Correction: Fitch Rates North Harris County Water Authority, Texas' Water Rev Bonds 'A+'

NEW YORK--()--(This is a correction of a press release published on July 7, 2016.) It updates the description of the senior lien revenues and refunding bonds.

Fitch Ratings has assigned an 'A+' rating to the following North Harris County Regional Water Authority, Texas (the authority) bonds:

--Approximately $280.8 million senior lien revenue and refunding bonds, series 2016

The bonds are scheduled to sell the week of July 18th via negotiation. Series 2016A proceeds will be used to refund certain outstanding Series 2008 bonds for interest savings without extension of maturity, and series 2016B proceeds will finance various capital improvement projects.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a first lien on net revenues of the authority's water system (the system), plus amounts in the reserve fund and transfers from the coverage fund.

KEY RATING DRIVERS

SOUND FINANCIAL PROFILE: Historical annual debt service (ADS) coverage is sound and liquidity is robust. Rising fixed costs are expected to push ADS coverage to more modest levels in the near term.

SUBSTANTIAL CAPITAL AND DEBT NEEDS: The authority's capital improvement program (CIP) to meet future groundwater reduction requirements is substantial and is anticipated to be entirely debt-financed. This borrowing program is expected to further pressure the authority's already high debt burden.

INCREASING RATES: User charges are expected to continue rising incrementally to fund additional capital needs, although rates are expected to remain moderate over the long term. Given that other regional water purveyors are facing similar groundwater conversion costs, rates are likely to remain competitive in the long term.

BELOW-AVERAGE LEGAL COVENANTS: Legal provisions are somewhat weaker than peer wholesale systems but are adequate.

ESSENTIAL PROVIDER WITH STRONG ENFORCEMENT: The authority provides an essential service as a wholesale water provider to the cities of Tomball and Jersey Village, as well as about 145 utility districts in the suburban areas north of the city of Houston (the city); all water utilities within the authority's service area must reduce their overall groundwater pumping. Enforcement provisions in place are expected to ensure timely recovery of revenues by the authority.

RATING SENSITIVITIES

ACCELERATING CAPITAL COSTS: Significant increases in conversion cost requirements beyond what is currently planned would further pressure the authority's debt profile and rate structure. The Stable Outlook reflects the expectation that costs will not vary materially from current projections and the capital and debt profile will remain consistent with the current rating.

CREDIT PROFILE

The authority is a wholesale water provider serving a 338 square mile mostly suburban area in northern Harris County. With an aggregate population estimated at 664,000, its customers include 147 municipal and other retail water utility systems and 78 industrial, commercial, recreational, governmental, and other institutional well owners. The region experienced extensive land subsidence as a result of decades of groundwater pumping, which in turn led to the Harris Galveston Subsidence District (HGSD) in (1999) promulgating strict requirements for pumpers to convert to alternative sources of supplies (i.e. surface water), either individually or collectively in stages.

The authority has adopted, and the HGSD has approved, a groundwater reduction plan (GRP) which incorporates construction of a surface water distribution system and purchase of treated water from Houston for sale to groundwater users and other retail agencies within the authority's service area.

SIGNIFICANT CAPITAL NEEDS

The GRP was designed to meet increasingly stringent pumping restrictions in 2010, 2025, and 2035; the authority met the 2010 conversion requirements and is gearing up to ensure compliance for the 2025 conversion requirements. Total capital costs for conversion to surface water supplies from 2016 through 2022 are estimated at $1.1 billion.

Major projects include the authority's share of a regional project with Houston to expand the Northeast Water Purification Plant, a second source line and transmission lines to deliver treated water from the plant to the authority, and an internal distribution system to convey the water to the member retail municipal utility districts. Additional capital needs for repair and replacement of existing infrastructure and to update the authority's groundwater reduction plan totals about $518 million during the same time period.

Capital projects are expected to be entirely debt funded. The majority of future borrowings will be comprised of bonds purchased by the Texas Water Development Board through the State Water Implementation Revenue Fund, a program that was established to provide low cost financing for projects in the state water plan.

The authority has $873 million in remaining commitments from the TWDB for capital projects that will be taken down in annual installments as projects move forward. The authority is requesting an additional $226 million related to the projects and may fund additional projects through revenue bonds sold in the open market. These borrowings will further pressure already high debt levels.

ADEQUATE FINANCIAL METRICS EXPECTED TO WEAKEN

The authority has posted coverage ranging from 1.3x to 1.9x in the last five years, allowing it to build substantial liquidity and maintain healthy reserves. Liquidity at the end of fiscal 2015 was robust with unrestricted cash at $131.5 million (more than five years of operations and maintenance [O&M] spending); however, liquidity is expected to decline over the CIP implementation period.

The forecast coverage is expected to decline over the next five years as the authority embarks on the 2025 surface water conversion phase. Coverage from net revenues is projected to range from 0.65x to 1.1x from 2016 to 2021. When ending fund balance in the coverage and improvement funds are included (as permitted in the bond covenants), adjusted coverage will range from 1.8x to 4.4x from 2016 to 2021.

AFFORDABLE CHARGES DESPITE PLANNED HIKES

The authority's surface water and pumpage fees are expected to increase as the capital plan progresses. While the planned increases on a percentage basis appear substantial, charges should remain affordable relative to median household income. Retailers will add their distribution costs to the ultimate consumer bills.

Currently, the authority's surface water and pumpage fees equal $2.85 and $2.40 per 1,000 gallons of water, respectively. The current pro forma includes incremental annual increases in both fees through 2023. Revenue collections from retail customers are near 100% and should remain so, given that the expense of developing alternative water supplies for retailers is cost prohibitive. Also, failure to reduce groundwater pumping levels to HGSD required levels would result in financial penalties.

BELOW-AVERAGE LEGAL COVENANTS

Legal provisions are somewhat weaker than peer covenants, given the allowance for the use of fund balance in the rate covenant calculation. Nevertheless, legal provisions are adequate overall due to several required reserves. Per the indenture, a coverage reserve (equal to 25% of maximum ADS) and a common debt service reserve are pledged to bondholders. In addition, the authority is required to maintain an O&M reserve equal to two months of budgeted O&M expenditures.

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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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008895

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst:
Gabriela Gutierrez, CPA, +1-512-215-3731
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst:
Doug Scott, +1-512-215-3725
Managing Director
or
Committee Chairperson:
Steve Murray, +1-512-215-3729
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Gabriela Gutierrez, CPA, +1-512-215-3731
Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst:
Doug Scott, +1-512-215-3725
Managing Director
or
Committee Chairperson:
Steve Murray, +1-512-215-3729
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com