Fitch Ratings assigns the following rating to the Board of Water Supply City and County of Honolulu, Hawaii:
--Approximately $90 million water system revenue bonds, series 2012A rated 'AA+'.
In addition, Fitch affirms the following ratings:
--$298.3 million outstanding water system revenue bonds at 'AA+'.
The Rating Outlook is Stable.
Bond proceeds will be used to refund outstanding bonds for level savings. Current savings estimates are around 8.5% present value savings. The bonds are expected to price via negotiated sale during the week of March 12, 2012.
SECURITY
Bondholders are secured by a net revenue pledge of the Honolulu Board of Water Supply's (BWS) water system.
The 2012A bonds include a springing covenant that will reduce the required debt service reserve fund to 50% of maximum annual debt service (MADS) from the 100% MADS that is currently required.
KEY RATING DRIVERS
RESIDENTIAL SERVICE AREA: BWS provides water to a service territory that includes the entire island of Oahu. Residential customers provide 60% of revenues.
AMPLE, HIGH-QUALITY SUPPLY: The system has rights to sufficient ground water supplies to meet its anticipated needs with limited treatment costs and no regulatory issues at present. The advantageous water supply results in affordable rates for the system, even with scheduled increases.
FIVE-YEAR RATE INCREASES ADOPTED: After some delay, the board adopted a package of five annual rate increases of 9.65% in fiscals 2012-2016 to fund 100% of the capital program from revenues. Some consideration is being given to deferral of the increased scheduled for July 1, 2012, which would weaken financial margins in fiscal 2013.
STRONG FINANCIAL POSITION: Financial performance and liquidity is strong. Revenues are relatively stable given the consistent demand. Expenditures are experiencing upward pressure but recently adopted rate increases will fund those increases.
MODERATE CAPITAL NEEDS: Reinvestment in the system is needed but the additional spending is moderate. Capital needs are related almost exclusively to repair and replacement of aging infrastructure and are currently estimated around $214 million over the next five years.
INDEPENDENT GOVERNANCE STRUCTURE: The independent board structure provides some protection from political influences regarding the timing and scope of rate increases. Discussions in the community to bring the water system back under city council oversight are preliminary and would require voter approval. Fitch views the potential change as credit neutral at this time but could become a concern if timely rate recovery appeared to be at risk.
WHAT COULD TRIGGER A RATING ACTION
SUSTAINED LOWER FINANCIAL PERFORMANCE: Financial metrics are expected to dip in fiscal years 2012 and 2013 as a result of increasing expenditures and a possible deferral of the fiscal 2013 rate increase. Fitch would view a sustained trend of metrics at this lower level as more appropriate for an 'AA' rating.
CREDIT PROFILE
PRIMARILY RESIDENTIAL CUSTOMER BASE
BWS provides water service throughout the island of Oahu (City and County of Honolulu) to an estimated residential population of 905,000. As of fiscal year 2011, BWS served approximately 170,000 accounts, 93% of which are residential, lending stability to the customer base. BWS does not serve the military installations that have their own well systems. User concentration is moderate, with the top 10 comprising 20% of water revenues. However, the top three users are governmental entities, which help mitigate concentration risk.
FULL RIGHTS TO AMPLE HIGH-QUALITY WATER SUPPLY
Water supply is provided from groundwater, though alternative sources are expected to account for an increasing percentage of the supply portfolio going forward. The groundwater supply is high quality and requires very limited treatment, resulting in a low-cost supply. The water supply is an aquifer located under the island. Currently, there is a sustainable yield of 407 million gallons per day (mgd) of which 294 mgd is permitted to all parties on the island. The board's authorized use is 182 mgd, which is sufficient to meet the average use of 139 mgd. Although excess capacity exists, water use has been largely flat for the past 10 years, given conservation efforts and lower agricultural use.
MODERATE CAPITAL NEEDS
BWS embarked on a capital improvement plan (CIP) in 2006 that focused on system rehabilitation, capacity and storage enhancement, and alternate water source projects. Following a major capital needs assessment a couple of years ago, current needs focus primarily on water delivery assets - the aging pipelines. Capital needs are moderate and estimated around $214 million. Spending will ramp up over the next few years. Staffing levels related to capital projects had been reduced over the past few years as part of the board's cost containment efforts and staffing will need to be increased in order to deliver the planning capital projects.
Honolulu has an older system, as evidenced by its average age of plant of 18 years, as compared to Fitch median for the 'AA' category of 13 years. In recent years, capital spending has been less than the amount of annual depreciation, indicating reinvestment that has not kept pace with the aging of assets. As the capital plan gains momentum, improvement in these ratios is expected.
BOARD-APPROVED FIVE-YEAR RATE PACKAGE IN DECEMBER 2011
Rates are established by the seven-member board, who are appointed by the Mayor and confirmed by City Council. In December 2011, the board adopted a five-year package of rate increases that will increase rates 9.65% annually. Some delay in approval resulted in the increase for fiscal 2012 not going into effect until January 2012. However, the other four increases will be implemented for the full fiscal year.
The rates are designed to fund increases in operating expenditures and to generate up to $40 million-$50 million annual cash flow in the later years to support the planned capital spending discussed above. The rate increases follow-on the previous five years of sizable rate increases that began in 2006 to begin funding the long-delayed capital needs of the system.
The previous rate package resulted in a cumulative 40% rate increase over those five years and the new package will result in a cumulative 48.25% rate increase by the end of fiscal 2016. However, management is currently considering the deferral of the 9.65% increase that would become effective July 1, 2012, since spending on certain capital projects may be delayed from the current schedule. Reserves are already strong and management believes there is no need to collect the revenues in advance of capital spending.
Even following these increases, water rates are competitive with other large urban systems, primarily as a result of the system not having to pay for water supply or expensive treatment processes. The average monthly residential bill is $43.00. Residential customers will be moved to monthly billing during the summer of 2012. This will improve BWS' cash flow and provide more level billing for customers. BWS provides billing services for the city's wastewater services; a combined bill is sent to customers.
Following the approval of the large rate increases, a resolution was introduced in the city council in January 2012, to amend the city charter provision that establishes BWS as a semi-autonomous agency of the city and county of Honolulu. City council would have to approve such a change in order for it to be placed on the ballot for voters. If this is done, the potential change is viewed by Fitch as credit neutral, although it appears to signal a degree of rate sensitivity and room for improved communication between BWS and the City Council. It is Fitch's opinion that potential disruption to the approved rate increases, beyond the deferral already mentioned, would appear to weaken the system's financial position and/or capital reinvestment plans.
HEALTHY FINANCIAL PERFORMANCE
Financial performance has been strong with debt service coverage of revenue bonds at 2.04 times (x) in fiscal 2011 and all-in debt service coverage (including the subordinate state loans) at 1.89x. Financial performance in fiscal 2012 will be lower. Expenditures have increased by around $20 million, primarily with higher carbon and power costs as well as increased spending on pump station repair and maintenance.
Revenues experienced some increase but since the rate increase was only effective for part of the fiscal year, it has not kept pace with expenditures. Debt service coverage of revenue bonds is projected at 1.64x, which is still in compliance with BWS' own policy target of 1.6x. Liquidity is strong at 475 days cash. Debt levels are average at $1,943 per customer.
Coverage in fiscal 2013 will likely be in the same range as that of fiscal 2012 if the rate increase is deferred in that year. Coverage levels would then improve to between 2.0x-3.0x as annual rate increases are implemented. Debt service on the revenue bonds and state loans remains level at about $22 million. The excess cash flow generated by the annual rate increases would fund the capital plan.
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.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 10, 2011.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647331
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