This rating action is based on KBRA s U.S. Municipal Water and Sewer Revenue Bond Methodology.

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1 U.S. Public Finance Water Revenue Bond Surveillance Report Executive Summary Kroll Bond Rating Agency (KBRA) has affirmed the long-term rating of AA with a Stable outlook on the s. This rating action is based on KBRA s U.S. Municipal Water and Sewer Revenue Bond Methodology. Security The City of Chicago s are limited obligations of the city having a claim on payment solely from second lien bond revenues derived from net revenues available in the city s Water Fund, and deposited into the second lien bonds account, which claim is subordinate to the claim of senior lien bonds. The senior lien is open, but has not been utilized since 2001 and KBRA is comfortable with city management s assurances that no further senior lien issuance is contemplated. Key Rating Strengths The large, diverse, and stable metropolitan Chicago customer base that includes the City and 125 suburban communities. High quality, reliable Lake Michigan water source; essential service with substantial excess system capacity. Management s enactment of operational efficiencies have reduced staffing levels and slowed the pace of expense growth to offset increased pension costs. Strong liquidity position. Key Rating Concerns High debt to net fixed asset ratio, although commencement of pay-as-you-go financing is a moderating factor. Legal provisions provide narrow coverage and minimal anti-leveraging security protection. Rating Summary Management The City of Chicago Department of Water Management (DWM) operates an extensive municipal water system that collects, purifies, and distributes water to customers within the City of Chicago ( the City ) and 125 suburban communities located in areas surrounding the City. DWM is an executive department of the City and the DWM commissioner is answerable directly to the mayor and city council. The DWM operates some of the largest collection and treatment facilities within the United States through which it provides water to approximately 41% of all Illinois residents. Customers located within the City of Chicago are served as direct DWM customers while suburban customers are served indirectly through smaller municipal water systems or joint-action agencies that purchase water from DWM for resale purposes. The DWM has responsibility for the operation, maintenance, repair, improvement, and extension of the water treatment and distribution system. In KBRA s opinion, the City of Chicago Department of Water Management continues to take proactive steps to address system capital needs, maintain improved debt service coverage and liquidity levels, control system expenditure growth and manage risks within its debt structure. Net revenue coverage of April 28, 2017

2 second lien water revenue bonds is in excess of 2.5x, and the balance in the Water Rate Stabilization Account covers approximately three months of expenses. In KBRA s opinion, management has maintained its focus on critical renewal and replacement infrastructure needs for the aging water system. Historically, low customer rates afforded the flexibility to implement large rate adjustments necessary to generate revenues needed to supplement bond proceeds and accelerate the capital improvement program. In KBRA s view, the capital-improvement plan (CIP) is a well-thought-out plan to restore the system to a state of good repair, notwithstanding the significant capital requirements. Water rates are set by the city council pursuant to city ordinance. Rates can be adjusted at any point in the fiscal year and there is no regulation, oversight, or input on the setting of rates by any regulatory authority or other governmental jurisdiction. Beginning June 1, 2016, rates are adjusted annually in accordance with an automatic rate setting process. The automatic rate adjustments are based on the annual rate of inflation and are capped at an annual increase of 5%. KBRA views the city council s support of ongoing rate adjustment as a credit positive. Management s success in implementing a series of large annual rate increases has significantly improved net revenues available for capital-improvement spending, which has allowed DWM to accelerate the replacement of aging infrastructure. The current ten-year capital-improvement plan, which was initiated in 2012, is intended to modernize and rebuild much of the City s water and sewer infrastructure. The highlights of the plan include replacing 880 miles of water mains, designing the electrification of four pumping stations, and the installation of 204,000 water meters. As of December 31, 2016, the DWM has installed more than 100,000 water meters and remains on schedule and on budget for the $3.8 billion 10- year capital plan. It is KBRA s view that the DWM Management team has shown a strong ability to manage its extensive water system. This ability is underscored by Management s successful oversight of the rate setting process. Based on the foregoing, KBRA continues to view the management of the City of Chicago s municipal water system as consistent with a AA rating determinant rating. Legal Mechanics and Security Provisions In KBRA s opinion, legal mechanics, and security provisions are adequate. KBRA views the rate covenant requirement of the greater of (1) 1.20x senior lien debt service, or (2) the sum of 