NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'A+' on the following Toledo, OH (the city) outstanding revenue bonds:
--$2.8 million sewer system (the system) revenue bonds, series 2005.
The Rating Outlook is Stable.
SECURITY
The bonds are payable by net sewer system revenues, including various pledged funds.
KEY RATING DRIVERS
WEAK FINANCIAL MARGINS: The system's financial profile is characterized by weak all-in debt service coverage (DSC) margins but robust cash levels. Projections show both trends continuing through the five year forecast as more debt is acquired, increasing annual fixed costs but preserving cash levels.
REGULATORY-DRIVEN CAPITAL NEEDS: The sewer system's capital improvement plan (CIP) is dominated by projects necessary to meet a consent decree to eliminate combined and sanitary sewer overflows (CSOs and SSOs). The city has fully outlined and identified a plan of funding for all required projects in its long-term capital program and expects to fulfill its mandated obligations by 2020, as required.
HIGH AND INCREASING DEBT BURDEN: Debt ratios are high relative to comparable ratings and will rise further as additional debt is obtained to complete consent decree milestones. The system's debt burden is almost entirely comprised of subordinate-lien loans from the Ohio Water Development Authority and Ohio Public Works Commission (OWDA and OPWC).
LIMITED RATE-SETTING FLEXIBILITY: The average residential monthly sewer charge exceeds Fitch's 1% of median household income (MHI) affordability threshold but is still considered regionally affordable.
IMPROVING ECONOMY: Service area economics remain somewhat weak, however, unemployment has fallen to historic lows and local economic development is improving after several years of depressed activity.
RATING SENSITIVITIES
MAINTENANCE OF STABLE FINANCES AMID GROWING DEBT: The ability for Toledo, Ohio to maintain or exceed current financial margins in the sewer system fund (the system) given escalating annual debt service costs is necessary to preserve rating stability. Negative deviation from management's stated financial projections may result in downward rating action.
APPROVAL OF ADDITIONAL SEWER RATE INCREASES: Rating stability depends on the system's ability to secure city council approval of an additional rate plan in calendar year 2016, above those already approved for the Toledo Waterways Initiative Program, to fund planned renewal and replacement spending. Spending that in unaccompanied by additional revenues could pressure financial margins to a point that would result in negative rating action.
OPERATING PROFILE CONSTRAINED BY LARGE MANDATED PROJECTS
In 2002, the city entered into a 20-year consent decree with the U.S. Environmental Protection Agency (EPA) in order to mitigate CSOs and SSOs. The city created the Toledo Waterways Initiative (TWI) Program to actively manage the required $520 million of identified mandated consent decree projects. To date management has expended 72% of required consent decree/TWI capital outlays.
The TWI's primary projects include the construction of massive underground retention tanks that store excess wastewater flows during periods of heavy precipitation until the city's Bay View Wastewater Treatment Plant (WWTP) has capacity to treat the flows. Most have been completed since the program's inception and the largest project currently under construction is the underground Ottawa River Storage Facility, which when completed will have the capacity to store over 36 million gallons of combined sewage. The city has until 2020 to fulfill its consent decree requirements and believes it is on target to meet that goal.
WEAK FINANCIAL PROFILE
The city has had to incur significant external funding in order to accomplish the capital requirements of the TWI Program. Over time, debt, comprised of both senior lien revenue bonds and OWDA and OPWC subordinate lien loans has escalated. The system's net revenue coverage of all-in debt (senior and subordinate ADS), has averaged an adequate 1.45x from fiscal years 2010 through 2014 and all-in coverage in fiscal year 2015 based on unaudited results was a slim 1.25x. Management's financial projections as of March 2016 predict all-in coverage to range between 1.2x - 1.4x through fiscal year 2020. As the city plans to continue funding its consent decree projects with additional subordinate loans, margins are likely to stay low, consistent with the projections. By fiscal 2016, Fitch projects that all-in ADS should consume a very high 40% of gross operating revenues (the 'A' median average is 23%) and remain elevated at this rate through fiscal 2020.
