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June 3 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned an ‘A’ rating to the following Indiana Finance Authority (IFA) bonds on behalf of Citizens Authority (CWA):
--$237 million first-lien wastewater utility revenue bonds, series 2014A (CWA Authority Project).
The series 2014A bonds are expected to sell via negotiation during the week of June 9, 2014. Bond proceeds will be used by CWA to fund capital improvements to the system. A portion of the proceeds will also be used to repay a draw made on a line of credit (for capital projects), to fund a debt service reserve and pay costs of issuance.
The Rating Outlook is Stable.
The Indiana Finance Authority’s (IFA) series 2014A first-lien bonds are secured by Citizen’s Authority (CWA) series 2014A first-lien wastewater revenue bonds, which are senior lien obligations of the wastewater system (the system), payable from a senior lien on system net revenues.
SUBSTANTIAL CAPITAL REQUIREMENTS: CWA’s approximately $1.1 billion capital program is driven by regulatory requirements and relies on significant annual debt issuance over the next five years. As a result, debt will continue to increase well above already high levels.
SOUND FINANCIAL COVERAGE: The system generates solid coverage of all debt service, consistent with Fitch’s ‘A’ category median for utility credits. STABLE REGULATORY ENVIRONMENT EXPECTED: The regulatory oversight by the Indiana Utility Regulatory Commission (IURC) creates a level of uncertainty for the CWA’s financial profile. However, recent legislation and an expedited filing process for certain petitions, including rate adjustments, should bring stability to the regulatory environment.
LIMITED RATE AFFORDABILITY: Continued above-average rate increases will result in rate pressure, with the average monthly wastewater utility bill currently at Fitch’s affordability threshold of 1% of median household income (MHI). However, user charges are currently comparable to other large systems near the region.
FAVORABLE SERVICE TERITORY: The city of Indianapolis (the city) has a large and well-diversified economy. The consistent steady gains in employment bolster the system’s ratepayer base.
MEETING PROJECTIONS; RATE HIKES ESSENTIAL: The ‘A’ rating reflects Fitch’s expectation that the system will meet projected operating results and debt service coverage levels.
Management’s ability to achieve timely implementation of rate hikes to sustain solid financial margins and required capital funding is key to rating stability. ESCALATION IN CAPITAL NEEDS: Fitch expects debt levels to stabilize following completion of the sizeable current capital program. Increases to the current size and scope of the capital program would be viewed negatively.
CWA acquired the system on Aug. 26, 2011, assuming most assets and certain liabilities of the city’s sanitary district. The system is largely a retail provider of sanitary sewer service to nearly the entire consolidated city (Indianapolis-Marion County). The system has approximately 225,000 customer accounts, including seven wholesale customers.
The current five-year CIP covers fiscal 2014-2018 and totals approximately $1.1 billion. The system’s substantial capital costs are driven by a consent decree (CD) requiring CWA to implement a Combined Sewer Overflow (CSO)-Long-Term Control Plan (LTCP) by 2025. CSO project costs included in the CIP total approximately $670 million during the next five years and account for roughly 63% of plan spending.
The necessary CSO-LTCP projects include the construction of several deep underground tunnels and storage facilities designed to capture 95%-97% of wet weather CSO and result in no more than two to four overflow events per typical year. Prior to the acquisition, the city had a history of proactively implementing a CSO-LTCP. Upon assuming the city’s obligation under the CD, CWA has continued to aggressively implement the LTCP, which Fitch views positively. CWA is currently in full compliance with the CD, according to the most recent six-month status report, dated April 11, 2014. Other projects in the current CIP include general system improvements and expansions (27% of spending) and septic tank elimination efforts (10% of spending).
Approximately 84% of the current CIP is expected to be funded with bond proceeds (including series 2014A). The remaining amount will be funded by pay-go. Over the next four years, CWA plans to annually issue first-lien system bonds ranging between $149 million-$178 million each year. The significant debt is expected to be supported by a combination of annual base rate increases, through the standard IURC filings, and the Environmental Compliance Plan (ECP) recovery mechanism. The ECP is a new expedited rate-raising process to recover debt service costs associated with the CD.
