Fitch Affirms Richmond, VA's Public Utility Revs at 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the ratings on Richmond, VA's (the city) approximately $700 million in outstanding utility revenue bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from the net operating revenues of the city's water, sewer and gas utility systems (the system).

KEY RATING DRIVERS

REGIONAL SERVICE PROVIDER: The city plays an important role as a large regional water, sewer, and natural gas service provider to a broad and mainly residential customer base.

CAPITAL CITY, ECONOMIC HUB: The local economy consists of a diverse mix of employment including manufacturing, retail, services, distribution, and banking. The presence of the commonwealth's main state offices, as well as several institutions of higher education adds to employment diversity.

HEALTHY FINANCES: System finances are well-managed. Revenue bond coverage has been strong and liquidity is solid. Financial results may become pressured with expectations for additional debt over the next five years, although Fitch expects strong fiscal oversight will continue to produce solid results.

HIGH DEBT, SIZABLE CAPITAL PLAN: The debt burden remains high and the capital improvement plan (CIP) is comprehensive. The city expects to issue some additional debt, keeping debt ratios high for the foreseeable future.

HIGH RATES: The combined monthly residential bill for water and sewer is high and additional rate increases appear necessary to fund the capital program.

SUFFICIENT SUPPLY AND TREATMENT CAPACITY: Water supply is ample and water and wastewater treatment capacity is sufficient for demand, which has experienced slight declines over time, consistent with the national trend. The city is in compliance with a state order to reduce its combined sewer overflows.

RATING SENSITIVITIES

RATING STABILITY EXPECTED: The rating is subject to shifts in various credit fundamentals including financial performance and capital and debt management. Fitch believes such shifts are unlikely in the near term. The Stable Outlook reflects the expectation the system will remain fiscally sound while the capital program (and funding sources) is successfully managed.

CREDIT PROFILE

Richmond (GO bonds rated 'AA+' by Fitch) owns and operates a combined utility system consisting of natural gas distribution, potable water treatment and distribution, and wastewater collection, treatment and disposal. Each of the utilities is operated as a separate self-supporting enterprise under the auspices of the department of public works. Service is provided to a mostly residential and mostly retail customer base.

REGIONAL SERVICE PROVIDER WITH STRONG ECONOMIC UNDERPINNINGS

The water and sewer systems each serve roughly 60,000 direct retail customers and approximately 76,000 additional customers through wholesale agreements. The natural gas system provides service to about 110,000 direct retail customers, including customers living in adjacent counties. In total, the city serves a population base of over 700,000 area residents.

Wholesale customers consist of very highly rated municipalities including Henrico, Hanover and Chesterfield Counties, all of whom have a Fitch 'AAA' rating on their outstanding general obligation (GO) bonds. In addition, both Henrico and Chesterfield counties carry 'AAA' ratings from Fitch on their water and sewer utility bonds, although the Outlook on Henrico's water and sewer bonds remains Negative. In fiscal 2014, leading utility customers accounted for about 18% of total system revenues, with wholesale revenues accounting for approximately 6% of total revenues.

As the capital of the commonwealth of Virginia, Richmond is the hub of economic activity for a growing metropolitan area. State and federal employment provide stability to the city's economy, and large employers, including several large health systems and multi-national financial firms offer significant employment opportunities. At 5.4% in December 2014, the city's unemployment rate continues to trend positively. Income levels remain comparatively low, although system collection rates remain strong.

HEALTHY FINANCES, RELIANCE ON DEBT FUNDING

Financial results remain sound, characterized by strong debt service coverage (DSC) of senior lien revenue bonds and stable liquidity over the past seven fiscal years. For fiscal 2014 (results unaudited), DSC was again strong at 2.4x from all available revenues, and coverage of all debt, including general obligation bonds issued on behalf of the system, remained near its historical 1.6x level. Transfers out are minimal at 1% of operating revenues.

Pro forma results provided by the city show coverage of existing senior debt remaining above 2x, and coverage of all obligations no less than 1.4x through the forecast (fiscal 2015-2017). Pro forma coverage includes moderate revenue growth from a combination of rate increases and new gas customers, and no additional debt. The current pro forma is slightly better than the previous forecast shown to Fitch as expectations for the size and timing of additional debt has favorably changed. While coverage levels are strong, the resulting cash flow is below annual depreciation levels. System reinvestment is partially debt-funded with only 23% of the CIP projected to be funded from pay-go revenues.

