Fitch Downgrades Tarrant Regional Water District, Texas' Water Revs to 'AA'; Outlook Stable

Fitch Ratings assigns an 'AA' rating to the following Tarrant Regional Water District, Texas (TRWD) revenue bonds:

--$335.4 million water revenue bonds, series 2014.

The bonds are expected to sell competitively the week of Jan. 27, 2014. Proceeds will be used to pay for the planning, design, construction and right of way costs related to the district's water system, fund a debt service reserve, and pay costs of issuance.

In addition, Fitch downgrades to 'AA' from 'AA+' the following TRWD ratings:

--$573.7 million in outstanding water revenue bonds.

The Rating Outlook is Stable.

SECURITY

The series 2014 bonds are special limited obligations of TRWD payable from pledged revenues, which consist mainly of payments made by the cities of Fort Worth, Arlington, Mansfield and the Trinity River Authority (TRA; combined, the contractors) pursuant to the Tarrant County Regional Supply Facilities Amendatory contract (the contract) between TRWD and the contractors.

KEY RATING DRIVERS

FORT WORTH CREDIT PROFILE DRIVES DOWNGRADE: The downgrade to 'AA' principally reflects the downgrade of the city of Fort Worth's (the city) water and sewer system revenue bonds in recent months. The city accounted for 59% of total water payments made to the district in fiscal 2013.

STRONG LEGAL COVENANTS: Legal provisions provide for a joint and several contract among the contractors for the repayment of obligations to TRWD, including debt service on the bonds. The payment history of the contractors is exemplary.

STEP-DOWN APPROACH: Beginning with the highest credit quality contractors, Fitch uses a step-down approach to yield a group of contractors with sufficient capacity to cover delinquencies from defaulting district customers.

INCREASING CAPITAL AND DEBT NEEDS: Expected capital needs are sizable and will substantially increase the TRWD's debt burden over the next five years.

ESSENTIAL SERVICE: The contractors are either entirely or almost entirely dependent on TRWD for supplies, and development of alternative sources likely would be cost prohibitive.

RATING SENSITIVITIES

MEMBER CREDIT PROFILES: Deterioration of the credit quality of the contractors would likely have negative credit implications for the bonds.

TIMELY CONTRACTOR ANNUAL PAYMENTS: Failure by a contractor to pay its contracted amounts in a timely fashion would be viewed negatively.

CREDIT PROFILE

SERVICE AREA

TRWD operates as a water control and improvement district, providing raw water service to about 50 municipal and non-municipal entities located both within and outside of Tarrant County. Overall, the district provides water either directly or indirectly to about 95% of Tarrant County and an estimated 1.6 million people. The district is governed by a five-member, publicly elected board. Board members are elected to four-year terms.

JOINT AND SEVERAL WATER CONTRACT

Effective in 1982, the contract provides the terms under which TRWD shall supply raw water to the contractors and the contractors agree to pay for such service. The contractors agree to make monthly payments to TRWD equal to the annual requirement of the district's O&M expenses, debt service requirements (including debt service on the bonds), and any other requirement under the district's bond resolution, including replenishment of any draws on the debt service reserve fund.

If there is a deficiency in the district's revenues required to fund such items, the contractors are required to make up this difference proportionally to their level of consumption relative to all non-delinquent customers and prior to the next debt service payment date. To date, the contractors have never failed to make timely payments to the district required under the contract. The contract is in effect until all outstanding debt obligations are paid in full.

STEP-DOWN APPROACH WITH SOLID MEMBER CREDIT PROFILES

The contractors accounted for about 89% of all water deliveries and 90% of all water payments made to TRWD in fiscal 2013. The obligation of each contractor to make TRWD annual payments is payable as an O&M expense from each contractor's water and sewer system (in the case of Fort Worth, Arlington, and Mansfield) or Tarrant County Water Project (in the case of TRA) and superior in priority to the contractor's own debt obligations. Fort Worth's (59% of TRWD fiscal 2013 water payments) water and sewer revenue bonds are rated 'AA' by Fitch, while Arlington (18%) and Mansfield's (3%) water and sewer revenue bonds are rated 'AAA' and 'AA', respectively. Fitch does not rate TRA's debt pertaining to the Tarrant County Water Project but believes TRA's credit profile is also very strong; TRA contributed 10% of the district's fiscal 2013 water payments.