1.00x annual senior lien debt service, 1.10x annual second lien debt service, and 1.00x annual subordinate lien debt service as sufficient, especially in light of the City Council s ability to adjust rates. The senior lien remains open. However, the City has not utilized the senior lien since issuing the Series 2001 Bonds and KBRA does not expect further senior lien bond issuance. The flow of funds is standard, with debt service paid after operations and maintenance, and excess revenues maintained within the System. There is no debt service reserve requirement for the. It is KBRA s view that the absence of a reserve requirement for second-lien water-revenue-bond debt service is offset by the system s strong liquidity levels that approximate three months of operating expenses. A policy regarding minimum rate-stabilization reserve levels has not been set forth in writing, but has been an adopted practice. In KBRA s view, the additional bonds test for second-lien parity bonds is lenient. It requires 1.00x pro forma MADS coverage of outstanding senior lien bonds, 1.10x coverage of second lien bonds, and 1.00x coverage of subordinate bonds. Under certain circumstances, the City may issue second-lien parity bonds without meeting the additional bonds test. These circumstances are: (1) to refund outstanding water revenue bonds if the City believes there will be insufficient funds available to Page 2 April 28, 2017

3 make principal or interest payments as they become due; or (2) if the proposed refunding debt service requirements are less than the currently outstanding bonds. While KBRA sees the potential for further leveraging of pledged revenues, it is our view that future borrowing will be more moderate, as pay-asyou-go financing is currently used to a much greater extent than in past years. The City is required to demonstrate compliance with its rate covenant prior to the end of each fiscal year. If the annual review indicates that projected gross revenues are not sufficient to meet the rate covenant, the City must prepare a rate study and identify the rate adjustments needed to meet the rate covenant. The Office of Budget and Management and the chief ginancial officer are then required to recommend appropriate rate adjustment action to the city council. Payments into the Senior Lien Debt Service Account are made 10 days prior to each principal and interest payment date. If the Senior Lien Debt Service Reserve Account is drawn upon, the reserve requirement must be restored within 12 months. The Water Rate Stabilization Account is required to be tapped first in the event of insufficiencies in the Senior Lien Debt Service Account. Any termination payments made with respect to any swap agreement would be subordinate to the payments due on the second lien bonds. The Water Rate Stabilization Account may be used for: (1) paying expenses or obligations of the Water System; (2) making deposits in the Senior Lien Debt Service Account; (3) making deposits in the various Subaccounts of the Senior Lien Debt Service Reserve Account; (4) making deposits in the Second Lien Bonds Account; (5) making deposits when due in the Subordinate Lien Obligations Account; (6) making deposits when due in the Commercial Paper Account; (7) making deposits when due in the Line of Credit Notes Account; (8) any cost of repairs, replacements, renewals, improvements, equipment, or extensions of the Water System, or (9) any other cost or expense relating to the Water System or the financing or refinancing of the Water System. Based on the foregoing, KBRA continues to view the legal mechanics and security provisions of the City of Chicago s as consistent with an A- rating determinant rating. Bankruptcy Assessment KBRA has consulted outside counsel and it is KBRA s understanding that the City is a municipality under Illinois state law. KBRA understands that state law does not currently permit municipalities in the State to file for protection under the U.S. Bankruptcy Code, except in accordance with the provisions of the Local Government Financial Planning and Supervision Act ( the Act ), 50 ILCS 320/1. Under the Act, applicable only to units of local government which have a population under 25,000, a financial-planning and supervision commission has the power to recommend to a unit of local government that the unit file a petition under Chapter 9 of the U.S. Bankruptcy Code and submit this recommendation to the state. KBRA understands that State law 50 ILCS 320/9(b)(4), however, does not currently include any provisions specifically authorizing any municipal entity other than the Illinois Power Agency to file a bankruptcy petition. Further, it is KBRA's understanding that it is unlikely that the existing broad grant of home rule powers to home rule municipalities like Chicago under the Illinois Constitution and other Illinois law would satisfy the specific authorization required in order to permit the City to file for protection under Chapter 9. However, no assurance can be provided as to whether the State of Illinois may adopt in the future a law that would permit municipalities such as the City of Chicago to file for bankruptcy relief and a bill that would grant such authority has been introduced in the General Assembly. KBRA also understands that the grant of the lien on and security interest in second lien bond revenues appears to be susceptible to an argument that the grant of the lien and security interest only attaches to Page 3 April 28, 2017

