Fitch Affirms Virginia Beach, VA Water and Sewer System Revs at 'AAA'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the following Virginia Beach, VA (the city) revenue bonds:
--$184.4 million water and sewer system (the system) revenue bonds at 'AAA'.
The Rating Outlook is Stable.
The bonds are payable from a first lien pledge of the net revenues of the system including connection fees.
KEY RATING DRIVERS
STRONG FINANCIAL MANAGEMENT: Financial performance remains strong with debt service coverage (DSC) consistently above 2.0x. Liquidity is also strong with unrestricted cash in excess of 475 days cash on hand as of fiscal 2014.
MANDATED CAPITAL; DEBT REMAINS FAVORABLE: The system's capital improvement program (CIP) totals $235 million and focuses on aging sewer infrastructure related to the regional consent order to reduce sewer system overflows (SSOs). Approximately 64% of the program is expected to be debt-funded but debt ratios should remain manageable.
STABLE ECONOMY AND CUSTOMER BASE: The economy, traditionally concentrated in the military and tourism, continues to diversify and has remained stable. The system's customer base is large and mostly residential.
LIMITED SYSTEM OPERATIONS: The system consists of water distribution and sewer collection and conveyance assets only, limiting longer-term operating issues and capital needs to renewal and maintenance.
SUCCESSFUL CIP IMPLEMENTATION, STRONG FINANCES: Fitch expects the city will continue to address its aging sewer infrastructure and successfully meet its consent order requirements regarding sanitary sewer overflow mitigation while maintaining financial metrics consistent with 'AAA'-rated utility systems.
The city of Virginia Beach is the commonwealth's largest city, with an estimated 451,672 residents in 2014.
LIMITED OPERATING PROFILE, ABUNDANT WATER SUPPLY
The city's water system consists of water distribution assets only. In the 1990s, the city constructed a pipeline and obtained rights to pump surface water from Lake Gaston to address water supply needs.
The Lake Gaston Project, completed in 1997, includes a 76-mile, 60-inch diameter pipeline extending from a tributary of Lake Gaston to the city of Norfolk's treatment facilities, and provides Virginia Beach with an ample long-term independent water supply source. Virginia Beach pays Norfolk for a proportional share of operations and maintenance (O&M) expenses, depreciation, and a rate of return on assets. The city's long-term contract with Norfolk expires in 2030.
The sewer system is a collection and conveyance system only. The sewer system includes collector lines, force mains, and pump stations which are used to collect and transport wastewater to the treatment facilities operated by the region's highly rated sewer treatment provider, the Hampton Roads Sanitation District (HRSD, revenue bonds rated 'AA+' by Fitch). HRSD provides wastewater treatment services to 17 cities and counties in the state and operates 11 total treatment facilities in the region. HRSD bills customers directly for treatment service.
STRONG FINANCIAL OVERSIGHT, CAPITAL NEEDS MAY PRESSURE COVERAGE
The system's financial profile has historically been strong, with solid financial margins leading to both ample liquidity levels and high DSC. Coverage of senior lien bonds (the sole source of system debt) from all available revenues remained strong in fiscal 2014 at more than 3.0x, and days' cash on hand was a healthy 475 days. Excluding connection fees, DSC was a still strong 2.9x in fiscal 2014.
Results for fiscal 2015, which are preliminary and unaudited, point to another year of strong fiscal performance, although DSC declines slightly from a rise in annual debt service. The system ended fiscal 2015 with approximately $116 million in unrestricted cash, an increase from the prior fiscal years and equivalent to 535 days' cash on hand. Liquidity may decline as the city uses some of the system's existing cash and annual cash flows to fund roughly one-third of the CIP but Fitch expects cash levels should remain solid assuming the city raises rates as identified in its financial forecast.
Pro forma financial results show a steady rise in debt service and a corresponding decline in DSC, similar to prior forecasts. The projections appear reasonable and include additional bonds, manageable rate increases, and no growth in demand. Historically, the city has used more pay-go funding than is currently anticipated in the CIP. In addition, the system has generated better financial results than prior projections have indicated, providing a track record that the projections are conservative and will likely be surpassed. Fitch expects the city to outperform projections during implementation of its sizable CIP.
LEVERAGE TO REMAIN MANAGEABLE
The system had $210 million in bonds outstanding as of fiscal 2014, resulting in still modest debt levels. Debt-to-net plant totaled 32%, which is in line with similarly-rated systems, and debt per customer was just $804. Debt carrying costs were low at just 12% of gross revenues. The system's manageable debt burden is a credit positive, although debt related to HRSD and the city of Norfolk's facilities are not included in the ratios (Norfolk's service charges are an O&M expense of the system, and HRSD bills city customers directly for treatment services).
Additional debt is expected to be issued to finance roughly two-thirds of the system's six-year $235 million CIP through fiscal 2021. The amount of anticipated debt may be less than is currently projected based on the city's historical use of pay-go funding and its practice of pushing debt issuance into later years of the CIP. The next new money issuance is projected by the city to occur in early 2016, nearly two years after the last issuance. The system's large cash balances and the projected $16 million-$18 million in excess cash flow (after O&M, debt service, and transfers have been paid) provides significant resources for additional pay-go funding.
Fitch projects the system's debt burden will rise but remain manageable and approximate the medians for 'AAA' water and sewer systems once the capital plan is fully implemented, including the issuance of approximately $150 million in additional bonds. The city has spent approximately $150 million on capital acquisition over the past five years, helping to lower the system's average plant age and keep the system in a good state of repair.
STABLE ECONOMY AND CUSTOMER BASE
The city is located within the Hampton Roads region of Virginia. The economy has traditionally been concentrated in the military and tourism sectors, and both remain significant to the employment base. Several military bases, including the east coast's master jet base, provide significant economic activity to the region with an annual payroll of approximately $2.5 billion and over 34,000 jobs. Efforts to diversify the economy continue as the city works to attract service industries including professional services, telecommunications and marine-related services.
The system serves a predominantly residential customer base. In fiscal 2014, retail service was provided to approximately 133,000 water and 130,000 sewer customers, with little customer concentration. The region's unemployment rate for July 2015 was 5.2% and has been on the decline for the past several years. Income levels are above average with median household income at 128% of the U.S. average.