SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms the following Municipality of Anchorage, Alaska wastewater revenue bonds at 'AA':
--$62.3 million series 2007 and 2004.
The Rating Outlook is Stable.
The bonds are backed by net sewer revenues before the enterprise's payments-in-lieu-of-taxes (locally called a municipal utility service agreement or MUSA payment). The bonds are senior to state revolving fund loan payments.
KEY RATING DRIVERS
SOLID FINANCIAL PERFORMANCE: All-in debt service coverage (DSC) net of MUSA payments was very strong at 2.1x across the period. All-in coverage is forecast to decline as low as 1.1x with additional leverage over the next five years, but Fitch expects coverage to quickly recover to levels consistent with the rating. Liquidity was healthy with days cash rising to 317 days in 2014.
REGULATED RATES: Rates are low, although rate flexibility is tempered by regulation of the utility's rates by the Regulatory Commission of Alaska (RCA). The utility has a solid record of securing regulatory approval of needed rate increases.
SIGNIFICANT DEBT BURDEN: Debt levels are high at $3,395 per customer and will more than double with $188 million of additional debt planned by 2020. The utility's ongoing heavy reliance on debt financing for ongoing repair and replacement capital needs is a weakness, in our view, potentially reducing future debt capacity that may be needed to address potential regulatory capital requirements.
ENVIRONMENTAL REGULATORY CONCERNS: The utility's main treatment plant treats wastewater to advanced primary standards, which is growing less common among rated utilities and requires ongoing approval of the full secondary treatment waivers from the U.S. Environmental Protection Agency (EPA). Capital needs and debt levels would rise significantly if the EPA required the utility to upgrade to full secondary treatment, which could put downward pressure on the rating.
SOLID SERVICE AREA: The utility provides essential wastewater services to 95% of the Municipality of Anchorage, the economic center of the state of Alaska. The state is currently experiencing an economic downturn due to a period of low oil prices, but the wastewater utility is not directly affected by changes in oil prices.
DEBT PRESSURES RATING: The rating could come under downward pressure if increased leverage pushes all-in debt service coverage down to the low end of forecast results for a sustained period. The rating is unlikely to rise due to the elevated debt burden.
REGULATORY RISKS: The rating could also come under downward pressure if regulatory pressures force a further significant rise in debt ratios beyond the levels currently envisioned.
Anchorage provides wastewater services to 56,853 customers, which includes most of the Anchorage Bowl, and two small outlying communities.
STRONG FINANCIAL PERFORMANCE TO MODERATE
Financial performance is quite strong for the rating category, but likely to moderate with additional leveraging. Fitch-calculated DSC of the senior revenue bonds was very strong at 7.2x in 2014 (last audited financial year) and 6.5x in 2015 (unaudited). All-in DSC after MUSA payments was also solid at 2.2x in 2014 and 1.8x in 2015. Both senior and all-in DSC are forecast to decline with the issuance of additional debt.
The utility's conservative financial forecast shows all-in DSC dipping to very narrow levels for a brief period (as low as 1.1x in 2019) as the utility adjusts to new debt. The drop is driven by a large debt issuance planned for 2018. Rate regulators allow the wastewater enterprise to adjust rates to recover debt service costs immediately, but the utility may only include a return on invested capital in rates once the financed projects are completed and put into service. Such timing issues are unlikely to weigh on the rating absent indications that the utility would be prohibited from raising rates to return coverage to more healthy levels in the near term. Management expects coverage to recover quickly to 1.3x or better, but it does not expect coverage to recover to historically strong levels.
The utility is likely to beat the conservative forecast, which assumes no connection fee revenues, very slow demand growth, and no new state grants for capital. The utility has a strong history of outperforming such forecasts. However, the rating could come under downward pressure if all-in DSC drops to the 1.1x level forecast for 2019 for a sustained period. Fitch believes the utility can sustain a short period of narrow all-in coverage at the current rating level due to its very stable revenues (about 70% from fixed residential charges), its solid reserve position, and strong history of raising rates as necessary.