Because of the joint and several nature of the district revenues Fitch evaluates the ability of a group of contractors to cover payment defaults from other district purchasers without impairing the non-defaulting members' own credit quality using a top-down approach, beginning with the smallest group of and strongest credit quality contractors. In determining the appropriate group of contractors, Fitch considers the non-defaulting customers' ability to absorb any delinquencies by other TRWD water purchasers from both one time sources and then on a recurring basis. In the event of revenue shortfalls from district customer payments, Fitch believes a group consisting of Fort Worth, Arlington, and Mansfield combined have the capacity to absorb such shortfalls.

Fitch estimates these three contractors have more than sufficient cash resources to pay any immediate TRWD revenue shortfall. Further, Fitch estimates that if the customer defaults described above continued indefinitely, only a single moderate rate increase in the 3%-4% range by Fort Worth, Arlington and Mansfield would be necessary to offset the ongoing costs.

The lowest rating of the non-defaulting group is 'AA', which reflects the de facto lowest quality of revenues available to pay debt service, and the district's financial capacity is limited essentially to contractor payments. Therefore, Fitch uses the 'AA' rating as a significant determinant in assigning the district's rating.

FORT WORTH'S WEAKENED FINANCIAL PROFILE DRIVES DOWNGRADE

All of the city's water is purchased from the district. Fort Worth is the district's largest customer, accounting for 59% of the district's water sales in fiscal 2013. Fitch downgraded Fort Worth's water and sewer revenue bonds to 'AA' from 'AA+' in April 2013.

Following one of the driest years on record, the city's system financial performance dipped in fiscal 2012, with senior lien debt service coverage (DSC) dropping to 1.6x in fiscal 2012 (1.2x net of transfers out) and total DSC declining to 1.4x for the year (1.1x net of transfers out). Liquidity levels also declined to 88 days cash on hand. Furthermore, the city failed to raise rates for fiscal 2013 after a year of weak financial performance.

While there is some concern that DSC levels have been declining since fiscal 2006, the city has expressed its commitment to maintaining all-in coverage at its policy of 1.5x or above before transfers by adjusting rates as needed. The city adopted a 6% water and 5% sewer rate increase for fiscal 2014 and is proposing annual rate increases in the range of 4% to 6% through fiscal 2018. Fitch will continue to monitor the system's financial performance.

ADEQUATE FINANCIAL PERFORMANCE AND AFFORDABLE RATES

Financial performance is typical for a wholesale provider where revenues are derived from take-or-pay contracts. Annual debt service coverage has been, and is expected to continue to be, at or about 1.0x, per the contract. In terms of liquidity, because the contract delineates what constitutes part of the annual charge that contractors pay, reserves are limited to those pertaining to the bond covenants.

Rate setting is done by the district board. Rates are adjusted annually as needed to meet the annual requirements of the district. However, the dominant factor in determining rates is the consumption levels of the customers, which vary from year to year, given that consumption is the basis for customer payments to the district. Fiscal 2014 district rates of $0.96 per 1,000 gallons are very reasonable. Rates are anticipated to increase by 36% to $1.31 by 2018. Nevertheless, at $1.31, which translates to about $427 per acre feet, rates are still projected to be very affordable relative to the district's peers.

SIZABLE CAPITAL IMPROVEMENT PLAN

TRWD's large capital improvement plan (CIP) totals an estimated $1.1 billion through fiscal 2018 that will increase TRWD's debt burden by an estimated 76% over the next five fiscal years. Fitch believes the resulting cost increases will be manageable for member agencies but will monitor the impact, if any, on member agencies' capacity to meet their debt service obligations to the TRWD. The primary CIP project is the design, permitting, project management, and construction costs of a 150-mile pipeline to deliver 347 million gallons per day (mgd) of water from East Texas to the Dallas-Fort Worth metroplex. The project will provide the additional water supply the district anticipates will be needed in the 2018-2020 time frame.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's U.S. Municipal 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 3, 2013);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);

--'2014 Water and Sewer Medians' (Dec. 12, 2012);

--'2014 Outlook: Water and Sewer Sector' (Dec. 12, 2013);

--'Fitch Downgrades Fort Worth, Texas' Water and Sewer Revs to 'AA'; Outlook Stable' (April 10, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=816110

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