Senior lien DSC has been strong historically due to its minimal composition of the system's overall debt profile; in (unaudited) fiscal 2015 it was a robust 9.7x. Management does not currently anticipate it will acquire additional revenue bonds; therefore, senior lien DSC levels should remain high.
Liquidity has been strong over time with available system liquidity equating to an average of 330 days' cash on hand (DCOH) since fiscal 2010. Unrestricted cash totaling $46.9 million in fiscal 2014 equated to about 458 DCOH. Fitch expects cash to stay strong, at levels more than sufficient to meet the very minimal pay-go portion of the system's capital needs based on the substantial amount of debt forecasted.
INCREASING DEBT AND CAPITAL BURDEN
The sewer system's five-year fiscal 2016-2020 CIP totals $336.7 million and is about 85% debt-funded. Over half of the CIP will support the city's consent decree mandated projects outlined in the TWI Program. The entirety of the TWI Program is currently forecast to be supported by the low-interest subordinate OWDA and OPWC loans. Additional loans will support the balance of the CIP, which is scheduled to fund renewal and replacement (R&R) of standard, aging system assets.
Capital spending per capita is high for the rating at over $600 given the system's significant level of capital investment. This metric is expected to continue to increase. Leverage ratios are also high; debt comprises 60% of the system's net plant and debt per customer approximates a very high $4,500 (over twice the 'A' category median). These metrics are expected to remain elevated as upwards of $280 million more in debt is projected to be obtained over the next five years. Debt amortization is currently rapid with 89% paid off in 20 years however the additional forecasted debt issuances will likely slow the current rapid payout pace significantly.
LIMITED RATE-SETTING FLEXIBILITY
Sewer rates consist of a fixed service fee, a volumetric usage charge, and in more recent years, an additional fixed TWI Program fee that directly funds consent decree-related projects. The service charge and volumetric rates were both raised by 3% in fiscal 2014 and 10.3% in fiscal 2015. The additional TWI charge has stayed flat at $15.82 each year since fiscal year 2011. The utility received city council support in August 2014 to raise rates by 7.1% annually through fiscal 2019 and 7.9% in fiscal 2020. These approved rate increases support the remaining TWI Program costs.
As mentioned, management has scheduled extensive R&R needs in the CIP and will seek approval for additional rate increases from city council for its next four-year rate plan for fiscal years 2016 - 2020. Approval of the new rate plan should occur in later calendar year 2016. Based on the successful passage of prior rate plans, management is optimistic that the current rate plan should be well-received and approved by city council. Fitch expects that the proposed plan will yield revenue projections sufficient to meet the system's growing debt service costs in line with historical performance.
The typical residential customer spent $165 per quarter (or approximately $55 per month) on their sewer bill in fiscal year 2015. This equated to roughly 2% of MHI, which is considered high by Fitch as it exceeds the 1% threshold for a single utility bill's proportion of monthly spending. When charged along with the city's water bill, which comprises 0.6% of MHI, combined utility rates equate to nearly 3% of MHI. As both the water and sewer utility's rates are increasing to support each system's debt-funded capital programs, individual rate-setting flexibility may become increasingly strained. Management indicates that Toledo's utility rates are considered competitive regionally and therefore the passage and acceptance of rate increases should be successful.
RECOVERING SERVICE AREA
Toledo is the county seat of Lucas County, located in northwestern Ohio. The city's economy is driven by manufacturing, health care, education and local government. Toledo experienced several years of substantial economic decline consistent with other Rust Belt cities but is now on the rebound; ProMedica, a non-profit health care system in northwest Ohio and southeast Michigan, is currently constructing its new headquarters in the city's downtown, coincident with the development of a downtown entertainment district. Greater efforts are being made by city and county officials to promote in-city residential migration and as a result housing occupancy rates are rising and new developments are on the rise. The city's unemployment rate has continued to decline; however, at 6.5% in January 2016 ranked higher than Lucas County (6.1%), the state (5.7%) and national levels (5.3%). Wealth levels as measured by per capita personal income persist to be lower than the county, 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
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
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Dodd-Frank Rating Information Disclosure Form
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1001505
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