Moody's assigns A3 underlying rating with a positive outlook to Truckee Meadows Water Authority bonds
Moody's has assigned an A3 underlying rating with a positive outlook to the Truckee Meadows Water Authority's initial issuance of water revenue bonds.
NEW YORK, May 21, 2001 — Moody's has assigned an A3 underlying rating with a positive outlook to the Truckee Meadows Water Authority's initial issuance of water revenue bonds.
The bonds are principally being issued to fund the Authority's purchase of the water utility division of the Sierra Pacific Power Company. The division, a fully-integrated source-to-tap water utility, serves the majority of residents and commercial enterprises in the Authority members' geographic boundaries, principally in the Reno/Sparks area. Authority members are the City of Reno, City of Sparks, and Washoe County. The A3 rating primarily reflects financial results that are likely to be somewhat below average for an A-rated municipal water enterprise, the transition risks from private to public ownership, and an otherwise favorable credit profile, including a relatively large, highly diverse customer base, ample supplies of generally high quality water, and modest additional capital investment needs.
The underlying security for the bonds will primarily be provided by a pledge of net revenues of the water enterprise. FSA is expected to insure this debt and subject to Moody's review of the insurance policy and other relevant documentation, the bonds are expected to carry FSA's current financial strength rating of Aaa.
Debt service coverage likely to be somewhat thin; risk is partly mitigated by favorable expected reserve levels Moody's believes the Authority's financial projections are reasonably conservative, but likely operating results will nevertheless be below average for an A-rated water enterprise. In fiscal 2005, the first year of full principal and interest debt service payments, the Authority projects debt service coverage of only 1.35x. Typical coverage for a municipal water enterprise would be on the order of 1.7x.
While the projected coverage should be more than sufficient to absorb unexpected fluctuations in revenues and expenditures, the lack of an established operating history for the utility as a public enterprise adds a measure of uncertainty to these financial projections.
Operating revenue growth is realistically projected to average 4.7% over the fiscal 2002-2006 period, reflecting continued customer growth and modest, 3% rate increases in the out-years. By way of comparison, Sierra Pacific's customer growth averaged 3.8% over the 1996-2000 period. Rates have not been increased since 1998.
Moody's notes that current rates are fairly high compared to neighboring systems, but payment delinquency rates have been minimal (less than half a percent annually) and the change of ownership will not by itself result in any rate changes.
Operating expenditures are conservatively projected to increase in fiscal 2002, reflecting transition costs, and then dip the following year. Over the fiscal 2003-2006 period, total O&M is reasonably projected to increase at a 3.9% average annual rate. Sierra Pacific's recent O&M experience is estimated to have been mixed, with total O&M falling 7.2% in 2000, compared to a prior year's increase of 5.0%.
The extent to which the experience of a private enterprise can be extrapolated to a public enterprise is complicated by their differing natures, but the Authority's first year O&M assumption of $27.7 million suggests a reasonable cushion for unexpected costs when compared to Sierra Pacific's estimated calendar year 2000 O&M of $22.7 million.
Aside from a debt ratio that will be very high, the Authority's balance sheet and liquidity should be strong relative to operations and other, comparably rated enterprises. A number of reserve funds will be established with debt proceeds, and debt service is limited to interest only in the first three years, which should provide a fair amount of free cash flow.
The Authority's feasibility consultant projects liquid funds and accounts, excluding the debt service reserve, to range from $38 million to $48 million in the first three years of operations. Initial reserves funded from debt proceeds will include 3 months of O&M ($6.0 million), a $4.6 million O&M reserve fund, plus $3.7 million in additional start-up funding.
Transition risks modestly constrain current credit quality
The A3 rating reflects, in part, the operational uncertainties inherent in transitioning the water utility ownership and operation from a private enterprise to a public one.
For the most part, the water utility's employees will remain the same, including a significant share of upper management, somewhat mitigating this transition risk. Also, as noted above, Moody's believes the O&M projections are reasonably conservative.
