AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA' rating on the following Chesapeake, Virginia (the city) revenue bonds:
--$32.5 million water and sewer system revenue bonds (taxable Build America Bonds) series 2010B.
The Rating Outlook is Stable.
The bonds are secured by a senior lien on net revenues of the city's water and sewer system (the system).
KEY RATING DRIVERS
STABLE FINANCIAL PERFORMANCE: The system enjoys financial flexibility due to healthy cash reserves and solid debt service coverage on an all-in basis. Currently high cash balances are expected to decline closer to historical norms as the system addresses the back-log of pay-go capital projects now slated for completion in the coming years.
RATE PRESSURE: User rates for city-provided water and sewer service are deemed affordable, registering well below Fitch's affordability threshold despite recent increases. When taking into account charges for wastewater service provided by Hampton Roads Sanitation District (HRSD), rates climb to 2.1% of median household income (MHI), just over Fitch's 2.0% affordability threshold. With additional costs associated with a regional consent order, it is anticipated that wholesale wastewater rates will continue to rise by 8% to 10% annually for the next decade.
MANAGEABLE DEBT PROFILE: Debt ratios are favorable and currently below average for the rating level. However, the city anticipates incrementally issuing $54 million in revenue bonds between fiscal 2019 and fiscal 2025. The currently low debt burden provides for ample capacity to handle the future debt.
AMPLE WATER SUPPLY: Chesapeake's water and sewer utility system benefits from an ample water supply and treatment capacity as well as a stable service area.
SOLID, DIVERSE ECONOMIC BASE: The city's economy is strong, characterized by high wealth levels and low unemployment. Chesapeake's economy, though diverse and steadily expanding, retains its support from the stable military and port presence in the Hampton Roads region.
CAPITAL PROGRAM IMPLEMENTATION: Fitch expects the city will continue to address infrastructure needs relating to regional consent order requirements and sanitary sewer overflow mitigation. Significant increases in capital expenses related to the consent order could pressure the system's debt profile and financial flexibility. The Stable Outlook reflects Fitch's opinion that such changes are unlikely.
The system provides water treatment and distribution and wastewater collection service to a service area population of over 185,600, equal to 79% of the city's total population. Water and sewer accounts totaling over 63,000 are primarily residential users. Customer accounts have grown little over the past five years, averaging growth of slightly less than 1% annually. As such, average total water demand typically does not fluctuate much.
ADDRESSING REGIONAL CONSENT ORDER
The system collects wastewater and conveys it to HRSD (wastewater revenue bonds rated 'AA+'/Stable Outlook). Billing for both water service and sewer collection is administered by the HRSD and collection rates are strong.
HRSD, together with the city and 12 of the municipalities HRSD serves (the localities), were placed under federal and state consent decrees to reduce sanitary sewer overflows throughout the region. The localities and HRSD have entered into a memorandum of agreement in which HRSD will fund costs associated with improving capacity of the regional sewer system and assume the regulatory liability for capacity-related sewer overflows. The localities are responsible for renewal and replacement of their own sewer collection systems. The city estimates that 30% of its 2016-2020 capital improvement program (CIP) relates to consent decree projects.
REGIONAL SEWER PROVIDER RATE PRESSURE
The current average residential monthly bill, based on 6,750 gallons of water consumption, equals just over $122. This includes city water and sewer charges as well as wastewater services provided by HRSD. Rates calculated as a percentage of MHI register 2.1%, just above Fitch's affordability threshold of 2.0% of MHI. The city council approved a multi-year rate package of a 4.9% annual rate increase through fiscal 2018. HRSD also anticipates rate increases ranging from 8% to 10% over the same time period. Fitch will monitor the impact of these additional rate hikes, which will further limit rate flexibility over the near- to medium-term.
SOLID FINANCIAL PERFORMANCE
Financial operations are sound, generating favorable operating margins and healthy cash reserves. Recent sizable water rate increases added to the system's cash position and enabled the system to end fiscal 2015 with approximately $69 million in unrestricted cash, equating to over 600 days of operations. Fitch does not anticipate cash balances climbing further, as the city plans to cash fund at least a portion of future capital projects. Forecasts point to a drop in cash level but no further than management's reserve balance target of $25 million.
Debt service coverage was also bolstered by the rate increase, with the three-year average all-in coverage coming in at a sound 2.2x. Fitch's calculation of all-in coverage incorporates management's financial projections which point to a continued trend of healthy coverage of at least 2.1x through the 2020 forecast period.
FAVORABLE DEBT BURDEN
The system's five-year CIP is manageable, totaling $134 million and takes into account a back-log of projects that had been put on hold while the utility department underwent some turnover in management. Officials estimate debt-financing a small portion (7%) with revenue bonds, with the balance of capital funding coming from cash reserves. With flat retail sales and low growth, the city has been able to defer water resource and distribution projects. The focus of the current CIP is related to addressing the regional consent order and system repair and maintenance.
Current debt levels are low, with system supported debt divided between $32 million in senior lien revenue bonds and $83 million in city general obligation (GO) bonds, which are paid on a subordinate basis from net system revenues. After the five-year horizon, the city anticipates issuing an additional $46 million in revenue bonds to finance capital needs. The size and timing of planned debt issuance coupled with rapid amortization will keep direct debt levels relatively flat for the intermediate term.
AMPLE WATER SUPPLY
Through long-term take-or-pay supply contracts, potable water is purchased from neighboring cities of Norfolk (water revenue bonds rated 'AA+'/Stable Outlook) and Portsmouth (GO bonds rated 'AA'/Stable Outlook), accounting for about one-third of the 16 million gallons per day (mgd) average demand. The system also utilizes its own supply with surface water drawn from the Northwest River and groundwater derived from seven existing wells. The balance of available supply comes from a separate 30-year contract with Norfolk that provides the city with a minimum of 7 mgd of untreated water. The city estimates the current water supply of about 25 mgd is sufficient through 2040. Treatment capacity of internal supply and bulk raw water is ample.
SOLID ECONOMIC PROFILE
Chesapeake (GO debt rated 'AAA'/Stable Outlook) is located in the Hampton Roads area of Virginia, and the city's diverse economy benefits from the regional economic support of the military and port operations. The largest employers represent varied industries, including military contractors. The city also has a substantial retail sector and an increasing number of international corporations.
The estimated population for 2015 was approximately 230,000, an increase of about 17% since the 2000 census, below the rapid population gains of the 1970s through the 1990s that ranged from 28%-33% each decade. Per capita income levels hover around national averages and below those of the commonwealth, although the city's above-average median household income is augmented positively by military pensions. The unemployment rate, at 4.2% in November 2015, trends below the U.S. average though it remains at slightly above the state's rate.
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 and Burton and Associates (rate consultant).
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
Dodd-Frank Rating Information Disclosure Form