AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned a 'AA' rating to the following Garland, Texas (the city) revenue bonds:
--$15.99 million water and sewer system revenue refunding bonds, new series 2016.
The bonds will be sold via negotiation on November 15. Proceeds will be used to refund outstanding series 2007 bonds for savings.
In addition, Fitch has affirmed the rating on the following outstanding obligations (pre-refunding) at 'AA':
--$124.7 million water and sewer system revenue bonds, series 2007, 2008, 2009, 2010, 2011, 2011A, and 2012;
--$60.1 million water and sewer system revenue refunding and improvement bonds, series 2013, and new series 2014;
--$90 million bank notes corresponding to water and sewer commercial paper notes, series 2015
The Rating Outlook is Stable.
All bonds are payable from a pledge of the net revenues of the city's water and sewer system (the system). The outstanding prior lien bonds (through series 2013) are senior to the new series bonds, which are a second lien obligation. The prior lien is closed. The bank notes represent a fourth lien on system revenues and are subordinate to the outstanding prior lien bonds, the second lien new series bonds, and certificates of obligation issued by the city secured by a lien on and pledge of system net revenues.
KEY RATING DRIVERS
SATISFACTORY FINANCIAL METRICS: Debt service coverage (DSC) was a sound 1.6x on an all-in basis in fiscal 2015, slightly better than the prior year. Coverage net of transfers to the city's general fund, however, is a slim 1.18x all-in and is projected to decline in the five year forecast.
LIMITED EXCESS CASH FLOW: The system makes large annual transfers to the city's general fund totaling 11% of operating revenues (roughly $11 million in fiscal 2015). The transfers absorb most of the excess cash flow, increasing the need for debt-funding of capital improvements.
WHOLESALER COST AND RATE PRESSURES: The city's dependence on its wholesale water provider North Texas Municipal Water District (NTMWD) creates cost pressure outside of the utility's direct control. Rates hikes generally have kept pace with rising water costs, but additional system rate adjustments to accommodate wholesaler and debt service cost increases could reduce affordability over the medium term.
INCREASING DEBT LEVELS: Direct system debt per-customer levels become elevated above the 'AA' median when taking into consideration planned debt to support capital projects. System debt levels are further pressured by off-balance-sheet debt of NTMWD.
ASSURED SUPPLY: The system has assured water supply through at least 2030 from its long-term, perpetual contract with NTMWD.
MATURE DALLAS METRO SUBURB: The city is part of the larger Dallas-Fort Worth-Arlington (DFW) metropolitan statistical area (MSA) economy and employment base. Anchored by manufacturing and distribution, Garland's overall economic base remains sound.
DETERIORATION OF FINANCIAL MARGINS: Weakening financial metrics could negatively impact the rating. In particular, debt service coverage net of transfers that is below 1.0x would likely lead to a rating downgrade.
The water system serves approximately 68,800 city customers and purchases its water on a wholesale basis under a perpetual contract from NTMWD. Existing and projected water supplies from NTMWD reportedly are sufficient to meet all customer demands through at least 2030. The wastewater system serves around 66,500 customers within the city as well as portions of five other cities, including the city of Dallas.
WEAKENED FINANCIAL PERFORMANCE
System operations have been pressured by increasing debt service and purchased water costs resulting in financial metrics stressed against Fitch's 'AA' category medians. Since fiscal 2012 the city's purchased water rate has increased on average 11% annually and NTMWD rates are anticipated to continue to rise by 7% to 11% annually through fiscal 2021.
Audited fiscal 2015 results were better than previously projected nonetheless on a declining trajectory. All-in DSC was adequate at 1.6x (1.2x net of transfers out) down from a high of 2.4x in fiscal 2011 (1.8x net of transfers out). The fiscal 2015 coverage levels fall short of Fitch's 'AA' category median levels of 2.0x DSC on an all-in basis, and 1.8x all-in DSC net of transfers out. Cash balances, which are weak for the 'AA' category, declined at the close of fiscal 2015 to 132 days cash on hand from 180 days in fiscal 2011. Fiscal 2016 unaudited results point to better DSC at 1.8x all-in (1.4x net of transfers-out).
