SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned the following ratings to the city of Los Angeles, California debt:
--Approximately $457.4 million senior lien wastewater revenue bonds series 2015 A, B, C and D at 'AA+';
--Approximately $32.4 million wastewater revenue bonds series 2015A (subordinate) at 'AA'.
The 2015A and 2015B are scheduled to sell via negotiation the week of May 21. The 2015C, 2015D and 2015A (Subordinate) bonds are scheduled to sell via negotiation the week of June 9. Bond proceeds will refund outstanding debt, including the city's outstanding commercial paper, and provide about $200 million of new money for the city's ongoing sewer capital improvement program (CIP).
In addition, Fitch affirms the following ratings:
--$1.1 billion senior lien sewer revenue bonds at 'AA+';
--$1.5 billion subordinate lien sewer revenue bonds at 'AA'.
The Rating Outlook is Stable.
SECURITY
Senior lien bonds are secured by net revenues of the wastewater system after the payment of operations and maintenance (O&M) expenses. Subordinate lien bonds are secured by net revenues of the wastewater system after payment of O&M expenses and all senior lien requirements pursuant to the senior lien general resolution.
KEY RATING DRIVERS
SOUND FINANCIAL PERFORMANCE: Financial performance is sound with adequate all-in debt service coverage (DSC), strong senior lien coverage and healthy liquidity. Revenue growth has been less robust than expected due to ongoing reductions in billable sewer flows and the implementation of a new billing system.
MANAGEABLE DROUGHT EXPOSURE: The severe California drought and related conservation measures are likely to reduce revenues somewhat from prior expectations in the near-term, but the system's revenues are tied to indoor water usage, which is likely to decrease much less sharply than outdoor water usage. If the drought causes greater than expected conservation, it could put downward pressure on the rating.
SIGNIFICANT RATE COMMITMENT: Policymakers approved an unprecedented 10-year rate package in 2012 that will enhance system financial performance over the long term and provide a growing source of equity funding for capital needs. The rate package has generated less revenue than expected due to changes in usage, but rate certainty remains a credit strength with significant rate increases approved through 2021.
HIGH LEVERAGE: Debt levels remain elevated, and debt is expected to remain high as the system only gradually shifts to a higher equity contribution to its capital program. The transition has been slowed by unexpected weakness in revenue growth.
EXPANSIVE SERVICE TERRITORY: The utility provides an essential service to a large and diverse service area with a fundamentally sound economy.
STRONG MANAGEMENT PRACTICES: Financial and capital planning are thorough and professional. Rate setting is difficult, but policymakers have shown rate discipline without overt politicization of sewer rates.
RATING SENSITIVITIES
DOWNGRADE RISK ON FINANCES: The rating could come under downward pressure if revenue weakness pushes all-in debt service meaningfully below 1.5x on a sustained basis.
ELEVATED BORROWING PLANS: Weakness in revenue growth has forced the city to continue to rely heavily on debt to fund capital improvements. Continued increases in debt ratios could put downward pressure on the rating.
CREDIT PROFILE
COVERAGE RECOVERS, BUT REVENUE LAGS
Financial performance is sound, but revenues have underperformed prior expectations on decreasing sewer flows and the implementation of a new billing system. Fitch calculated senior DSC (excluding connection fees, which are not pledged to bondholders) remained very strong at 2.9x in fiscal 2014, and all-in DSC was adequate at 1.5x. Coverage has improved from the system's last review in 2013, when all-in was estimated at 1.3x for 2012.
Liquidity remains solid, providing ample room for the utility to manage temporary revenue misses. The utility had $118.6 million of unrestricted cash and investments at the end of fiscal 2014 and $40.1 million of restricted operating and maintenance reserves. Days cash was solid at 218 days, while days working capital was quite strong at 602 days.
LAGGING REVENUE PERFORMANCE
While coverage has improved, revenues continue to lag prior forecasts due to a continuing decline in billable sewer flows and problems with the implementation of a new billing system. Sewer service charges were $51 million below budget in 2014 with about $14 million of the shortfall due to reduced flows and are expected to be about $94 million below budget in 2015.