The system’s debt ratios are very high with debt per customer, after the series 2014A issuance, at $6,252, and debt per capita at $1,503, far exceeding Fitch’s ‘A’ rating category median levels. Debt ratios are expected to continue to increase in the foreseeable future as CWA plans to fund its significant CIP with bonds. However, management believes that the level of pay-go will be increased steadily with the goal of attaining 100% pay-go by the scheduled end of the CD in 2025. Fitch expects debt levels will remain significant for several years as principal payout is slow with only 56% of outstanding principal amortizing in 20 years.
The system’s audited financial results are sound, generating 2.5x and 1.91x senior lien debt service coverage (DSC) for fiscal years 2012 and 2013, respectively. All-in DSC of 1.85x for fiscal 2012 and 1.48x for fiscal 2013 are also respectable and consistent with the system’s performance prior to the acquisition. However, liquidity metrics for the system are mixed with over 300 days cash on hand in fiscal 2013 but relatively low free cash-to-depreciation at 57% compared to ‘A’ rated category medians.
CWA projects significant revenue growth over the next five years resulting from annual rate increases. Expenditures are expected to remain stable. While there is significant planned debt issuance over the next five years, management targets to maintain senior lien DSC above 1.8x. All-in DSC is projected to range between 1.45x-1.67x. However, the ability of system users to absorb significant annual rate increases over the next several years will be important to achieving projected DSC levels.
The IURC maintains jurisdiction over the approval of rates and charges of the system. In the past, the IURC’s oversight has hindered timely rate increases for certain other utility systems. However, in 2013, the Indiana Legislature passed Senate Bill 560, which helps to mitigate the effects of regulatory lag by requiring that rate cases take no longer than 300 days.
Failure to act within the 300-day time frame will result in 50% of the rate request becoming effective immediately, subject to refund if the final order authorizes less than the 50%. The IURC has indicated its desire to finalize all rate cases within the 300-day requirement.
The IURC formally approved the details and the procedures of the ECP recovery mechanism on June 14, 2012, which can be applied on CD projects beginning in 2014. This tool is designed to timely recover debt service, debt service reserve funds, costs of issuance related to CD costs. In addition, in February 2014, utility systems received the authorization (under Indiana House Bill 1132) to petition the IURC for adjustments of basic rates for certain capital costs including wastewater system replacements and upgrades.
While over half of the system’s projected rate increase requirements can occur through the recovery mechanism, thus alleviating some of the risks related to timely rate increases, system rate affordability remains a concern.
Wastewater user charges, based on approximately 7,500 gallons (Fitch’s assumption for U.S. average household consumption), are 1.4% of MHI. This measure is well above Fitch’s affordability threshold of 1% and is expected to increase to 1.5%, as the wastewater rates are set to rise in October. On a combined basis, water and wastewater user charges are over 2% of MHI.
Current user charges, based on the single-system’s actual average consumption of approximately 4,500 gallons, are somewhat more affordable at $35.9 per month or just 1% of MHI. On a combined basis, rates reflecting average water and wastewater usage total $65.8 and are 1.8% of MHI, approaching Fitch’s affordability threshold.
CWA maintains that its rates are in line with other systems in the region. CWA plans to increase rates annually either through general rate hikes or the ECP recovery mechanism. Fitch expects such rate hikes to be sizeable given debt needs. CWA expects to file its next rate case in early 2015 to have new rates for fiscal year 2016 and 2017.
The city’s economy is well-diversified and serves as the economic engine for the surrounding area. The city has a large retail sector as well as a significant manufacturing presence, which includes pharmaceuticals and automotives. The city’s economy also includes health services, life and sciences companies and other business and professional service companies.
The city’s unemployment rate of 6.2% in March 2014 was down from the March 2013 rate of 8.3% and is comparable to the unemployment rate of the state (6.2%) and the nation (6.8%). MHI levels in the county are 11% and 18% lower than state and national levels, respectively.