4 net revenues available for bonds once those net revenues have been actually deposited into the second lien bonds account or other the applicable accounts. Accordingly, there is a risk that, in a Chapter 9 bankruptcy case of the City, a bankruptcy court might hold that the lien and security interest in second lien bond revenues is limited to only the net revenues available for bonds that have actually been deposited as of the date of the filing of the bankruptcy case, and that the lien and security interest will not apply to net revenues available for bonds collected thereafter should the City of Chicago fail or refuse to deposit those post-petition net revenues into the appropriate accounts. Because the net revenues available for bonds are generated by the City s water system, KBRA understands that the net revenues available for bonds will qualify as special revenues as that term is defined in the bankruptcy code. Therefore, assuming the lien and security interest does apply to postpetition net revenues available for bonds without any requirement that those net revenues be deposited into the designated accounts, and also assuming the sufficiency of the pledged revenues after the payment of necessary operating expenses, it is also KBRA's understanding that even if the City were permitted to file for protection under Chapter 9, a filing by the City should have little to no effect on the payment of the bonds during the bankruptcy case, since the bonds are secured by a pledge of special revenues. However, in determining necessary operating expenses, the bankruptcy court may not be limited to the definition of operating and maintenance costs of the System as set forth in the ordinance. In addition, while there is no case law from which to make a definitive judgment, it is possible that in the context of confirming a plan of adjustment in a Chapter 9 case of the City, where the plan has not received the requisite consent the holders of the bonds, a bankruptcy court may confirm a plan that adjusts the timing of payments on the bonds or the interest rate or other terms of the bonds, provided that the bondholders retain their lien on the special revenues and that the payment stream has a present value equal to the value of the special revenues subject to the lien. KBRA understands that the ordinance also allows the City to comingle the collected net revenues available for bonds with other receipts. As a result, there is a risk that if the City were to file a petition for bankruptcy relief under Chapter 9, a bankruptcy court might hold that amounts on deposit in comingled accounts may not be available for payment of the principal and interest on the bonds unless the bondholders can trace those funds. There can be no assurance that the bondholders could successfully so trace such collections. Service Area and Economy KBRA believes that the System s service area provides favorable support for operations. Chicago is the third largest city in the U.S. based on population and, in addition, water is provided to 125 suburban communities in the areas surrounding the City. The City s area is 228 square miles, but including all areas served, the service area approximates 806 square miles. The population served totals approximately 5.3 million, which represents about 41% of the State s population. The service area population is nearly evenly split between the City and the suburban customers. The City s service to suburban customers is based on various contracts as well as state law that requires the City to supply water to any municipal corporation within the service area of the Metropolitan Water Reclamation District of Greater Chicago. The City is required to supply water to these customers at a price that is not greater than that applicable to similar large water users located within the geographic limits of the City. Service is provided pursuant to contractual agreements, which can be amended or discontinued at expiration. The City considers it highly unlikely that a material number of customers will seek to replace the City as a provider of water service for a number of reasons. The principal stated reason is that the capital costs of obtaining a reliable source of water, such as that from Lake Michigan, in an alternative manner would be prohibitive. Page 4 April 28, 2017

5 The City of Chicago s population had declined somewhat through 2010, but has grown modestly in recent years to 2.72 million in While the City experienced population declines, Cook County suburban communities recorded population growth. Between 2000 and 2010, the Chicago-Naperville-Elgin MSA recorded 3.9% growth in total population. Since 2010, the MSA s population has grown an additional 0.9%, which is consistent with City-wide population growth. The City s population is highly educated, with 36.6% of the population over the age of 25 having a B.A. or advanced degree. This is above comparable State and national levels and reflects the nature and quality of the employment base in the City. Per capita income in the City is up 23.4% from 2010 to 2015 to a level slightly above the nation, but still remains slightly below that of the state (99.3%). The City continues to have a high poverty level of 20.9%, which is not inconsistent with its urban nature. System customers outside of the City evidence higher per