Sewer flows have declined in a manageable and predictable manner and are not a major credit concern. Billable flows have fallen by 3.6% over the past five years due to a secular decline in water usage with the adoption of water saving technology. Flows are forecast to fall more rapidly in 2015 (1%) and 2016 (5%) due to drought pressures. This estimate appears reasonable given that most water conservation occurs outdoors and does not affect sewer flows. Declines in the historic range are to be expected and more than fully offset by approved rate increases.
The system lost a greater amount of revenues due to problems with the implementation of a new billing system. The problem is likely to be temporary, and most of the lost revenues will be recouped over time. However, the impact on revenue is quite large at $60 million in 2015. The utility believes the bulk of the implementation problems have been resolved and has resumed collection procedures. The city has conservatively forecast past-due collections, and collections are likely to create some upside room for the forecast as billing problems are resolved. Still, a failure to resolve billing problems fully would put downward pressure on the rating.
The utility's forecast shows all-in coverage (including coverage of state revolving fund loans) averaging about 1.4x over the next five years. Fitch believes the forecast is conservative with demand forecast to fall on drought conservation without any recovery assumed and modest collections of arrears. The utility is likely to beat this forecast, but performance at the projected level would put downward pressure on the rating.
ADOPTED RATES A MAJOR POSITIVE
The city has shown solid sewer rate discipline with a 10-year rate package approved unanimously by the mayor and city council in 2012. The rate plan calls for 6.5% yearly adjustments for fiscals 2015-2021. The adjustments should improve revenues and more than offset expected weakness in flows. No additional action is required prior the rates hikes taking effect.
LEVERAGE STILL RISING
In addition to the expectation for improved financial performance, the rate adjustments should provide for an increasing annual level of equity capital funding, alleviating leverage pressure over time. This improvement is taking longer to materialize than expected due to the revenue weakness described above, but Fitch continues to expect approved rates to eventually allow the city to shift to a more significant equity contribution to capital spending over time.
Debt ratios are high relative to other comparably rated utilities and will increase further over the fiscal 2015-2019 CIP horizon. The utility will have $2.8 billion of debt outstanding after the current bond issue. That's more than twice the median for 'AA' rated utilities at $4,413 per customer. The utility plans to borrow an additional $938 million over the next four years, pushing debt per customer to $5,144. These debt estimates remain preliminary and could change if sewer revenues improve or substantial lost revenues are recouped with the correction of recent billing problems. However, the forecast level of borrowing could put pressure on the rating.
The current $1.55 billion five year capital improvement plan is down from prior years due to the completion of mandated regulatory projects, particularly those associated with a 10-year collection system settlement agreement (CSSA) signed in 2004 between the city and regulators. While CSSA required projects are completed, the CIP continues to allocate significant funding to pipeline renewal in order to address aging infrastructure and ensure continued system performance.
The system is an aging urban sewer system that's likely to continue to require significant investments in its pipe system for the foreseeable future. Average age of plant is elevated at 23 years. System investment has been healthy over the past five years with capital expenditures averaging 102% of depreciation. The utility appears well positioned in terms of treatment plant capacity and level of treatment.
VAST SERVICE TERRITORY RECOVERING
The system provides wastewater collection, treatment, and disposal services for an area of about 600 square miles, including most of the city and certain neighboring municipalities. Customer levels have remained virtually flat over the last five fiscal years and currently number around 630,000 accounts. Customer concentration is not a significant credit concern with the top 10 payers providing just 5.4% of revenues in 2013.
The city sits at the heart of a vast and diverse regional economy that is recovering from a deep recession. Unemployment runs above the national average due to weak educational attainment, but it has been improving since 2010 and hit a seven-year low of 7.7% in March 2015. Service area wealth levels are around 20% lower than the state but only mildly below the national average. Despite the approved rate package, residential customer charges currently are and are expected to remain within or near Fitch's 1% of median household income (MHI) affordability benchmark.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was informed by information from CreditScope and IHS Global Insights.
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=984551
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