Fitch Affirms Memphis, TN's Utility Sanitary Sewerage System Revs at 'AA-'
Fitch Ratings takes the following action on Memphis, TN's revenue bonds:
--Approximately $121 million outstanding utility sanitary sewerage system revenue bonds, affirmed at 'AA-'.
The Rating Outlook is Stable.
The bonds are secured by a senior lien pledge of the net revenues of the city's sanitary sewerage system (the system), including system development charges.
KEY RATING DRIVERS
IMPROVED FINANCIAL PERFORMANCE: Financial results have significantly improved as result of the large and necessary rate increase implemented in fiscal 2011. The system ended the fiscal year with roughly $30 million in unrestricted resources (including R&R funds) and over 3.5x coverage of debt service and transfers, reversing a trend of dismal financial performance for several years prior.
RATES REMAIN AFFORDABLE: Rates have been low historically, and despite a 115% rate increase needed to both overcome the weak financial performance of the past and to meet the large expected future capital obligations, the average customer pays a still reasonable $17 per month for service. Additional increases are not expected for several years.
SIGNIFICANT, AFFORDABLE CAPITAL NEEDS: Capital investment primarily related to sanitary sewer overflows (SSO) over the next 10 years are fairly significant, however, Fitch believes the system's low current debt burden, affordable rate structure, and strong financial margins provide a solid framework to meet these long-term capital pressures.
LARGE INDUSTRIAL CUSTOMER PRESENCE: The customer base remains somewhat concentrated with large industrial users accounting for over 30% of total revenues. No single customer comprises more than 6% of revenues, and the overall customer base is stable with little change in individual leading customers.
STABLE REGIONAL ECONOMY: The city's role as the major employment center for a three-state, four-county metropolitan statistical area remains a stabilizing credit factor. The economy is broad and diverse with employment spanning the distribution, warehousing, health care, higher education, government, and tourism sectors. The unemployment rate has improved but remains elevated.
LARGE CUSTOMER BASE WITH INDUSTRIAL CONCENTRATION
The city of Memphis (GO bonds rated 'AA-' by Fitch) owns and operates the system, providing sewer collection, treatment, and disposal services to a large customer base of approximately 260,000 accounts. The service area is large, covering 442 square miles in total, and includes the city, as well as a portion of the surrounding suburban communities of Shelby County (GO bonds rated 'AA+').
The total population served is estimated to be 900,000, and it remains stable. The customer base, while large, is somewhat concentrated with the top 15 industrial customers comprising roughly 30% of total system revenues. The customer base is stable and the city reports no material changes in its largest customers.
STABLE REGIONAL EMPLOYMENT BASE
The city's economy is anchored by transportation and health care and plays a vital role as the major employment center for a three-state, four-county metropolitan statistical area (MSA) encompassing jurisdictions in Arkansas, Mississippi, and Tennessee. Along with healthcare and transportation, employment in distribution and warehousing, higher education, government, tourism, and agri-business provides broad and diverse employment options.
Distribution and warehousing is supported by a solid intermodal network including Memphis International Airport ('A+'; Negative Outlook), the world's largest cargo airport, the Port of Memphis, freight rail, and an array of interstate highways. The economy remains stable; a combination of rising employment and lower labor force participation has lowered the unemployment rate to a still elevated 8.9% in August 2012.
SYSTEM TO UNDERGO LARGE CAPITAL PROGRAM TO ADDRESS SSO
The system is operated under the purview of the Division of Public Works (DPW). DPW is responsible for the billing and collections of the system's large industrial users, while residential/commercial customers are billed by the city's electric utility - Memphis Light, Gas & Water.
The system contains 3,600 miles of sewer mains, 28 miles of interceptors, 99 pump stations, and two treatment plants with a combined capacity to treat over 300 million gallons per day (mgd). Plant capacity is strong with average daily flows totaling 154 mgd in 2012. The treatment plants discharge effluent under recently extended National Pollution Discharge Elimination System (NPDES) permits granted by the state.
Strong system infrastructure capacity is somewhat offset by the system's age and long-term capital rehabilitation needs. In response to a consent decree to address SSO's, the system anticipates spending roughly $250 million over the next 10 years to assess and improve existing infrastructure to eliminate sewer overflows. In addition, management expects to spend an additional $12 million annually on ordinary system upkeep and repair not related to the consent decree.
Overall, capital needs are fairly significant, and the city expects to issue roughly $160 million in new debt over the next five years. However, Fitch believes the system's low and rapidly amortizing current debt profile, affordable rate structure (0.6% of MHI), and strong financial margins and free cash flow provide a solid framework to meet these long-term capital pressures. Debt per customer was $600 as of fiscal 2011, and while it is projected to rise to about $900 over the near term, Fitch projects debt per customer to remain below the median for similarly rated systems.
LARGE RATE INCREASE REVERSES TREND OF WEAK FINANCIAL PERFORMANCE
The system reversed a trend of weak financial performance with a large rate increase adopted for fiscal 2011. The increase nearly doubled operating revenues in fiscal 2011 over the prior year and led to a strengthening of the system's well below average coverage of debt service (1.1x in fiscal 2009, and 1.4x in fiscal 2010) and poor liquidity (72 days cash on hand in fiscal 2010). The system ended fiscal 2011 with roughly $62 million in net available revenues, producing very healthy 3.9x coverage of fiscal 2011 debt service.
Along with the fixed costs associated with debt, the system transfers millions annually to the city's general fund (GF) in the form of PILOT and return-on-equity payments. The transfers have been steady at about $6 million annually. When including these additional fixed costs, total coverage was closer to 3.5x in fiscal 2011.
The generation of sizable excess revenues has allowed the system to re-establish a strong financial position. At fiscal end 2011, the system's $31 million in available resources, which includes unrestricted cash and investments, and renewal and replacement funds, provided over 350 days of operations. Preliminary results for fiscal 2012 show a slight decline in debt service coverage (mainly a result of an increase in debt service) to a still very strong 3.4x, and a slight improvement in liquidity. When including the annual transfers, coverage of all fixed obligations was closer to 3.0x.
City-provided financial projections are fairly conservative. The projections include provision for additional bonds, no rate increases, and flat revenue growth. The forecast shows a decline in total coverage over time as the new proposed debt service ramps up. Total coverage is anticipated to decline to about 1.7x by fiscal 2017, which is still satisfactory.
RATES REMAIN AFFORDABLE
Rates remain affordable despite a 115% rate hike in fiscal 2011. The average residential customer pays just $17 per month for service, which is just 0.6% of median household income (MHI). When including the average monthly fee for water service, the combined water and sewer bill is $32 (or 1.1% of MHI). Given the strong financial margins, rates are not projected to rise for at least the next several years. However, Fitch notes the large projected long-term capital expenditures and anticipated debt issuance will erode the currently strong financial margins over time, likely leading to additional rate increases in the future.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012);
--'2012 Water and Sewer Medians' (Dec. 8, 2011);
--'2012 Sector Outlook: Water and Sewer' (Dec. 8, 2011).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2012 Water and Sewer Medians
2012 Outlook: Water and Sewer Sector
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