Municipal Utilities OVERVIEW & METHODOLOGY UPDATE Ted Damutz, VP-Senior Credit Officer GFOAA Tuscaloosa February 4, 2016
Municipal Utility Sector is Relatively Stable..» Monopolistic service» Highly essential service» Operations (not finances) highly regulated» Relatively affordable» Paid from user fees generated from system operations 2
..But There are Risks for Some Systems» Public resistance to rate increases» Limitations to support from general government» Source constraints» Environmental consent decrees with state and federal regulators can result in significant additional debt» Risk from general government distress, even if separately secured or governed 3
Current Municipal Utility Ratings» Moody s maintains approximately 1,120 municipal utility ratings» Ratings range from Aaa to Caa3, with a median rating of Aa3 Rated Municipal Utility Systems by Type 400 300 200 100 0 Water & Sewer Water Sewer Electric Stormwater Solid Waste Gas Rating Distribution 300 200 Rating 100 0 Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 4
Type of System» Water, sewer or combined water / sewer» Local retailer water distribution, sewerage collection» Regional wholesaler water supply, sewerage treatment» Integrated systems supply / distribution or collection / treatment» Independent authority or part of a general purpose government 5
Areas of Analysis» Economy / Service Area» Management / Governance» Rate setting authority» Debt / Capital Needs / Regulatory Compliance» Covenants and Other Security Provisions» Financial Performance (Including Key Ratios) 6
Economy / Service Area» Signs of Strength Growing or Stable, Diversified Economy Predominance of Residential Ratepayers» Signs of Weakness Economic or Population Decline Other Economic Vulnerabilities Rapid Population Growth Ratepayer Concentration Dominant Payers or Dominant Industry 7
Management / Governance» Signs of Strength Regular, moderate rate increases Independent rate setting authority Conservative financial policies, consistently adhered to» Signs of Weakness Infrequent, large rate increases Rates not competitive Politicized rate setting process Problems with revenue collection Absence of long-term planning Violation of permits / regulations 8
Debt / Capital Needs / Regulatory Compliance» Signs of Strength Capital needs identified and quantified; funding identified Consistent record of completing capital projects on time and within budget Manageable debt levels Level or front-loaded debt structure» Signs of Weaknesses Large, unaddressed capital needs Construction risk or uncertainties about costs of capital program Exposure to unhedged variable rate debt Exposure to swap termination or bank bond acceleration Back-loaded debt structure 9
Financial Performance Summary» Signs of Strength Ratios compare favorably to similar systems and medians Current net revenues provide good coverage of peak debt service on outstanding bonds including new issue» Signs of Challenges Ratios compare unfavorably to similar systems and medians Operating ratio or debt ratio is rising; debt service coverage is declining Net revenues need to grow (through future rate increases or increased system use) to cover future debt service on currently outstanding bonds Dependence on connection fees and other volatile or non-recurring revenues Assumptions underlying forecast appear optimistic given past trends 10
Financial Performance Operating Ratio» Operating Ratio O&M expenses divided by total operating revenues Median Values Operating Ratios 2014 Water Systems 64.6% Sewer Systems 55.7% Water / Sewer Systems 63.0% Source: Moody s MFRA. Based on a population of 322 water systems, 222 sewer systems, and 360 water/sewer systems. 11
Financial Performance Debt Service Coverage» Net revenues divided by annual principal and interest requirements Median Values Debt Service Coverage 2014 Water Systems 2.09x Sewer Systems 1.89x Water / Sewer Systems 1.95x Source: Moody s MFRA. Based on a population of 322 water systems, 222 sewer systems, and 360 water/sewer systems. 12
Municipal Utilities Scorecard Weighted Factors Broad Scorecard Factors Factor Weighting Rating Sub-Factor Sub-factor Weighting Asset Condition (Remaining Useful Life) 10.0% System Characteristics 30% Service Area Wealth (Median Family Income) 12.5% System Size (O&M) 7.5% Annual Debt Service Coverage 15.0% Financial Strength 40% Days Cash on Hand 15.0% Debt to Operating Revenues 10.0% Management 20% Legal Provisions 10% Rate Management 10.0% Regulatory Compliance and Capital Planning 10.0% Rate Covenant 5.0% Debt Service Reserve Requirement 5.0% Total 100% Total 100% 13
Update to US Municipal Utility Methodology» Update to methodology Applies to all municipal utilities, including water, sewer, water and sewer, stormwater, gas, electric (non-generation), solid waste, and other combined utilities Quasi-monopolistic systems that provide essential services and are financed by user charges Vast majority are municipally owned» Introduction of a scorecard Provides transparency and insight into the credit factors we consider important Includes a set of common rating factors and metrics that apply to all utilities, followed by notching factors that accommodate more individualized credit considerations Does not include every rating consideration final ratings are determined only by a Rating Committee 14
