AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings assigns the following rating to the city of Garland, Texas' (the city) bonds:
--Approximately $27.2 million water and sewer system (the system) revenue refunding and improvement bonds, series 2013 'AA+'.
The bonds are scheduled to sell competitively the week of May 6. Bond proceeds will be used to refund certain outstanding bonds of the city for interest savings without extension of maturity, construct improvements and extensions to the system, and pay costs of issuance.
In addition, Fitch affirms the rating on the city's outstanding bonds as follows:
--$209 million in outstanding water and sewer system parity bonds at 'AA+'.
The Rating Outlook is revised to Negative from Stable.
SECURITY
The bonds represent senior obligations of the combined system, payable from net system revenues.
KEY RATING DRIVERS
UNCERTAINTY IN FINANCIAL POSITION: The Negative Outlook incorporates the likelihood of diminishing financial flexibility, reduced debt service coverage (DSC), and weak results in other key financial metrics based on current declining trends.
DECLINE IN DSC: Senior lien annual DSC dropped to 2.0x and total DSC declined to 1.6x in fiscal 2012. Liquidity improved, although it remains slightly below average, equal to just over half a year of operating cash on hand.
WHOLESALER COST PRESSURES: The city is susceptible to operating cost pressure from its wholesale water provider.
ABOVE-AVERAGE DEBT PROFILE: System debt levels are moderately high, especially when taking into consideration off-balance sheet debt of the North Texas Municipal Water District (NTMWD) (the district, the system's wholesale water provider). Debt levels should remain above-average assuming the bulk of the system's capital program is debt-funded. High debt levels are somewhat offset by the city's above-average principal amortization.
ASSURED WATER SUPPLY: The system has assured water supply through 2030 under a perpetual contract with the NTMWD. The terms of purchase are somewhat disadvantageous due to the service area's weather fluctuations, but management has implemented rate hikes to keep pace with rising water costs.
ADEQUATE RATE FLEXIBILITY: Rates are higher than surrounding area providers, but the city maintains sufficient rate flexibility relative to Fitch's affordability threshold benchmark and has demonstrated a willingness to raise rates to maintain financial performance.
ESSENTIAL SERVICE, DIVERSE ECONOMY: The system provides an essential service to a mature service area that is part of the large and diverse Dallas area economy. The city has low unemployment and slight above average wealth levels.
RATING SENSITIVITIES
DIMINISHED FINANCIAL CUSHION: Realization of projected declines in DSC over the course of the forecast period and/or ongoing weak results in other key financial metrics would likely result in a downgrade.
CREDIT PROFILE
The water system serves approximately 70,000 city customers and purchases its water on a wholesale basis under a perpetual contract from NTMWD, of which Garland is a member city. Existing and projected water supplies from NTMWD reportedly are sufficient to meet all customer demands through 2030. The wastewater system serves more than 67,000 customers within the city, as well as portions of five other cities, including the city of Dallas.
WEAKENED FINANCIAL PERFORMANCE
System operations have been pressured by fluctuating weather conditions, efforts to conserve water, and a somewhat disadvantageous water supply contract. Management is committed to maintaining financial health as evidenced in its timely rate hikes and ongoing commitment to adjust charges as needed. Rates have increased consistently since 2009 to provide additional revenue to support increasing operating and debt service costs.
The monthly bill at $68.09 (assuming usage of 7,500 gallons per month for water and 6,000 gallons per month for sewer) is the highest in the Dallas/Fort Worth Metroplex and currently registers at 1.5% of median household income (MHI), still falling under Fitch's 2% of MHI affordability threshold. Forecasts provided by management indicate continued rate increases in future years. Anticipated water rate increases, ranging from 7% to 9%, are higher and planned more consistently than the less frequent and more modest wastewater rate increases, which range from 2%- 5% and start in 2014.
Due to the Texas Drought, water use restrictions were implemented late in fiscal 2011. Reduced water demand during the 2012 summer months led to a loss in operating revenue, resulting in a decline in net revenues available for debt service in fiscal 2012. Audited fiscal 2012 results point to senior lien annual DSC declining to 2.0x (1.5x net of transfers out) from a high of 3.0x in fiscal 2011. Including debt service requirements of about $30 million in outstanding general obligation debt issued for system improvements, all-in coverage dropped to 1.6x (1.2x net of transfers out) for the year from a good 2.4x in fiscal 2011.
Through the fiscal 2017 forecast period, all-in DSC is expected to be reduced to between 1.4x and 1.5x. The city's forecast assumes increased debt service costs from planned debt issuances, annual rate increases and conservative annual operating expense growth. Driving the lower coverage levels is the increasing purchased water costs and growing debt service requirements. Water costs associated with the NTMWD contract increased 9.6% in 2011 and accounted for more than 50% of the water fund's operating expenses. The city has been informed that the NTMWD rate will increase by around 11% in fiscal year 2014, due to necessary upgrades to meet regulatory requirements. Maintenance of sound debt service coverage commensurate with the high rating is a key credit consideration given the city's plan to further leverage the system for capital projects.
Fitch notes that transfers out of the system are high, averaging 12% over the past five fiscal years. Transfers out of the system combined with limited surplus cash from operations after payment of operating and debt service costs have left a minimal amount of free cash available to cover depreciation (free cash to depreciation at 24% in fiscal 2012). Fitch will continue to monitor system financial performance. Any further decline in financial margins will be viewed negatively and may be inconsistent with the present the rating level.
Liquidity levels improved for the year, increasing to 187 days cash on hand (DCOH) in fiscal 2012 from 180 DCOH in fiscal 2011. Given capital needs are anticipated to be predominantly debt-funded, cash balances are expected to remain at similar levels over the forecast period.
HIGH DEBT BURDEN
The system's capital improvement plan (CIP) for fiscal years 2013-2017 totals $136 million, which is down slightly from the prior five-year plan. The CIP is expected to be financed exclusively from debt proceeds (with a portion of the current offering to be used to fund fiscal 2013 capital needs). Approximately 56% of the CIP addresses sewer system improvements that will ensure compliance with new and enhanced regulatory and operational standards while the remaining 44% is for water system improvements.
Direct system debt levels are above-average. For audited fiscal 2012 debt to plant was 62% while debt per capita was $1,059, both above the 'AA' category medians. Including NTMWD obligations supported by the system, system debt levels increase by approximately 56% and are well-above category 'AA' rating median levels. Although the system's CIP is anticipated to be 95% debt funded, debt levels are expected to remain relatively stable due to the above-average pace of existing debt amortization (principal payout at 66% and 100% in 10 and 20 years, respectively).
MATURE, STABLE ECONOMIC BASE
Garland benefits from its location within the Dallas-Fort Worth metropolitan area. Manufacturing and distribution remain the city's primary economic engines, and the city's industrial market reportedly is the second largest in the Dallas-Fort Worth metroplex. The city's unemployment rate, measured at 7.1% in January 2013, is slightly higher than the state (6.9%) and metropolitan statistical area (6.7%) but remains better than the national (8.5%) average. Local wealth levels within the city, as measured by per capita buying income and median household income, are slightly higher than state but are on par with national averages.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in Fitch's U.S. Municipal 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 12, 2012;
--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 3, 2012;
--'2013 Water and Sewer Medians', dated Dec. 5, 2012;
--'2013 Outlook: Water and Sewer Sector', dated Dec. 5, 2012.
Applicable Criteria and Related Research
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684901
2013 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695756
2013 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695755
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=789596
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