capita income and more modest poverty levels. On a per-capita basis, personal income levels across the Chicago-Naperville-Elgin MSA and Cook County have increased by 23.0% and 25.3% since 2010, respectively. After experiencing significant employment losses during the recession, the City s employment trends continue to recover and improve. The City s annual unemployment rate peaked in 2010 at 11.2%, which was well above pre-recession levels but consistent with State and national trends. Preliminary data as of February 2017 indicates that the City s unemployment rate notably declined to 5.5%. This trend is generally consistent with the surrounding MSA, Cook County, State, and United States. However, nationwide unemployment continues to decline. The City enacted a series of rate increases beginning in 2008 that have increased the water rate from $9.70 to $28.52 per 1,000 cubic feet, as of January Beginning in June 2016 and every year thereafter, per an ordinance of the City of Chicago, water rates are adjusted based on the prior calendar year s rate of inflation tied specifically to wage earners in the City of Chicago. Annual rate increases are capped at 5.0%. Despite the frequency and magnitude of recent increases, rates are still low when compared to similar systems across the country. This is somewhat offset by the limited services provided by the City that does Page 5 April 28, 2017

6 not include wastewater treatment. Suburban accounts are charged the same rate as City accounts, thus obviating one potential area for disagreement. On April 1, 2016, the City began collecting a garbage collection fee as part of the combined water and sewer utility bill for certain City residents. Management states that as of calendar year 2016, Chicago residential accounts that receive the unified bill make up approximately 32% of the water system s annual revenues. It is KBRA s view that although the fee is not related to water operations, it must be incorporated into KBRA s view of affordability levels because non-payment could result in discontinuation of water service. It is KBRA s opinion that the $9.50 per month fee amount is not expected to have an outsized impact on the current overall affordability levels. Future significant fee rate increases may impact this view. KBRA understands that the garbage collection fee will only apply to residential accounts within the City of Chicago that have four or less residential units. KBRA will monitor the monthly garbage collection fee rate and may amend our assessment of the overall affordability if there are significant fee rate increases. Water-Sewer Utility Tax In September 2016, the Chicago City Council passed a newly created utility tax. The tax is a key part of the City s strategy to address and stabilize the chronically underfunded Municipal Employee s Annuity and Benefit Fund (MEABF). The newly codified utility tax has appeared on the combined water-sewer utility bills of Chicago residents and businesses since March KBRA understands that the City intends to phase in the consumption based utility tax with annual rate increases through The initial tax rate of $0.59 per 1,000 gallons of water and sewer service increases the average annual residential bill by $53.10 (7.7%), or $8.86 on bills sent out every two months. KBRA further understands that the tax rate will increase to $2.51 per 1,000 gallons by the end of the four-year phase-in period. In that year, a customer would pay an additional $226 per annual, or about 32.9% more than the current rate. These projected amounts do not include the garbage fee of $9.50 per month collected by the City on the combined watersewer bills of some Chicago residents, nor do they incorporate any future inflation-based water rate increases. At this time, KBRA maintains the view that despite the frequency and magnitude of the projected rate increases, rates will remain affordable and comparable to those of large utility systems across the country. However, KBRA notes that the tax will result in higher water-sewer utility bills, which will likely add an element of pressure for some ratepayers. KBRA recognizes these challenges as being balanced against the essentiality of water service and the historically below average rates charged by the City for water and sewer service. As of February 2016, the system s rates for water and sewer service were far below those of comparable cities, including New York City and Los Angeles. The system s rates are also slightly below rates charged by other large Midwestern cities including Detroit, Cincinnati, and Cleveland. Based on the foregoing, KBRA continues to view the service area and economy of the City of Chicago s municipal water system as consistent with a AA+ rating determinant rating. System Characteristics As of December 31, 2015, the system supplied a total of 494,029 accounts. Of these, 265,838 were metered, and 228,191 were non-metered. The number of metered accounts increased by 10.1% between 2014 and 2015 and, for the first time, exceeded the number of system-wide non-metered accounts. In 2009, the City implemented its MeterSave program, which installs residential water meters free of charge. The program is designed to promote conservation. The system has made significant strides adding meters to all single-family and two-family dwellings that were previously not metered. In 2016, the City installed Page 6 April 28, 2017

