Fitch Affirms Columbus, OH's Sewer Revs at 'AA/F1+'; Outlook Stable
--$375 million sewerage system fixed-rate revenue bonds, series 2008A and series 2014 at 'AA';
--$51.9 million sewerage system adjustable-rate revenue bonds series 2008B at 'AA/F1+'.
The Rating Outlook is Stable.
The bonds are payable from a senior lien net revenue pledge of the city's sewerage system (the system).
KEY RATING DRIVERS
ROBUST LIQUIDITY, WEAK CASH FLOWS: System liquidity is very strong at 840 days cash on hand in fiscal 2015 and is forecast to remain strong over the next five years. However, annual free cash flow (FCF) and all-in debt service coverage is limited, requiring capital needs to be funded with existing cash or additional debt.
LARGE DEBT BURDEN AND CIP: The system is in the midst of a large long-term capital improvement program (CIP) to address sewer overflows. Capital planning efforts are sound and capital needs are well defined. However, the debt burden is already substantial and the city expects to fund the entire CIP with additional debt.
ADDITIONAL RATE INCREASES EXPECTED: Rates are already somewhat elevated and additional increases are needed to fund the capital program and expected increases in annual debt service. While the city has a solid history of raising rates, financial results are just adequate for the rating. Future rate increases are projected to be sufficient to maintain financial metrics similar to current levels.
STABLE AND DIVERSE ECONOMY: The system serves a sizeable, diverse and economically strong service area, which includes the city and portions of the surrounding suburban communities. The economy benefits from an extensive government, university and healthcare presence.
POTENTIAL LIQUIDITY DEMANDS WELL COVERED: The 'F1+' short-term rating on the series 2008B variable-rate demand bonds reflects the system's solid credit fundamentals and long-term rating, as well as its ability to cover the maximum potential liquidity demands by at least 1.25x from internal resources.
WEAKENING OF FINANCIAL RESULTS: Deterioration in the Columbus, Ohio sewer system's financial performance as a result of a failure to increase rates as planned, or increases in the debt burden beyond current projections would be viewed negatively in light of the system's already slim financial margins and elevated and rising debt position.
Columbus (GOs rated 'AAA'/Stable Outlook) is the state's capital, located in central Ohio within the boundaries of Franklin County (the county) and, to a limited extent, Fairfield and Delaware counties. The system serves as a regional sewer provider to residents of the city as well as to nearby suburban communities and to parts of adjacent counties. The system's retail customer base is mostly residential with 272,000 metered accounts in 2015. Wholesale service is also provided, although the majority of the system's revenues are derived from the diverse and stable retail base.
STRONG LIQUIDITY OFFSETS WEAK ALL-IN DSC
System finances are somewhat mixed, evidenced by historically strong debt service coverage (DSC) on senior-lien bonds and ample liquidity. However, coverage of total fixed charges, including subordinate lien GO bonds and state loans, is much slimmer at 1.1x on average over the past six fiscal years. While system revenues are not pledged to GO bondholders, Fitch also considers all-in DSC given management's intent to support these obligations from utility revenues.
The system's free cash flow, which measures excess annual cash flow from operations available after payment of operating costs and debt service, is low, averaging just 18% of annual depreciation over the past three years. The weak cash flows help keep rates generally affordable but require capital needs to be funded from additional debt or existing cash (or a combination thereof).
Future annual rate hikes, if approved at the estimated 3%-7% level through the financial forecast period, are manageable and expected to keep the current financial profile stable while meeting increasing debt service costs. The city's financial forecast also includes the use of fund balances to reach sum-sufficient coverage on an all-in basis. However, Fitch believes the forecast to be conservative given that prior results typically exceed projections.
Liquidity is currently ample, somewhat offsetting the low DSC (and cash flows) and providing the system with financial flexibility. The unrestricted cash and investment balance was approximately $219 million at fiscal 2015 year-end, equal to a very robust 840 days cash on hand. Strong liquidity is also important to support the city's outstanding variable-rate demand bonds. The city expects to debt-fund the capital improvement plan (CIP), which should allow cash balances to remain healthy but will also result in an increase in the already high debt burden. Future debt is expected to be issued as either GO bonds or additional state loans, so senior-lien DSC is expected to remain strong.
