Fitch Ratings has assigned the following ratings to San Antonio, TX's water system junior lien bonds, issued for the benefit of the San Antonio Water System (SAWS):
--$348.4 million water system junior lien revenue and refunding bonds series 2015B (no reserve fund) rated 'AA'
The bonds will be sold via negotiation the week of January 19. Proceeds of the bonds will be used to refund certain outstanding junior lien and senior lien obligations, as well as provide funding for capital projects.
In addition, Fitch affirms the following ratings (pre-refunding):
--$1.4 billion in outstanding water system revenue bonds (senior lien) at 'AA+';
--$951.3 million in outstanding water system junior lien revenue bonds at 'AA'.
The Rating Outlook is Stable.
SECURITY
Repayment security of the water system senior lien revenue bonds is provided by a pledge of net revenues of SAWS's water and wastewater system (the system). The junior lien revenue bonds are paid subsequent to the senior lien bonds.
KEY RATING DRIVERS
ADEQUATE FINANCIAL PERFORMANCE: All-in debt service coverage has stood at an adequate 1.6x over the last three years despite sustained drought conditions. Fitch expects SAWS's strong financial planning and careful rate management to continue to support adequate coverage levels over the long term while keeping pace with ongoing capital needs.
STRONG MANAGEMENT WITH EXTENSIVE PLANNING: SAWS maintains strong management practices, including a 20-year long-range financial and rate forecasting model that incorporates future capital investment and related rising operating expenditures.
SUBSTANTIAL CAPITAL NEEDS: The system's nearly $1.5 billion capital improvement program (CIP) over the next five years (2016 - 2020) is driven by wastewater needs to comply with regulatory standards, as well as requirements to secure future diverse water supplies. Fitch believes credit concerns regarding the system's sizeable CIP are somewhat offset by the system's planned use of available reserves and substantial drop in CIP spending beyond 2021 as reflected in SAWS's 20-year projections.
HIGHLY LEVERAGED: The system is expected to remain highly leveraged given its large capital plan.
COSTLY SUPPLY DIVERSIFICATION EFFORTS: SAWS's water supply diversification efforts continue to introduce new non-Edwards aquifer sources to its water supply inventory, however at a materially higher cost.
COMPETITIVE RATES: The system's rates are competitive compared with area and statewide peer systems. A comprehensive rate study is underway and rate hikes are planned to support the system's substantial capital needs. Fitch believes rates will remain competitive with peer systems and affordable relative to area wealth levels.
STRONG AND DIVERSE SERVICE AREA: The trend of San Antonio's overall economic activity and diversification remains stable, with the softening in residential building activity partially offset by steady commercial and military construction.
RATING SENSITIVITIES
MAINTENANCE OF ADEQUATE FINANCIAL PROFILE: A weakening in the system's ongoing financial performance could put downward pressure on the rating, given the system's growing water supply costs, substantial capital program and resulting leverage ratios, especially as it compares to the medians of similarly rated credits.
PROJECTED DECLINE IN CAPITAL SPENDING: The rating reflects Fitch's expectation that the CIP and resulting debt levels will be manageable until the CIP declines beyond 2021. Material increase to the CIP projections from the system's current 20-year plan could exert financial pressure inconsistent with the current rating.
CREDIT PROFILE
IMPROVED COVERAGE SUSTAINED
Debt service coverage (DSC) rebounded after experiencing some volatility due to extreme weather years in 2009 and 2010. All-in DSC typically exceeded 1.7x prior to 2009, but it dipped to a low 1.2x in 2010. A rate increase and rising water sales produced results closer to historical levels with all-in DSC rebounding to 1.7x by 2011. All-in DSC has remained adequate at 1.6x, slightly above the system's 1.5x target, over the last two audited years. Financial results for 2014 point to similar all-in DSC.
MULTIYEAR PLANNING A POSITIVE
SAWS has prudently developed and annually updates a multiyear financing plan that includes expected capital and operational costs and incorporates its planned rate increases. The six-year projections for fiscal years 2015 to 2020 reflect all-in coverage hovering around 1.6x to 1.7x. Fitch recognizes that SAWS typically outperforms its projections and exceeds its all-in target of 1.5x due to conservative assumptions. A key rating driver is Fitch's expectation that SAWS will continue to maintain coverage levels above its target despite the system's cost pressures and substantial capital needs.