7 an estimated 20,000 additional water meters reaching a total of 100,000 installations since the start of the program. All suburban customers, which are primarily comprised of municipal corporations, are metered. Water is sourced from Lake Michigan pursuant to Illinois Department of Natural Resources regulations. The reliability and abundance of this source is a strong credit feature, especially since average daily usage is only about one-third of treatment capacity. While the City s population has declined since 2000, it now appears to be stabilizing. Nevertheless, the overall service area population is growing due to suburban area gains more than offsetting City declines over time. There is a degree of customer concentration, as the ten largest customers are all municipalities or water agencies or commissions, that together accounted for approximately 34.0% of FY 2015 water sales. The largest customer, the DuPage Water Commission, continues to represent about 13.0% of water sales. The total number of water accounts has been stable; each suburban customer (e.g. municipality, water agency, and commission) represents one account. The sheer size of a water system that serves a population of over five million necessitates continual repair and replacement, requiring significant capital investment. Water-main distribution infrastructure, in particular, is old and in need of renewal. The deteriorated state has caused leaks that have damaged streets, sidewalks, and other infrastructure, not to mention higher than anticipated unaccounted water. Between 2005 and 2011, water main replacement averaged 29 miles per year. Seventy miles were replaced in 2012, followed by 75 miles in 2013, 85 miles in 2014, and 90 miles in In 2016, the City replaced an additional 90 miles of water mains. Going forward, officials expect main replacement to continue to average 90 miles annually. As part of the system s 10-year Capital Improvement Plan, the remaining steam-powered pumping stations are in various stages of conversion to electricity. So far, one of the conversions has been completed and the remaining pumping stations continue to be in the design or development stage. Each conversion is estimated to save the system an estimated $4.5 million in annual operating costs. The system s two water treatment plants also continue to undergo rehabilitation and upgrades. Based on the foregoing, KBRA continues to view the system characteristics of the City of Chicago s municipal water system as consistent with a AA+ rating determinant rating. Financial Metrics Financial operations have exhibited improvement over the last several years, due to a series of rate increases that have sharply increased operating revenues. Revenue performance has been favorable despite slight decreases in residential water usage as more accounts are converted from unmetered to metered, and unmetered water loss due to leakage has been reduced. Debt service coverage had narrowed to levels approximating the rate covenant, prior to the adjustments, which began in Net revenues available for debt service have risen from $139.7 million in fiscal year 2009 to $458.0 million in fiscal year 2015, which represents a compound annual growth rate of 21.9%. Meanwhile, expenses have increased at a compound annual growth rate of 3.6% over that period. The total number of Water Fund employees has decreased from 2,234 in 2001 to 1,517 as of December 31, In addition, the DWM has negotiated other labor cost saving measures in its collective bargaining agreements. These include the use of seasonal employees, apprentice break-in rates, reductions in overtime for certain trades, and longer probationary periods. Current agreements remain in place through fiscal year 2017, so personnel costs in the intermediate term are largely known. KBRA believes that controlling expense growth is of critical importance, given that conservation and metering efforts are likely to result in constrained revenue growth in the absence of significant customer growth and further significant rate increases. Between FY 2014 and FY 2015, System expenses grew by 7.4%. This Page 7 April 28, 2017

8 relatively large increase was primarily driven by the Department s increased employee pension reimbursement costs that were calculated in accordance with the City s 2014 pension reform efforts. The System s FY 2016 audited financial results are not yet available. Based on the City s FY 2017 budget, the Water Fund s estimated FY 2016 financial performance was largely in line with budgeted expectations. Coverage of the modest amount of senior lien bonds outstanding has benefited from the increase in operating revenues. Senior-lien debt service coverage was 21.33x in fiscal year 2015, while second lien debt service coverage ratio was approximately 2.90x. The Water Fund has the ability to issue obligations subordinate to the second lien bonds, and has done so with Illinois Environmental Protection Agency (IEPA) loans, which are used to finance the metering program and other capital improvements. Overall debt service coverage, including senior, second lien, and subordinate debt was 2.56x in FY FY 2016 figures for debt service coverage are not yet available. However, when calculating debt service coverage for FY 2016, assuming FY 2015 levels of net revenues, senior lien and subordinate lien debt service coverage for the System are estimated to be 21.50x