1. System Characteristics (30%)» Asset Condition (10%) - Net fixed assets/depreciation Proxy for the age and health of the system and where it stands in its useable lifecycle An indicator of the ability to comply with environmental regulations and continue delivering adequate service with existing resources» Service Area Wealth (12.5%) - MFI as % of US Income of residents within service area conveys capacity of ratepayers to afford rates necessary to fund operations and capital upgrades» System Size (7.5%) O&M expenditures Larger systems tend to be more diverse and enjoy economies of scale Different types of systems have varying cost structures 15
2. Financial Strength (40%)» Annual Debt Service Coverage (15%) Net revenues/debt service Measures capacity to pay annual debt service from net revenues of the system and demonstrates financial performance and margin of protection for debt repayment» Days Cash on Hand (15%) - Cash and investments x 365/operating expenses Measures liquidity to meet expenses, cope with emergencies, and manage variances from forecasts» Debt to Operating Revenues (10%) Net debt/operating revenues Measures debt level relative to gross revenues and normalizes for difference in debt structure that may not be reflected in the annual debt service coverage metric 16
3. Management (20%)» Rate Management (10%) Assessment of track record of setting rates appropriately to cover operating expenses and capital costs Ability and willingness to make timely changes when necessary» Regulatory Compliance and Capital Planning (10%) Measure of utility s history of addressing state and federal regulatory requirements and meeting future capital needs 17
4. Legal Provisions (10%)» Rate Covenant (5%) Measures strength of legal commitment to set rates to cover operating costs and debt service, and usually an additional margin» Debt Service Reserve Requirement (5%) Measures strength of debt service reserve requirements relative to scheduled debt service 18
Below-the-Line Adjustments Examples of notching factors addressing individualized credit considerations System Characteristics Additional service area economic strength or diversity Significant customer concentration Financial Strength Extraordinarily high debt service coverage Debt service coverage below key thresholds Legal Provisions Structural enhancement and/or complexities Management Unusually strong or weak capital planning 19
Below-the-Line Adjustments: Factors not included in the grid» Credit attributes that may result in ratings different from scorecard results Adjustments/Notching Factors Factor 1: System Characteristics Additional service area economic strength or diversity Significant customer concentration Revenue-per-Customer greatly over/under regional average Exposure to weather volatility or extreme conditions Resource vulnerability (1/3 or greater) Sizable or insufficient capacity margin Weak depreciation/reinvestment practices relative to industry norms Other analyst adjustment to System Characteristics (Specify) Factor 2: Financial Strength Debt Service Coverage (Annual or MADS) below key thresholds: Additional Bonds Test and 1.00x coverage Constrained liquidity position due to oversized transfers Outsized capital needs Oversized ANPL relative to debt or significant ARC under-payment Significant exposure to puttable debt and/or swaps or other unusual debt structure Other analyst adjustment to Financial Strength factor (Specify) Factor 3: Legal Provisions Structural Enhancements/Complexities Other analyst adjustment to Legal Provisions factor (Specify) Factor 4: Management Unusually strong or weak operational or capital planning Other analyst adjustment to Management factor (Specify) Other Credit Event/Trend not yet reflected in existing data set 20
Relationship with General Obligation Rating» A municipal utility s credit quality is related to the strength of its associated local government entity. Examples of credit linkages include: Economy: Coterminous or overlapping economic base and service area Finances: Cash can often flow between the two entities Debt: Revenues to support GO and utility paid by the same group of constituents Management and Governance: Management teams may be the same or have close ties Capital Markets: GO and utility need to access the same capital markets for funding» Rating levels are usually similar (within 2 notches) due to these linkages 21
Larger Rating Differential Can Occur» Rare cases demonstrate independence from the associated GO rating and may warrant a greater notching difference. Typical features include: Non-coterminous service area with revenues coming from a substantially larger base Strict separation of accounts and assets Independent management and governance 22
Recent Examples of Credits Defaulting: When and Why» Jefferson County (AL) Sewer» Default date: 4/1/2008» Current rating: WR Highly over leveraged with complex derivative structure Weak fiscal and debt management Unwillingness to implement timely needed rate increases» Oakdale (CA) Sewer Default date: 8/31/12 Current rating: B1 Lack of fiscal controls Weak debt management 23
Questions 24
Chris Coviello Ted Damutz 212-553-0575 212-553-6990 christopher.coviello@moodys.com ted.damutz@moodys.com 25
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