HIGHLY LEVERAGED WITH LARGE CAPITAL NEEDS
Fitch considers the system to be highly leveraged with outstanding long term debt per customer at just over $3,000 compared with the 'AA' category median of nearly $2,000. This has been largely driven by the system's need to rehabilitate its ageing wastewater infrastructure and invest in capital projects necessary to secure future water sources.
SAWS 2016-2020 five-year CIP totals a large $1.47 billion. About 58% of the CIP will address wastewater infrastructure improvements, with the remainder addressing long-term supply and delivery projects. SAWS' maintains a 35% target level to cash fund projects. Accordingly, the sources of funding include pay-go monies derived from service revenue and impact fees (38%) and future debt issuance (62% of total sources).
Total wastewater CIP costs include the incremental cost of projects over the CIP period to reduce sanitary sewer overflows in compliance with a U.S. Environmental Protection Agency consent decree. The 10-year incremental cost associated with the consent decree is $490 million.
Historically SAWS has relied on the Edwards Aquifer for the vast majority of water supply. Environmental concerns with the aquifer habitat and recharge resulted in pumping restrictions and led to substantial efforts to diversify the area's water supplies. SAWS began adding several modest non-Edwards Aquifer water sources to its portfolio in 2002. The water supply projects included in the CIP are expected to increase the composition of non-Edwards Aquifer water over time. Fitch believes that water diversification will be a long-term positive to the system despite the significant cost, which is expected to be incrementally absorbed through rate adjustments.
OFF BALANCE SHEET WATER SUPPLY PROJECT
In addition to the CIP, SAWS has entered into a contract with the Vista Ridge Consortium to construct a 140 mile pipeline that will deliver 50,000 acre feet (AF) annually to SAWS's intake point from the Carrizo and Simsboro aquifers by 2020. This is projected to be the largest non-Edwards Aquifer water source in its supply portfolio. The pipeline project will be accounted for as an operating expense (prior to all debt service) at an estimated cost of $2,200 per AF. This will result in an increase of an estimated 20% in operating expenditures in 2020 when the project is expected to begin water deliveries. The term of the contract is for 30 years (from completion of the project), at which time the pipeline is turned over to SAWS and is expected to have a useful life of 30-50 years remaining.
AFFORDABILITY SOMEWHAT MITIGATES COST PRESSURES
Cost pressures resulting from rising debt service requirements and water supply costs are likely to pressure financial margins in the mid to long term absent sufficient rate adjustments to produce adequate margins commensurate with the high rating level. A 5.3% rate increase for water supply, delivery, and wastewater took effect January 2015 as previously forecasted. Planned rate hikes for total water and wastewater service from 2016-2020 average about 8.3% annually. The average monthly residential bill currently totals $59 (including pass through fees), which is lower than all other Texas urban systems except El Paso, affording the system significant rate flexibility, an important credit strength.
The system is currently undertaking a comprehensive rate structure study which will address the rising water supply costs and the integration of the former Bexar Metropolitan Water District, discussed below. Management plans to complete the study by the end of the year with plans to implement new rates in early 2016.
GROWING SERVICE AREA
SAWS is the predominant service provider in Bexar County, serving about 367,000 water and 417,000 wastewater retail and wholesale customers. The waterworks system extends approximately 627 square miles and 93% of customers are residential. The wastewater treatment boundaries cover 504 square miles and provide service to 1.3 million people. SAWS's main challenges continue to be the development of supplemental water resources given the projected doubling of population for the area by the year 2050 and the ongoing sewer system maintenance program.
BEXAR METROPOLITAN WATER DISTRICT
SAWS took over operations of the former Bexar Metropolitan Water District (BMWD) effective Jan. 28, 2012 as a result of a public election to dissolve the BMWD. After years of public criticism and numerous complaints regarding service and management of the BMWD, the state passed legislation requiring the public to vote on dissolution. The election was held in November 2011 at which time 74% of the voters approved the dissolution of BMWD and for the operations to be taken over by SAWS.
In order to protect bondholders and maintain credit neutrality, operating revenues and debt obligations of BMWD are required to remain separate from the system until certain requirements are met for full integration. The San Antonio City Council by resolution adopted an ordinance creating a separate 'District Special Project' (DSP) and the DSP is now reported as a separate component unit of SAWS beginning with the Dec. 31, 2012 financial statements.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the 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 2014);
--'Water and Sewer Revenue Bond Rating Guidelines' (July 2013);
--'2015 Water and Sewer Medians' (December 2014);
--'2015 Outlook: Water and Sewer Sector' (December 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
2015 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409
2015 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=965475
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.