and 2.51x, respectively. Concurrent with the broadening of coverage, the Water Rate Stabilization Account has increased from $51.4 million in FY 2008 to an estimated $91.2 million in FY 2015, and now approximates 96 days cash on hand relative to operating expenses. The increased revenues have also allowed pay-as-you-go funding to supplement bond proceeds, and are expected to moderate debt ratios in future years. The system had $296.1 million in unrestricted cash and cash equivalents in FY 2015 equal to approximately 320 days cash on hand. Debt to plant ratio as of FY 2016, at 49.8%, is in the moderate range, and reflects the issuance of more than $1.5 billion in second lien bonds since 2006, to address infrastructure repair and replacement needs. KBRA expects future borrowing requirements to be moderated by pay-as-you-go financing. In addition to pension payments made on behalf of Water Fund employees, the system reimburses the General Fund for a variety of items including certain services provided by other City departments, employee fringe benefits and certain payments made on behalf of the Water Fund. Such reimbursements amounted to approximately $129.1 million in FY The City does not have the ability to use Water Fund resources to subsidize general City operations. The system s Department of Finance bills large industrial and suburban accounts on a monthly basis. Metered commercial and residential accounts are billed every two months and non-metered accounts every six months. The system issues payment penalties if payments are not received within 24 calendar days of the billing date. Once delinquent accounts exceed 90 days past due and surpass certain balance thresholds, they are referred to an external firm for collection enforcement. The system has the authority to suspend services on severely delinquent accounts, but attempts to make every effort to collect past due amounts prior to termination of services. Between 2005 and 2015, system collections on net water sales averaged 98.0%. KBRA views both the system s collection enforcement framework and historical collection rates as very strong and believes they limit the potential buildup of receivables on the system s balance sheet. As more accounts are metered, KBRA also expects the system s day-to-day liquidity levels to further strengthen given the growing number of water bills paid every two months rather than on a biannual basis. Page 8 April 28, 2017

9 Prior to the implementation of the rate increases based on the consumer-price index in June 2016, KBRA ran a stress scenario to determine the degree by which the loss of the system s largest suburban customer may be affect operating revenues and debt service coverage. The stress case assumed a 13 percent reduction in water sales with no adjustments made in operating forecasted expenses. Under this scenario, debt service coverage ratio declines modestly, but margins remain ample. KBRA views this scenario as unlikely, given the essential nature of the service provided and the prohibitively high costs of sourcing an alternative water supply. Pension Funding System employees are members of the City s Municipal Employees (MEABF) and Laborers Annuity (LABF) Benefit Funds. DWM reimburses the City for payments made to each fund on behalf of the water system and its employees. In FY 2015, the system s employer contribution was approximately $12.7 million, which represented 3.8% of the total estimated operating expenses that year. On March 24, 2016, the Illinois Supreme Court upheld a circuit court ruling that certain pension reforms enacted by the City in 2014 were unconstitutional. This ruling eliminated the progress made in addressing the pension funding issues of the Municipal Employees and Laborers Pension funds, and returned funding to a statutory basis, which KBRA believes was unsustainable. In September 2016, the Chicago City Council passed a newly created utility tax. The tax is one piece of a multilayered strategy that combines new dedicated revenues, amended employee contribution rates and eligibility requirements, and a movement towards actuarial pension funding, as opposed to statutorily determined pension funding. Ultimately, the strategy is intended to achieve actuarially required funding levels for the MEABF by 2022 and a funded ratio of 90% by KBRA understands that the City intends to phase in the consumption based utility tax with annual rate increases between fiscal years 2017 and The revenues from the water-sewer utility tax are projected to generate $56.0 million per annum in additional funding for MEABF contributions in This amount is forecasted to rise to $239.0 million per annum by 2020, after the additional utility tax rate increases are fully phased in. Page 9 April 28, 2017