WEAK FORECAST WITH LARGE TRANSFERS OUT NOTABLY PRESSURES RATING
The five-year forecast for fiscal 2017 - 2021 is weaker than what was previously projected and further raises credit concerns over the large transfers out of the system. All-in DSC is forecast at 1.7x for fiscal 2017, declining gradually to a minimum 1.5x. However, factoring the transfers out, the DSC gradually declines to less than 1x by fiscal 2020. Actual results that fail to achieve DSC net of transfers above 1.0x would be expected to result in negative rating pressure. The forecast incorporates increased debt carrying costs associated with financing the capital plan, rising operating expenses, and annual water rate increases averaging about 5% as well as more modest 1% to 3% sewer rate adjustments.
Transfers out of the system have averaged 11% of operating revenue over the past five fiscal years and projected at similar levels over the forecast period. Transfers out of the system combined with limited surplus cash from operations after payment of operating and debt service costs have left a minimal amount of free cash flow (FCF) available to cover depreciation expense. FCF for fiscal 2015 is considered weak at 23%, down from 91% in fiscal 2011 which was consistent with the 'AA' category median.
RISING WHOLESALE WATER COSTS
Water costs associated with the NTMWD contract increased 14% in fiscal 2013 and 10% annually through the current fiscal year. NTMWD rates are expected to rise further ranging from 7% to 11% annually through 2021, driven by the need for regulatory upgrades. The city has raised its own water rates in an effort to keep up with rising purchased water costs, increasing rates by an average of about 10% annually from fiscal 2013 to 2015, and a large 14.6% in fiscal 2016. The fiscal 2017 rate increase was a modest 3.8% and projections reflect moderate rate increases averaging about 5% annually. Purchased water costs make up approximately 32% of fiscal 2015 water and sewer operating expenses and this figure is expected to grow to 52% by fiscal 2021. Despite raising user charges, operating revenues only increased by 9% from fiscal years 2011 to 2015, while operating expenses grew by 21% over the same period.
DIMINISHING RATE FLEXIBILITY
The monthly bill at $87.80 (assuming usage of 7,500 gallons per month for water and 6,000 gallons per month for sewer) is above average as compared against other municipal systems in the Dallas/Fort Worth Metroplex and registers at around 1.8% of median household income (MHI). Rates still fall under Fitch's 2% of MHI affordability threshold.
GROWING DEBT BURDEN
The system's fiscal 2017 - 2021 capital improvement plan (CIP) totals $120 million and will be entirely debt-financed, a negative credit consideration. The city utilizes a commercial paper (CP) program to finance the CIP, planning to fix out with long-term bond sales in fiscal 2018 and 2021. Approximately 70% of the CIP addresses sewer system improvements that will ensure compliance with new and enhanced regulatory and operational standards while the remaining 30% is for water system improvements.
Direct system debt per customer of $1,737 is below the 'AA' category median of $2,050, but debt-to-net plant is high at 57% compared to the 'AA' median of 47%. Debt levels are projected to grow to $2,064 within five years. Positively, the system benefits from very rapid amortization, with principal payout at 80% and 100% in 10 and 20 years, respectively, compared with the category medians of 40% and 84%, respectively.
SYSTEM AND SERVICE AREA
Garland (GO IDR rated 'AAA'/Stable Outlook) benefits from its location within the DFW MSA. Manufacturing and distribution remain the city's primary economic engines, and the city's industrial market reportedly is the second largest in the DFW metroplex. City wealth levels are on par with state and national levels. August 2016 unemployment is favorable at 3.9%, compared to the state's 4.9% and the nation's 4.8%. The individual poverty rate of 13.9% is just slightly lower than the state and U.S.
Additional information is available at 'www.fitchratings.com'.
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
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