Fitch Rates Galveston, TX Waterworks and Sewer System Revenue Bonds 'A+'; Outlook Stable

AUSTIN, Texas--(BUSINESS WIRE)--

Fitch Ratings has assigned an 'A+' rating to the following Galveston, TX waterworks and sewer system (the system) revenue bonds:

--$19.3 million waterworks and sewer system revenue refunding bonds, series 2014.

The bonds will be sold via negotiation on or around September 25. Proceeds of the bonds will be used to refund outstanding system obligations for debt service savings without extending final maturity.

In addition Fitch assigns an initial rating of 'A+' to approximately $33.5 million outstanding parity revenue bonds, series 2006 and 2012 (pre-refunding).

The Rating Outlook is Stable.

SECURITY

The bonds are secured and payable from a first lien on the net revenues of the water and wastewater system.

KEY RATING DRIVERS

HIGH DEBT / SIZEABLE CIP: The system's already high debt levels are projected to continue to rise with the planned debt for its capital plan, despite expected large federal grant proceeds. The system's capital improvement plan (CIP) is predominantly driven by plant asset recovery and reconstruction after the city was hard hit by Hurricane Ike in 2008.

FEDERAL GRANT INFUSION: Galveston suffered severe flooding damage during the hurricane and benefits from substantial federal contributions received for recovery. To date, the system has received over $70 million in federal aid. An additional $67 million or 52% of the system capital plan will be funded with federal grants.

STRONG FINANCIAL METRICS: System financial metrics are strong aided by recent rate increases. A forecast will be provided with future new money bond sales, as the system is currently undergoing a formal rate study to complement implementation of the large CIP.

LIMITED RATE FLEXIBILITY: The system implemented large rate increases over the last two fiscal years resulting in system rates that are viewed by Fitch as high relative to median household income (MHI).

ECONOMIC RECOVERY CONTINUES: 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 stabilize the local economy. Economic recovery continues at a solid pace, driven primarily by infrastructure projects and ongoing tourism growth.

RATING SENSITIVITIES

CONTINUED HEALTHY FINANCIAL PERFORMANCE: Maintenance of strong all-in debt service coverage (DSC) and solid liquidity levels could result in positive rating action.

CREDIT PROFILE

The city of Galveston (GO bonds rated 'AA-') is located on Galveston Island approximately 45 miles from Houston in southeast Texas. With a population of approximately 48,000 the city is the county seat of Galveston County (GO bonds rated 'AA+'). 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 20,600 water and 16,500 sewer connections. The city purchases treated water from the Gulf Coast Water Authority 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. Treatment capacity is ample, but the wastewater system has some non-compliance conditions resulting from Hurricane Ike that are expected to be corrected by November 2015.

STRONG FINANCIALS AND EXPECTED FORECAST

The city has received over $70 million in grants and insurance proceeds to date for system reconstruction after the hurricane. Through this grant reinvestment, the five-year historical performance shows a favorable decline in debt-to-net plant ratios.

Debt service coverage excluding the non-recurring grants and after adjusting for the contractual debt (that is paid as an operating expense of the system), has ranged from a low 1.6x to a high 2.8x from fiscals 2009 through 2013, reflecting relatively large rate hikes in fiscals 2012 and 2013. Liquidity at the close of fiscal 2013 was solid at 242 days cash on hand. The recent rate increases are positioning the system to implement its large CIP that will be partially debt funded. Moreover, the city has commissioned a comprehensive rate study that will serve as the basis for future rate increases and will provide a detailed financial forecast with integration of the system CIP. Although the rate study has not been finalized, Fitch expects the system will continue to post strong financial metrics.

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 from a substantial 60% in fiscal 2009 to 28% in fiscal 2013 through city-wide meter replacements, completion of which is slated for the end of this calendar year. Days of operating revenues in accounts receivables that hit a high 84 days in 2009 has also declined to 66 days in 2013, and further improvement is expected. The system bills monthly and has shut-off provisions for non-payment.

The city recently increased rates in fiscals 2012 and 2013 for both water and wastewater services. Combined rates and charges total $77 a month, considered high at 2.4% of median household income, somewhat limiting future rate flexibility. However, median household income 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 2015-2019 CIP totals $130 million. Approximately 67% of the CIP, or $87 million, will fund capital improvements to the water distribution system. The remaining $43 million of the CIP is for wastewater improvements including rehabilitation and reconstruction of two wastewater treatment plants, lift station repairs, and extending service to areas currently on septic systems. Approximately 52% of the CIP will be funded with hurricane recovery grants, 36% with bond proceeds, and the remaining with available reserves and recurring revenues.

The system's current debt profile consists primarily of parity revenue bonds, certificates of obligation issued by the city, and contractual obligations for bonds issued through its water provider, GCUA. Current debt per customer levels including the contractual obligations are high at nearly $1,950 per connection and are projected to rise to nearly $2,500 per connection in year five of the CIP.

ECONOMY

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. UTMB is nearing completion of a $438 million 13-story hospital to replace a facility damaged by Hurricane Ike. UTMB reports total fiscal 2013 personnel at 11,452, representing about 8% of the county's total employment base and a likely higher proportion of the city's base. The city's improved unemployment rate of 6.4% as of July 2014 reflects new job growth, but continues to trail the average Texas rate of 5.6% 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.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from CreditScope, and the Texas Municipal Advisory Council.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2014)

--'Water and Sewer Revenue Bond Rating Guidelines' (July 2013)

--'2014 Water and Sewer Medians' (December 2013)

--'2014 Outlook: Water and Sewer Sector' (December 2013)

Applicable Criteria and Related Research:

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=876396

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