Fitch Rates Sugar Land, TX Waterworks and Sewer System Revenue Bonds at 'AA+'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings assigns an 'AA+' rating to the following city of Sugar Land, TX (the city) bonds:

--Approximately $16.6 million waterworks and sewer system revenue and refunding bonds series 2015.

The bonds will be sold via competitive bid on April 21. Bond proceeds will be used to refund series 2006 bonds for interest savings, to fund capital projects and to pay issuance costs.

In addition, Fitch affirms its 'AA+' rating to the following outstanding city waterworks and sewer system bonds:

--$74.7 million revenue bonds series 2006, 2008, 2009, 2012 and 2013

--$11.4 million revenue and refunding bonds series 2009 and 2012A

The Rating Outlook is Stable.

SECURITY

The bonds are secured and payable from a first lien on and pledge of the net revenues of the waterworks and sewer system (the system).

KEY RATING DRIVERS

CONSISTENTLY STRONG OPERATIONS: Financial performance has been strong, characterized by high combined debt service coverage that has consistently exceeded 2x over the past five years. Liquidity has declined due to non-recurring capital outlays, nonetheless remains robust at 372 days cash on hand in fiscal 2014.

GROWING DEBT BURDEN: The system's debt per customer is high compared to that of the Fitch's 'AA' category rating medians. Additional capital needs that will require debt funding over the next five years are projected to continue to pressure already high debt levels.

AMPLE RATE FLEXIBILITY: Despite recent rate hikes, rates are very low relative to median household income (MHI), limiting direct pressure on the rate base.

GOOD PLANNING EFFORTS: The system is highlighted by comprehensive long-range financial and capital planning. In addition, the city consolidates efforts with other area providers to ensure timely compliance with groundwater reduction plans.

SOLID SERVICE AREA: The service area, which is located outside of Houston, exhibits good growth patterns, very robust income metrics, and unemployment that is consistently lower than the state and U.S.

RATING SENSITIVITIES

DETERIORATION OF FINANCIAL PROFILE: A decline in the city's financial profile, characterized by weak coverage levels and a substantial drop in liquidity could negatively impact the rating. The Stable Outlooks reflects Fitch's belief that this is unlikely. Given the system's elevated debt position, upward rating movement is unlikely in the near term.

CREDIT PROFILE

Sugar Land is a suburban community located about 20 miles southwest of Houston in Fort Bend County. The system provides service to an estimated population of approximately 86,500 through 30,000 water and 28,000 wastewater connections. The majority of customers are residential and there are no customer concentration concerns.

STRONG FINANCIAL METRICS

The system's historical financial performance has been very strong with combined annual debt service (ADS) coverage consistently at or above 2.2x through fiscal 2013. Due to increasing debt service costs, all-in ADS coverage has started to decline, but still registers a strong 2.0x for fiscal 2014. These results also exceeded the 1.4x ADS coverage projected for that year. For fiscal years 2015 - 2019, management forecasts weaker all-in ADS coverage at around 1.6x. The calculations include conservative assumptions and future planned debt.

Regular rate adjustments have maintained the system's above-average operating margins and helped to boost cash levels to a very high 844 days in fiscal 2013. The city restricted much of the 2013 surplus for capital projects reducing liquidity to a still strong 372 days in fiscal 2014.

SURFACE WATER CONVERSION

The city approved a Groundwater Reduction Plan (GRP) that outlines the city's strategies for meeting mandated conversion to non-groundwater sources pursuant to Fort Bend Subsidence District regulations. The GRP involved participation by smaller water providers in the area to consolidate water plans and collectively meet ground water withdrawal limits.

The city commenced its surface water conversion project, which involved the construction of transmission lines, groundwater plant improvements and construction of a 9 MGD surface water treatment plant (with capability for future expansion) adjacent to Oyster Creek and Gannoway Lake. Construction of the surface water treatment plant was completed on time in November 2013 at a cost of $105.9 million, all of which was debt funded.

Currently the city supplied surface water accounts for about 45% of total water demands. The GRP mandates for 2025 is to increase surface water to 60%. This will be achieved through increased use of Oyster Creek surface water, wastewater re-use, and expanding the surface water plant to 25 MGD.

