AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms its 'AA-' rating on the following Hopewell, Virginia (the city) sewer system revenue bonds:
-- $20.8 million sewer system refunding revenue bonds series 2011 A and B;
-- $4 million sewer system revenue bonds, series 2010.
The Rating Outlook is revised to Negative from Stable.
SECURITY
Bonds are limited obligations of the city, payable solely from net revenues derived from the city's sewer system (the system).
KEY RATING DRIVERS
PILOT PRESSURES COVERAGE AND OUTLOOK: The Negative Outlook reflects the system's swift drop in debt service coverage (DSC), registering just 1.1x for fiscal 2014. DSC was pressured by an above-average payment-in-lieu-of-taxes (PILOT) to the general fund. The system's PILOT to the general fund is high, averaging 15% of operating revenue over the past two fiscal years and expected to continue for at least two more years. This level of PILOT will continue to pressure DSC.
ROBUST LIQUIDITY: Despite the sizeable PILOT payment, system cash levels remain robust for the rating category at over 1,200 days of cash on hand (DCOH).
HIGH DEBT DRIVEN BY CAPITAL NEEDS: The system debt financed a large capital expansion and now the debt load is twice as high as similarly rated credits on a per capital basis. Debt levels should decline going forward as the system has no plans for additional debt in the immediate future.
COMPETITIVE RATES: The system's competitive rate structure is moderately tempered by the city's below-average income levels. Rates remain competitive despite recent years of double digit rate increases.
SMALL, CONCENTRATED CUSTOMER BASE: The customer base is relatively small, with large wholesale customers accounting for a sizable amount of system revenues. Area wealth levels are below average and unemployment is somewhat high. The wholesale service agreements are expected to remain stable.
RATING SENSITIVITIES
FAILURE TO IMPROVE COVERAGE: Failure to improve DSC coverage to a more adequate level for the rating category would likely result in a downgrade.
CREDIT PROFILE
REGIONAL SYSTEM
The city owns and operates a primary wastewater treatment plant, which was recently relocated and expanded to 16.5 million gallons per day (mgd) treatment capacity from 6.8 mgd. The primary plant was relocated to the site of the 50 mgd Hopewell Regional Wastewater Treatment Facility (HRWTF), which provides secondary treatment to the primary plant and to five industrial users. The HRWTF is accounted for as a separate enterprise fund of the city and those revenues are not pledged to and do not support the repayment of the system's bonds.
FINANCIAL MARGINS DECLINE
Starting in fiscal 2013 the city began to include a PILOT from the sewer fund to the general fund. DSC for fiscal 2013 was a sound 1.9x including an $860,000 PILOT or approximately 14% of operating revenues. However, DSC levels for fiscal 2014 were more greatly impacted due to the debt service costs growing to $1.6 million and the PILOT increasing to $923,000. DSC from recurring revenues fell to a weak 1.1x in fiscal 2014 and similar coverage levels are anticipated for fiscal 2015. Fitch notes the level of PILOTs is high, averaging 15% for fiscal years 2013 to 2015, and has had a significant impact on financial margins.
The rate covenant is adequate, allowing the inclusion of connection fees in the requirement that net revenues cover senior debt service by at least 1.15x or net revenues including rate stabilization fund cover maximum annual debt service by at least 1.5x. With the inclusion of the rate stabilization fund, calculated coverage was over 2x, therefore a rate covenant violation did not occur.
The 23% adopted rate increase in fiscal 2013 only registered a 4% operating revenue uptick in fiscal years 2013 and 2014. Further, additional flows anticipated from expansions at nearby Fort Lee did not materialize to the levels expected. This combination of under realized revenues and flows resulted in less operating revenues than anticipated when the PILOT was initiated by the city.
Offsetting some of Fitch's concern over the reduced DSC levels is the system's strong cash position. The system's cash balances declined only slightly, falling to $13 million (preliminary fiscal 2015 figures) from $15.5 million the year prior. Nevertheless, system liquidity remains robust at over 1,200 DCOH, over twice the 'AA' category median of 442 days.
HIGH BUT DECLINING DEBT BURDEN
As a result of the debt issued to finance the relocation and capacity expansion of the primary plant, leverage levels are high at $1,175 on a per capita basis compared to the 'AA' median of $521. Amortization is slow with only 54% of the debt principal paid off in 20 years. However, the debt burden should continue to decline as there are no additional borrowings expected over the next five years.
REDUCED PRIMARY CAPITAL REQUIREMENTS
With the large scale capital needs of the primary treatment facility addressed, the city has identified $2 million in annual capital needs over the next several years to adhere to a sanitary system overflow consent decree, which will be funded from excess system revenues. Costs associated with needed nitrogen removal at the regional facility are estimated at more than $80 million, with 60% to be grant funded and the balance to be paid by industrial users of the HRWTF system.
COMPETITIVE RATES
System rates are still relatively low at $22.50 for an average residential user, despite the 69% increase adopted in 2009 and additional 23% increase in fiscal 2013. Current rates (based on 5,000 gallons of water usage) register at 0.7% of median household income (MHI). This level is moderately below Fitch's affordability threshold of 1% of MHI, providing the system with adequate rate raising flexibility. Management is undertaking a rate study in the fall of 2015 to review revenue sufficiency. Additional rate increases over the coming five years are anticipated.
STABLE CUSTOMER BASE
The customer base includes around 8,500 retail customers, although the bulk of the treatment is provided to wholesale customers. Approximately 52% of fiscal 2014 revenues were accounted for by service contracts with the three largest users: the Federal Correctional Complex (FCC), Prince George County (general obligation [GO] bonds 'AA-'/Stable Outlook), and Fort Lee. FCC's agreement has expired, but the system is the only wastewater treatment option in the region, and the FCC continues to send flows to the system.
Fitch considers these contracts stable and current allocations provided by the system appear sufficient. Flows to the primary plant have averaged 5.2 mgd recently, and with increased conservation efforts and continued repair and replacement of the system's aged sewer lines management anticipates the increased capacity of the primary plant should be sufficient for at least the next several years.
LIMITED ECONOMY
The city of Hopewell (GO bonds 'AA-'/Stable Outlook) is located in the Richmond metropolitan area at the confluence of the James and Appomattox rivers, approximately 25 miles from downtown Richmond (GO bonds 'AA+'/Stable Outlook). The city's 2010 population of 22,591 has remained relatively flat since 2000 and city officials continue efforts to diversify the historically manufacturing-based economy, concentrating on the revitalization of downtown Hopewell.
An increase in personnel at nearby Fort Lee has benefited Hopewell and the system. The area economy is anchored by manufacturing and healthcare. Other economic indicators are weak, with local median household income falling each year for the last five years and now at 59% of the state and 72% of the national averages. Unemployment for March 2015 was reported at 8.3%, which while down from the year prior rate of 8.9% was still above the state (4.9%) and national (5.6%) 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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=991739
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991739
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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