Water and Sewer Medians' (December 2014);

--'2015 Outlook: Water and Sewer Sector' (December 2014).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2015 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409

2015 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981664

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
Primary Analyst
Christopher Hessenthaler
Senior Director
+1-212-908-0773
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Doug Scott
Managing Director
+1-512-215-3725
or
Committee Chairperson
Adrienne Booker
Senior Director
+1-312-368-5471
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler
Senior Director
+1-212-908-0773
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Doug Scott
Managing Director
+1-512-215-3725
or
Committee Chairperson
Adrienne Booker
Senior Director
+1-312-368-5471
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com