10 While KBRA views the action by the City as positive, it will take many years to reach a healthy funding level, and if actuarial assumptions prove to be inaccurate, additional funding resources may need to be identified. Furthermore, the proposed utility tax represents a notable increase in rates and charges. These actions may limit the magnitude of future rate increases for operations, especially if resource base growth is not sustained. Based on the foregoing, KBRA continues to view the financial metrics of the City of Chicago s municipal water system as consistent with a AA Rating Determinant rating. Debt Structure & Capital Plan Requirements As of FY 2016, the Water System has approximately $2.4 billion in outstanding senior lien, second lien, and subordinate debt. The City has issued second lien water revenue bonds on a biennial basis, with previous issues in 2006, 2008, 2010, 2012, 2014, and Following the issuance of the Series 2016A-1 and 2016A-2 Water Revenue Bonds, which were issued to finance three swap termination payments, the System no longer has any exposure to variable rate debt. The City Council has authorized the issuance of additional second lien water revenue bonds. It is KBRA s understanding that the additional bonds may be issued within the first half of calendar year 2017, and that proceeds will fund ongoing capital improvement projects. Capital Improvement Plan The significant amounts of debt issued have funded the system s repair and replacement of aging infrastructure. In 2012, the DWM initiated a 10-year program to replace 880 miles of 100-year old water lines, and to upgrade four of the original steam-powered pumping stations. The program is designed to upgrade water infrastructure by improving reliability and service for customers. Using the additional capital funds from increased rates, the DWM expanded its water main replacement goal from 30 to 70 miles in 2012, and accelerated the entire capital program. In 2016, DWM replaced approximately 90 miles of water mains and aims to maintain this level of replacement in FY 2017 as well. Page 10 April 28, 2017

11 Based on the foregoing, KBRA continues to view the system s debt structure and capital plan requirements as being consistent with a AA rating determinant rating. This assessment is based on the Department s elimination of variable rate debt and interest rate management products, as well as the system s relatively level debt service profile and debt burden associated with the system s large capital improvement program. Outlook: Stable The Stable outlook reflects KBRA s expectation that customer growth trends continue and that there are no significant changes in the supply contracts with suburban customers. It also reflects KBRA s expectation that the City s commitment to its water capital improvement plan is adhered to and remains on schedule without significant cost overruns. KBRA also expects debt service coverage margins to remain in excess of indenture requirements and that favorable water quality trends are sustained. In KBRA s view, the following factors may contribute to a rating upgrade: Greater than anticipated suburban customer base growth. Continued strong debt service coverage performance. Favorable progress in addressing infrastructure needs of the system. Improved debt ratios, reflecting moderation of borrowing and amortization of existing debt. In KBRA s view, the following factors may contribute to a downgrade of the rating: Loss of one or more major contractual customers. Unanticipated large capital expenses significantly beyond what is anticipated in the 10-year CIP which began in A significant change in KBRA s view of the overall bill affordability related to the addition of any fee, including the garbage collection fee and utility tax. Conclusion KBRA has affirmed a long-term rating of AA with a Stable outlook on the s Second Lien Water Revenue Bonds. Page 11 April 28, 2017

12 Analytical Contacts: Gopal Narsimhamurthy, Associate Director (646) Andrew Clarke, Senior Director (646) Related Publications, Series 2016 U.S. Municipal Water and Sewer Revenue Bond Rating Methodology Copyright 2017, Kroll Bond Rating Agency, Inc., and/or its licensors and affiliates (together, "KBRA ). All rights reserved. All information contained herein is proprietary to KBRA and is protected by copyright and other intellectual property law, and none of such information may be copied or otherwise reproduced, further transmitted, redistributed, repackaged or resold, in whole or in part, by any person, without KBRA s prior express written consent. Ratings are licensed by KBRA under these conditions. Misappropriation or misuse of KBRA ratings shall cause serious damage to KBRA for which money damages may not constitute a sufficient remedy; KBRA shall have the right to obtain an injunction or other equitable relief in addition to any other remedies. The statements contained in this report are based solely upon the opinions of KBRA and the data and information available to the authors at the time of publication of this report. All information contained herein is obtained by KBRA from sources believed by it to be accurate and reliable; however, KBRA ratings are provided AS IS. No warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability, or fitness for any particular purpose of any rating or other opinion or information is given or made by KBRA. Under no circumstances shall KBRA have any liability resulting from the use of any such information, including without limitation, for any indirect, special, consequential, incidental or compensatory damages whatsoever (including without limitation, loss of profits, revenue or goodwill), even if KBRA is advised of the possibility of such damages. The credit ratings, if any and analysis constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. KBRA receives compensation for its rating activities from issuers, insurers, guarantors and/or underwriters of debt securities for assigning ratings and from subscribers to its website. Page 12 April 28, 2017