AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings downgrades the following Millbrae, CA (the city) outstanding certificates of participation (COPs) to 'A+' from 'AA-':
--$5.6 million wastewater revenue COPs series 2009A (federally taxable Build America Bonds);
--$6.7 million wastewater revenue COPs series 2009B.
The Rating Outlook is Stable.
The COPs are secured by a pledge of net revenues of the wastewater enterprise fund including credits expected to be received from the federal government in association with the issuance of Build America Bonds (BABs).
KEY RATING DRIVERS
WEAKENED FINANCIAL METRICS DRIVE DOWNGRADE: The downgrade to 'A+' reflects weak financial performance (specifically as it relates to debt service coverage [DSC]) stemming from the city's previous lack of willingness to raise rates. Despite recent multi-year rate increases, Fitch does not expect DSC to return to previous highs.
SOLID LIQUIDITY MAY DECLINE: The system has very good liquidity levels for the rating category at around 600 days cash on hand as of fiscal 2014. However, liquidity may decline in the near term due to increased pay-go for capital projects related to a consent decree.
HIGH DEBT DRIVEN BY CAPITAL NEEDS: The utility's debt burden is very high at $5,855 debt per customer and is expected to increase further (by 1.6x) to fund collection system improvements required under the consent decree.
RATE PRESSURE: The adopted annual rate increases for fiscal years 2016 through 2020 to fund collection system improvements to reduce sanitary sewer overflows (SSOs) are insufficient to maintain DSC at 1.8x levels. Furthermore, rates are currently high at 1.1% of median household income (MHI), and are expected to remain elevated.
STABLE CUSTOMER BASE: The city provides wastewater service to approximately 6,500 customers in a built-out service territory with minimal growth and a strong local economy as an affluent suburb of San Francisco.
WEAKER FINANCIAL RESULTS: Material declines in liquidity or prolonged low coverage levels could result in negative rating pressure.
The system, which is owned and operated by the city, includes a wastewater treatment plant (WWTP) built in 1952 providing secondary treatment which was recently upgraded to comply with a consent decree. The system averages 1.5 million gallons per day (mgd) with permitted capacity of 3 mgd in dry weather and 9 mgd in wet weather. It also has a secondary system built in 1967 that provides biological treatment and disinfection. A cogeneration project added in 2006 provides 80% of the energy used by the WWTP and is self-supporting.
WEAKENED BUT ADEQUATE FINANCIAL PROFILE
The system's operations have been pressured and are now below Fitch's 'AA' category medians. Debt service coverage declined from 1.80x in fiscal 2013 to 1.35x in fiscal 2014 and is projected to come in at a low of 1.04x in fiscal 2015. Rates were held flat in fiscals 2012 through 2015 while operational and capital costs increased by an average of 9% over the same period, leading to a drop in DSC levels. Coverage is expected to improve, albeit to slightly lower levels than historical norms, due to a series of rate increases that go into effect on August 1, 2015.
Based on cash flows provided by the utility's rate consultant, coverage is projected to improve to 1.66x by fiscal 2016, before declining again in fiscals 2017 and 2018 due to rising debt service costs from a planned $30.2 million debt issuance slotted for fiscal 2017. Projected DSC levels -- between 1.2x and 1.3x -- are low, but somewhat offset by the utility's strong liquidity position.
Liquidity is healthy with $9.4 million, or 603 days cash on hand, in fiscal 2014 and a five-year average of 617 days. Given that the capital improvement plan (CIP) will be at least partially funded with pay-go, Fitch expects cash to decline in fiscals 2015 and 2016, but remain above the utility's informal policy of six months of operations. Liquidity is anticipated to improve by fiscal 2017 when debt is issued to finance system improvements required under the consent decree project.
PROGRESS TOWARDS CONSENT DECREE COMPLIANCE
In 2010, the city entered into a consent decree after a lawsuit was filed by the San Francisco Baykeeper Corporation (the Baykeeper) alleging the city was in violation of its National Pollutant Discharge Elimination System (NPDES) permit due to SSOs. The total cost of compliance is estimated at $34.2 million. The Baykeeper consent decree expires at the end of 2016, but the city is in the process of extending the agreement, with the proposed ten-year CIP beginning in 2015 and ending in 2024. The WWTP upgrade, which cost about $29 million, was completed in February 2013.
LIMITED RATE FLEXIBILITY
On July 28, 2015, the city adopted a four-year rate package, including a new SSO flat-rate charge of $23.90 that will be phased in over a two-year period starting on Aug. 1, 2015, phasing out on or about June 30, 2035 (when the planned debt is retired). The city retains some rate flexibility given that its rates are midrange compared to surrounding communities and residential wastewater usage is lower than average at 4,100 gallons per month (gpm). However, at $81 in fiscal 2014, the average residential monthly bill (assuming Fitch's standard wastewater usage of 6,000 gpm) equals 1.1% of MHI which is above Fitch's 1% affordability threshold. Assuming similar usage, the monthly bill is anticipated to reach $129 by 2019, which equals a very high 1.7% of current MHI. Fitch will monitor utility needs and future rate flexibility as they remain key drivers of future financial performance.
VERY HIGH DEBT BURDEN
Debt is high at over $5,800 per customer (as compared to Fitch's medians for the 'AA' category of around $1,936) and is expected to increase with a planned additional borrowing of $30.2 million in fiscal 2017 to comply with the consent decree. The fiscal 2016 to 2024 CIP totals $34.2 million, not including about $1 million per year in sewer main repair and replacement costs, which the utility plans to fund with pay-go.
AFFLUENT, STABLE CUSTOMER BASE
Millbrae is located in northern California approximately 15 miles south of San Francisco and directly adjacent to the San Francisco International Airport. With a population of about 23,000, the city serves about 6,550 wastewater accounts, of which 92% are residential. The wealthy suburban community boasts low unemployment and income is very high at 145% of state and 167% of 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.
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 31 Jul 2013)
Dodd-Frank Rating Information Disclosure Form