Fitch Affirms Melrose Park, IL's Water Revs at 'A '; Outlook Stable
--\$6.7 million water revenue bonds series 1998A.
The Rating Outlook is Stable.
The bonds are payable from net operating revenues derived from the operation of the village's water supply system (the system). The village and each of its wholesale customers are obligated pursuant to a water supply service agreement (the agreement) to pay the trustee a monthly capacity charge calculated to include 125% of each customer's pro rata share of debt service on bonds. The bonds are also backed by a debt service reserve fund that was initially funded with bond proceeds.
KEY RATING DRIVERS
SUFFICIENT FINANCIAL PROFILE: Although all-in debt service coverage (DSC) finished fiscal 2013 at a strong level, uneven debt service schedules can lead to pronounced variability in coverage. Liquidity levels are very low.
INTERGOVERNMENTAL SUPPORT BY UTILITY: The utility's practice of inter-fund transfers to the city's general fund leads to very low liquidity margins at the utility. Such transfers limit the financial flexibility of the utility and potentially limit capital reinvestment in utility infrastructure.
SOUND LEGALS: Legal covenants and the service agreement provide payment to bondholders, with no reported delinquencies from customers and step-up provisions in the event of delinquencies. The rating, in part, reflects Fitch's expectation that the village has the financial resources to absorb any potential member delinquencies on the remaining revenue bonds outstanding.
LOW DEBT LEVELS: The system's current debt levels are very low and amortization is very rapid. Future borrowing appears unlikely as most capital needs are expected to be pay-go financed.
WEAKENED METRICS FROM TRANSFERS OUT: The consistent practice of moving monies out of the utility fund and thereby weakening liquidity margins will likely prohibit any positive rating action. Conversely, low liquidity margins combined with DSC below rating category medians could create negative rating pressure.
The Melrose Park water system provides potable water to the village and six other municipalities (members) via a water supply contract (the contract) between the village and the city of Chicago (sr. lien water system obligations rated 'AA+' with stable outlook by Fitch). Pursuant to the contract, Chicago agrees to sell to the village, and the village agrees to purchase and take a supply of water derived from Lake Michigan. Chicago delivers treated water to a Melrose Park metered connection, which the village then distributes to its retail and wholesale customers. In addition to the water supply system, the village owns its water distribution system and sewer system (the utility) from which revenues are derived to pay its share of capacity charges.
SOUND FINANCIAL PROFILE DAMPENED BY TRANSFERS
The village's direct retail customers account for the largest source of revenue. The village's financial performance has been solid over the past several years. However, the uneven amortization schedule associated with the series 1998A bonds can often result in volatility in DSC. For example, a large debt service payment in fiscal 2008 led to all-in DSC of just above 1.0x. Subsequent to this, debt service declined and flattened out from 2010-2012, resulting in an average all-in DSC of 2.6x. Although management did not provide a forecast, scheduled debt service payments on the revenue bonds and parity state loans indicate that current revenue levels should keep coverage strong through bond maturity. However, due to large payments due in 2017 and 2018, all-in DSC will likely decrease in these years. The cash-funded debt service reserve in the amount of \$3.9 million will be used to pay much of the final revenue bond maturities in 2018 and 2020.
The system has been generating strong surplus cash since 2010. However, management's practice of transferring such surpluses to the village's general fund (\$7 million in both fiscals 2012 and 2013) resulted in very low cash balances at fiscal year-end. Fitch views large, inconsistent transfers out from the water and sewer fund as a credit negative as there can be no assurance of liquidity and available margins going forward. Legally, the village can transfer funds from the system after all indenture requirements are satisfied.
SERVICE AGREEMENT PROVIDES SOUND LEGAL SECURITY
Pursuant to the agreement, the village and its wholesale customers are required to remit directly to the trustee the monthly capacity charges, which are equal to each customer's pro rata share of debt service on the bonds. The share of debt service is based on the estimated benefits of the project received by each customer. Additionally, each wholesale customer is responsible for a quantity charge, which is based on actual quantity of water purchased and transmitted to each customer.
As specified in the agreement, each wholesale member is required to pay their pro rata capacity charges regardless of water delivery. In addition, if any member fails to make its scheduled payment on any of its charges, all non-delinquent members are required to make up such payment. Members have also covenanted in the agreement not to use any competing service and to pay the village a quantity charge directly for water transmitted.
The agreement expires at the latter of 2023 or one year after the last debt service payment on the bonds. To date there have been no reported member payment defaults. Fitch has not reviewed the credit quality of the village's wholesale customers, with the expectation that the Village could accommodate any member debt service payment deficiencies.
VILLAGE MAINTAINS LOW DEBT LEVELS
Village debt levels associated with the utility system are low at \$13.4 million, which is estimated to equate to approximately \$400 per customer. Additionally, debt amortization is rapid with all debt scheduled to amortize by the end of fiscal 2020. Utility capital needs are modest and are anticipated to be funded from surplus revenues.
Certain members have debt related to their respective distribution systems, but the amount of borrowing has been low and member bonds are subordinate in payment to the obligation to make capacity and quantity charges related to the bonds.
RATES LINKED TO CITY OF CHICAGO CHARGES
Under the service agreement, rates charged to the system are determined by the city of Chicago and are generally passed through to the system and hence the system's wholesale customers. At 1.7% of median household income, combined water/sewer bills are currently under Fitch's affordability threshold of 2%, creating some flexibility.