DESPITE INCREASES, RATES REMAIN VERY AFFORDABLE

Water and sewer rates are approved by the City Council as part of the budget process. Water rates have two components: a utility charge and a surface water conversion fee. The average city customer pays $59.30 for combined service charges (assuming average water and sewer usage of 7,500 and 6,000 gallons, respectively) or a very affordable 0.7% of MHI. An additional rate adjustment of approximately 2.5% is planned for fiscal 2017. Given the high area wealth levels, charges are expected to remain well below Fitch's affordability threshold of 2% of MHI for the near to intermediate term.

The system also collects GRP fees from participating entities in the consolidated GRP. These fees are based on groundwater withdrawals and, like the surface water fees for city customers, have also steadily increased to the current $1.75 per 1,000 gallons. In fiscal 2014, the surface water fees and GRP fees generated $12.9 million to support the surface water conversion efforts.

HIGH DEBT BURDEN AND GROWING

Debt levels grew rapidly as a result of the surface water conversion project. System debt ratios are very high with outstanding debt per customer at approximately $3,140, compared to the 'AA' category median of $1,934. With future debt planned to finance the maintenance related CIP and the wastewater treatment expansion, levels are expected to increase by approximately 17% in five years. Debt amortization at 41% and 81% in 10 and 20 years, respectively, aligns closely to the 'AA' category median.

The city's 2015 - 2019 CIP totals an estimated $100.3 million, with projects split between water (22%), surface water (14%) and wastewater (64%). Funding for 88% of the CIP is planned from future debt issuance, while the remaining projects will be funded with available resources. About one-third of the CIP is for a wastewater treatment plant expansion that has been deferred several years due to slower than previously expected flows. The remaining projects focus on system repair and maintenance. The current bond issue will fund the 2015 projects with additional issuances planned in future years.

TREATMENT PLANT EXPANSION ON HORIZON

Wastewater treatment is provided by the Sugar Land Regional Sewerage System Plant and the South Wastewater Treatment Plant. Both plants are operated by the Brazos River Authority (BRA). The current contract with BRA began in October 2010 and is for three years with two one-year extensions. With a combined capacity of 16 MGD and sewer flows averaging 8.0 MGD annually over the past five years, there is more than sufficient capacity remaining to handle near term city growth. City growth estimates indicate that by 2020 additional system capacity will be needed, therefore planning and construction of wastewater treatment expansion is included in the 2015-2019 CIP at a cost of approximately $30 million. The planned expansion could be delayed if flows do not materialize, but 24 months advanced planning and construction is necessary to meet the anticipated 2020 demand.

ROBUST SERVICE AREA ECONOMY

Sugar Land is located in the broad Houston MSA and residents have direct access to Houston's central business district via a major highway. Energy and petrochemical manufacturing remain the principal industries of the Houston economy. However, the area economy has also diversified into biomedical research, healthcare, aerospace, and international trade via the Port of Houston. The MSA is home to 26 Fortune 500 corporate headquarters.

The city's workforce is highly educated, which has continued to attract business investment. The local unemployment rate exhibited a narrow band of movement during the recession, peaking at a relatively low 6.5% in 2010 and declining steadily since then. The city's jobless rate of 3.4% in January 2015 is low and below the MSA (4.5%), state (4.6%), and U.S. averages (6.1%). Wealth and income levels are high, with median household income equal to 2x that of the nation.

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 additionally informed by information from CreditScope, and the Municipal Advisory Council of Texas.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2014);

--'Water and Sewer Revenue Bond Rating Guidelines' (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

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=982840

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Gabriela Gutierrez, CPA, +1-512-215-3731
Director
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Teri Wenck, CPA, +1-512-215-3742
Director
or
Committee Chairperson
Adrienne Booker, +1-312-368-5471
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Gabriela Gutierrez, CPA, +1-512-215-3731
Director
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Teri Wenck, CPA, +1-512-215-3742
Director
or
Committee Chairperson
Adrienne Booker, +1-312-368-5471
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com