SIZABLE CAPITAL PROGRAM RELATED TO CONSENT DECREES
The system is in the midst of a major capital construction cycle focusing on collection system expansion and other projects in accordance with two consent decrees the city signed with the Ohio Environmental Protection Agency (OEPA) over a decade ago. As part of the consent decrees, OEPA approved a 40-year comprehensive Wet Weather Management Plan (WWMP) in 2009 to address sewer overflows.
As part of an updated WWMP proposed by the city, and recently agreed to by OEPA, the city will substantially improve existing assets to limit inflow and infiltration, as well as incorporate green infrastructure projects to meet the consent decree requirements. As part of the revised plan, the city proposed moving the deadline for meeting the requirements ahead by 10 years. The city has nearly completed its major tunnel project and has generally met the regulator's milestones. The city expects to maintain compliance despite the shorter time-frame. Nevertheless, the system's $1.1 billion six-year CIP will require a significant amount of additional debt.
LARGE AND GROWING DEBT BURDEN
The system's debt burden remains substantial, with metrics including all debt associated with the system that are well above the medians for the 'AA' category. In fiscal 2015, the system had $1.7 billion in total debt outstanding, which is equal to 77% of net plant assets (median is 47% for 'AA' category) and debt totaled a very high $6,462 per customer. Fitch's median debt per customer ratio for 'AA' water and sewer systems is just $2,050.
Outstanding debt per capita, which includes the many end-users not captured in the many multi-family metered accounts throughout the city, was a more manageable but still elevated $1,412 in fiscal 2015. In addition, debt carrying costs were a substantial 59% of gross revenues in fiscal 2015. However, the high carrying costs are somewhat offset by the fairly rapid amortization of existing debt; more than 50% is retired within 10 years, and all debt is retired within 20 years.
Approximately 75% of the total debt outstanding consists of Ohio Water Development Authority (OWDA) loans and GO bonds, which are paid on a subordinate basis to the revenue bonds. This percentage will likely climb given the city's plans to use additional OWDA loans and future general obligation bonding authorization to fund the CIP. While senior lien bondholders appear insulated based on the current borrowing plans, Fitch considers the burden of all fixed obligations in its debt analysis. The currently high debt profile is projected to escalate even further with the planned additional debt to roughly $9,000 per customer by fiscal 2020 ($1,900 per capita).
Variable rate debt is limited to two series of bonds totaling around $100 million, or just 6% of total debt outstanding. With no swaps or liquidity facilities associated with these bonds, the system does not have exposure to counterparty risk, and interest rate risk is mitigated and managed by the city's substantial liquid resources.
RATES ARE ELEVATED, ADDITIONAL INCREASES PLANNED
Residential rates are based on water consumption and are billed quarterly as part of a combined water and sewer bill. Following routine and moderate increases in the 1990s, the city in 2004 began instituting double-digit annual rate hikes to fund capital expenditures associated with the consent decrees. However, annual adjustments since 2008 have moderated with rate increases averaging approximately 3% over that time. In fiscal 2016, the quarterly sewer bill for the average residential customer totals $139, or about $46 per month.
Sewer charges are already elevated at 1.3% of median household income (MHI) but are competitive when compared to other large regional area providers. Management prepares a 10-year forecast of rates and charges in conjunction with its financial pro forma. The most recent financial forecast assumes future annual rate increases of between 3% and 7% over the next decade. While rate hikes have been implemented systematically over time, Fitch would be concerned if the additional rate hikes become increasingly unpopular and politically difficult to implement.
AMPLE LIQUID INTERNAL RESOURCES
The 'F1+' short-term rating is supported by the long-term credit quality of the system and adequacy of the city's highly liquid resources available to fund any un-remarketed puts on the roughly $100 million in outstanding variable rate demand obligations. Based on Fitch's rating criteria related to self-liquidity, the system's position of eligible cash and investments available for same-day settlement exceeds the maximum tender exposure on any given date by the required 1.25x. The city maintains detailed procedures in the event of a failed remarketing that obligate the city's Treasury Investment Board to purchase any bonds tendered and not successfully remarketed.
BROAD-BASED AND STABLE ECONOMY
Columbus is anchored by a stable and growing economic base largely composed of professional and business services, healthcare, education, and government. As the state capital and home to Ohio State University, the city's economy remained relatively resilient during the most recent national recession.
Significant facilities investment by Ohio State University, Nationwide Children's Hospital, and IBM Corporation are expected to add to the city's expanding employment base. The city's employment profile remains positive. The June 2016 unemployment rate of 4.2% is below the state and the national averages.