Fitch Affirms Galveston (TX)'s Water and Sewer Revenue Bonds 'A+'; Stable Outlook
--$4.8 million revenue refunding bonds, series 2012; and
--$18.7 million revenue refunding bonds, series 2014.
The Rating Outlook is Stable.
The bonds are secured by and payable from a first lien on the net revenues of the city's water and wastewater system (the system).
KEY RATING DRIVERS
ADEQUATE FINANCIAL METRICS: System financial metrics are in-line with most metrics near 'A' category medians for water and sewer utility systems rated by Fitch.
HIGH DEBT/SIZEABLE CIP: The system's already high debt levels are projected to continue to rise with planned debt for its capital plan, despite expected federal grant proceeds. The system's capital improvement plan (CIP) is driven by plant asset recovery and reconstruction after the city was hard hit by Hurricane Ike (the hurricane) in 2008, as well as repair and rehabilitation of aging infrastructure.
LIMITED RATE FLEXIBILITY: The system rates are viewed by Fitch as high relative to median household income (MHI).
FEDERAL GRANT INFUSION: Galveston suffered severe flooding damage during the hurricane and benefits from substantial federal contributions received for recovery. In total, the city expects to receive about $140 million in federal aid for system capital assets.
GROWING REGIONAL ECONOMY: Galveston benefits from its participation in the diverse and growing Houston area economy. The city's low unemployment rate reflects an expanding local employment base driven by commercial and industrial growth. The city's economy is traditionally based on leisure, hospitality and port operations. Expanding health services and top government and education sector employers help to diversify the local economy.
SUSTAINED ADEQUATE FINANCIAL METRICS: Galveston's water and sewer system revenue bonds' rating is sensitive to shifts in various credit fundamentals, including deterioration in financial performance and material rise in debt burden beyond current expectations.
The city of Galveston (Long-Term Issuer Default Rating [IDR] 'AA-'/Outlook Positive) is located on Galveston Island approximately 45 miles from Houston in southeast Texas. With a population of approximately 50,000 the city is the county seat of Galveston County (IDR of 'AA+'/Stable Outlook). Hurricane Ike hit the upper Texas coast in September 2008, resulting in widespread flood damage across the island. The city's population and tourism declined subsequent to the storm, but management reports that 90% of its hotel stock was undamaged due to its proximity to the seawall which extends along the city's beachfront.
The system operates as an enterprise of the city, serving approximately 20,000 water and sewer connections. The city purchases treated water from the Gulf Coast Water Authority (GCWA) and has contracted rights to ample water capacity to service its relatively stable population base. The sewer system consists of five wastewater treatment plants operated by the city with ample treatment capacity.
POST IKE FINANCIAL ASSISTANCE
The city has received substantial assistance for system reconstruction after the hurricane. In total, the city will have received about $140 million in grants when it completes projects included in the CIP through fiscal 2018. Through this grant reinvestment, the five-year historical performance shows very strong improvement in debt-to-net plant ratios to a favorable 27% in fiscal 2015 from a high 65% in 2011.
STRONG FINANCIALS AND EXPECTED FORECAST
Excluding the non-recurring grants, Fitch-calculated all-in DSC (which includes general obligation bonds repaid from the water and sewer enterprise) ranged from a low 1.6x to a high 2.8x from fiscals 2011 through 2014. Senior lien debt service coverage averaged a solid 3.5x during the same period.
Fiscal 2015 audited results were lower reflective of a $3.2 million credit that the city applied to customer accounts resulting from an erroneous rate increase implemented in 2012. This is a non-recurring event that was booked entirely in fiscal 2015 and resulted in DSC levels that were lower than expected, nonetheless still adequate at 2.5x on a senior lien basis and 1.4x all-in. Liquidity at the close of fiscal 2015 was affected but also remained adequate at 154 days cash on hand, down from 220 days in fiscal 2014.
The city implemented a new rate structure and rate increase in fiscal 2016 to support the expected debt issuance for capital projects. For fiscal 2016, all-in DSC is projected at a strong 2.1x, with senior lien DSC at a solid 4.4x.
Fitch views favorably that the new management team has implemented the practice of preparing and annually updating a five-year forecast. The forecast includes implementation of its priority projects in the capital improvement plan (CIP). The 2017 - 2021 forecast reflects Fitch-calculated senior lien debt service coverage ranging from 1.4x to 2.6x assuming the new debt is issued on parity with the senior lien, and all-in DSC ranging from 1.2x to 1.6x. The forecast assumes no rate increases for sewer services and assumes an 8% water rate increase in fiscal 2018.
COLLECTIONS AND RATE INCREASES
The system sustained large unbilled water losses after the hurricane in large part due to faulty meters. Water losses have improved through city-wide meter replacements, but management is still working to further guard against these losses and improve collections. The system bills monthly and has shut-off provisions for non-payment.
The city recently increased rates in fiscal 2016 and also revised the rate structure to reduce the impact of the water rate increase on customers with low water use. Combined rates and charges assuming Fitch's standard water usage of 10 hundred cubic feet (hcf) and 7 hcf sewer totals $75 a month, or 2.4% of median household income (MHI), above Fitch's 2% of MHI affordability level. However, MHI levels do not incorporate income levels of more affluent second-home owners that live on the island part-time.
HIGH DEBT PROFILE WITH LARGE CAPITAL NEEDS
The system's 2017-2021 CIP totals $119.9 million. Approximately 70% of the CIP, or $84.2 million, will fund capital improvements to the water distribution system and the remaining $35.7 million of the CIP is for wastewater improvements. The city plans to fund approximately 61% with bond proceeds, 25% with available reserves and recurring revenues, and the remaining 14% with hurricane recovery grants.
The system's current debt profile consists primarily of parity revenue bonds, general obligation bonds issued by the city, and contractual obligations for bonds issued through its water provider, GCWA. Current debt per customer levels including the contractual obligations are moderately high at nearly $1,600 per connection and are projected to rise to nearly $2,500 per connection in year five of the CIP.
The local economy is centered in healthcare, maritime and tourism industries. The University of Texas Medical Branch (UTMB) anchors the city's health and education service sector and serves as a teaching hospital and hub for medical research. Earlier this year, UTMB completed the construction and opened a $438 million 13-story hospital to replace a facility damaged by Hurricane Ike. UTMB reports total fiscal 2015 personnel at 11,339, representing about 7.5% of the county's total employment base and a likely higher proportion of the city's base. The city's improved unemployment rate of 5.1% as of July 2016 is on par with the state and national averages for the same period.
The Port of Galveston and nearby Pelican Island support growing industrial operations, cargo transportation and petroleum support services. Recent and near-term infrastructure improvements bode well for ongoing growth in the island's maritime trade.