Liquidity remains healthy. Unrestricted cash and investments rose to $22.1 million, or a healthy 317 days cash, at Dec. 31, 2014. Unaudited 2015 results show continued gains in liquidity with days cash rising to 335 days.
DEBT CONTINUES TO CLIMB
The utility's debt burden is above average with an estimated $193 million, or $3,395 per customer, outstanding as of Dec. 31, 2015. Median debt per customer for 'AA' category water and sewer utilities is $2,050. Debt is projected to rise to more than $5,000 per customer by 2020 if the utility issues the full $188 million of debt projected in its current long-range financial forecast. The municipality may issue less because of grants, timing of capital projects and outperformance of the conservative financial forecast, but the debt burden is likely to rise and remain the utility's most significant credit weakness for the foreseeable future.
Amortization is rapid with 90% of debt repaid in 20 years, but will slow with new issuance. The utility's $179.4 million 2016-2020 five-year capital improvement plan (CIP) is primarily related to the repair and replacement of existing infrastructure and will be almost entirely debt-funded. This represents an unusually high degree of debt financing and positions the utility poorly to absorb possible increases in debt related to environmental regulatory requirements.
The utility currently operates its largest wastewater treatment plant (the John M. Asplund Wastewater Treatment Plant; 58 million gallons per day capacity) under an expired 301(h) waiver of the federal Clean Water Act, allowing the facility to treat waste to advanced primary standards rather than the typical secondary treatment standards. The utility submitted its application for another five-year waiver in 2005. It continues to await a decision from the EPA. The utility discharges to the Cook Inlet, and the Cook Inlet beluga whale was listed as an endangered species in 2009. The utility has completed an environmental impact study and does not believe that its discharges have harmed the endangered species.
From a credit standpoint, a loss of the waiver could require the utility to upgrade the facility to full secondary treatment, albeit likely over an extended timeframe (assumed to be up to 20-30 years). While the EPA has not indicated that it will revoke the waiver in the near term, Fitch will continue to monitor regulatory developments and required timelines to assess the possible impact they could have on the system's credit profile.
REGULATED, AFFORDABLE RATES
The wastewater utility has exhibited solid rate discipline, raising rates as necessary to provide healthy financial performance. It raised rates by an average 4.1% in the five years ended 2016. The utility did not raise rates in 2015 or 2016 because its financial planning showed a minimal need for rate increases. Management chose to hold rates steady to avoid the expense of a rate case, but plans to resume rate increases in 2017. The utility's debt issuance plans would require a period of 6% to 10% rate increases beginning in 2017. Rates remain very affordable at just 0.6% of median household income, suggesting adequate rate flexibility.
Rates are subject to final approval by the RCA through a rate-case process. This is unusual for municipal water and wastewater utilities and has created timing delays and forced occasional rate refunds in past years. Relations between Anchorage and its rate overseers appear to have approved in recent years with rates being approved at close to requested levels in a timely manner. However, Fitch continues to view rate flexibility as somewhat limited due to the regulated rate environment.
SOLID SERVICE AREA
The utility serves a diverse, stable customer base in an economically sound, but concentrated region. The customer base is largely residential with the top 10 customers providing just 4% of revenues and no individual customer providing more than 1% of revenues. The service area is the economic and population center of the state of Alaska (general obligation bonds rated 'AA+'/Outlook Negative). Anchorage's economy outperformed the nation during the recent recession with unemployment rising much less than the national average as the state's oil-dominated economy benefited from a period of high energy prices, but the state has suffered employment losses and steep state revenue declines since the onset of a deep decline in oil prices. Anchorage's unemployment rate remained low at 5.3% in May 2016. Median household income is strong at 142% of the U.S. level.
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 Lumesis and InvestorTools.
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