Liquidity is solid, although below average for the rating. The system ended fiscal 2014 with approximately $113 million in unrestricted cash, or 190 days cash on hand. When the cost of purchased gas, which is passed on dollar for dollar directly to the customer, is netted out of the days' cash calculation, liquidity improves to a more favorable level of about 330 days cash on hand. Fitch projects the city will maintain sound liquidity levels going forward. Continued solid financial management is key to long-term rating stability.

HIGH AND RISING DEBT BURDEN

The debt burden is elevated, providing some pressure to the system's credit profile. Outstanding debt as of fiscal 2014 is equal to $2,857 per customer when direct customers of all three systems and retail customers served through bulk contract are included (median for retail-only utility systems rated 'AA' category is $1,934). Debt-to-net-plant, at 77% in 2014 is well above the median for retail systems (50%). However, debt carrying costs are a more reasonable 21% of gross revenues.

All debt is fixed rate and structured with mostly level payments through fiscal 2017. A scheduled spike in debt service in fiscal 2018 is related to the issuance of short-term bonds in 2013. Thereafter, debt service gradually declines although additional debt will likely be layered on top when additional bonds are issued.

As the bullet maturity related to the 2013B bonds approaches, the city expects to either refund outstanding series 2007 bonds and use the debt service reserve to redeem the 2018 maturity, or refinance the 2013B bonds with longer-term debt. Fitch does not believe the structure presents material risk as the system's strong underlying credit fundamentals should allow it to retain adequate market access.

The debt burden is expected to rise with the addition of approximately $200 million in new debt beginning in 2017-2020. Fitch projects debt per customer will increase modestly by the end of the forecasted capital program. The city's long-standing track record of successfully managing a large capital program while maintaining a strong financial profile helps mitigate the high debt burden. Fitch expects this to continue.

HIGH USER CHARGES COULD DIMINISH FINANCIAL FLEXIBILITY

Customer bills include base and volumetric charges, and a purchased natural gas cost adjustment mechanism to offset commodity price volatility. Base charges represent a significant portion of the monthly bill, providing a level of predictability to the revenue base. Rates have been on the rise and are high relative to neighboring systems and to median household income (MHI).

In 2015, the average residential water and wastewater customer bill assuming 5,000 gallons of water per month is $89 for combined service, which is high at 2.6% of MHI. Fitch expects combined charges above 2% of MHI for consumption totaling 7,500 gallons per month - which is the national average - may be financially burdensome from an affordability standpoint. If residential customers in Richmond consumed 7,500 gallons per month, charges would be in excess of 3% of MHI.

The city has local rate-setting authority, an important consideration given additional rate increases are likely necessary to meet ongoing capital needs. City council has consistently approved rate increases as needed historically. Nonetheless, Fitch acknowledges the potential for reduced rate-raising flexibility as rates continue to rise.

LARGE CAPITAL PROGRAM, MAINLY DEBT-FUNDED

The system's five-year $590 million CIP is comprehensive, funding necessary system upkeep while ensuring compliance with state and federal mandates. Roughly 40% of the CIP consists of sewer system projects, while the remainder is split between water and natural gas projects, including renewal and expansion of distribution mains and water treatment plant and reservoir upgrades. The city will continue to fund projects to mitigate combined sewer overflows (CSO) with grant funds over the next several years. The CIP is mostly debt-financed, although a sizable amount of previously issued bonds remains available (about $185 million). The city does not expect to issue bonds again until 2017.

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' (July 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:

U.S. Water and Sewer Revenue Bond Rating Criteria

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

Revenue-Supported Rating Criteria

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

2015 Outlook: Water and Sewer Sector

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

2015 Water and Sewer Medians

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981978

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Contacts

Fitch Ratings
Primary Analyst
Andrew DeStefano, +1-212-908-0284
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Eva D. Rippeteau, +1-212-908-9105
Associate Director
or
Committee Chairperson
Kathy Masterson, +1-512-215-3730
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Andrew DeStefano, +1-212-908-0284
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Eva D. Rippeteau, +1-212-908-9105
Associate Director
or
Committee Chairperson
Kathy Masterson, +1-512-215-3730
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com