However, as a stand alone business, the Authority's water utility may not achieve the same financial economies of scale as the combined water and power operations of Sierra Pacific.
Sierra Pacific will continue to provide billing and revenue collection services on an interim contract basis, introducing a modest third-party bankruptcy risk to the current offering. The Authority has taken steps to minimize this risk, and Sierra Pacific Power Company itself has an A3 senior-secured credit rating.
The Authority will have a security interest in the revenues collected on its behalf, and the frequency with which revenue transfers are to be made, in combination with the Authority's security interest, should provide a strong legal position for continued transfers post-bankruptcy, in the unlikely event that one did occur. These features of the contract would also likely prevent the transfers from being categorized as preferential, and therefore subject to clawback to the bankruptcy estate.
Until August 1, 2001, revenues will be transferred to the Authority weekly, and after that daily. The initial contract will be for six-months, with two, six-month options to renew, after which the Authority expects to have its own billing and collection system in place.
Relatively large and diverse customer base
The Authority's geographic boundary is generally coterminous with Washoe County, which is located in northwestern Nevada bordering California and Oregon. The Authority's service territory, however, will be more limited and principally consists of the Reno/Sparks metropolitan area.
The service territory population is currently about 334,000, and water accounts number about 72,000, both of which measures are notably high for an A3-rated municipal water enterprise. Customers are for the most part retail and residential (93%).
Commercial customers accounted for 18% of Sierra Pacific's calendar year 2000 water sales revenue, but no single customer of any class accounted for more than 1.3%. The largest customer, the Sun Valley Water and Sanitation District, is one of just a few wholesale customers which constituted about 3% of total water sales revenues. Various public agencies (county, school district, university) and a couple of large hotels/casinos round out the top ten customer list, accounting for an aggregate 7.8% of revenues.
Reno (general obligation rating: A1) and its satellite city, Sparks (A3), account for the bulk of the service territory population (55% and 20% respectively). Reno is the county seat of Washoe County (Aa3) and the hub of a large regional economy, which, while still largely dominated by gaming and tourism, continues to diversify, adding and expanding manufacturing concerns and warehousing and distribution centers.
The city's population, currently at 183,000, has grown by about 35% since 1990. Development of the city's gaming and tourism sectors has been relatively flat in recent years with no new hotel construction and slowed growth in visitor volume, but expansion in other sectors is evidenced by annual increases in overall employment levels. Wealth levels in the city remain above both state and national averages and unemployment rates, recently at 2.8%, are consistently low.
Ample supplies of generally high quality water
The Authority's purchase of Sierra Pacific's water utility includes all of the company's related water rights. These rights aggregate to 168,187 acre-feet per year and largely represent rights to the Truckee River draining out of Lake Tahoe in the Sierra Nevada mountains. Water from this source is generally of very high quality and provides between 75% and 90% of annual supplies.
The water system's current average yield (94,500 af) is substantially less than the face value of its water rights, but it is comfortably in excess of current demand (80,300 af). Notably, the system's "critical dry year yield" (87,860 af) is also in excess of current demand. Meeting anticipated demand growth will require enhancing the system's yield to 119,000 af at buildout, but meeting this demand appears financially, operationally, and politically feasible.
In all likelihood, the Authority will be subject to continued political and legal disputes over the allocation of water, as is typical of water systems in the far West, but current issues and those on the horizon appear relatively manageable.
Peak summer demands are met in part with local groundwater supplies drawn from 29 wells. Water quality is fairly high, with 20 wells, which represent 62% of well capacity, requiring no treatment other than clorination prior to distribution. The remaining 9 wells require treatment for removal of contaminants to meet regulatory requirements but apparently no extraordinary efforts.
Arsenic is currently a contaminant of concern in three of the wells and could be a larger issue with the proposed tightening of federal standards. At a 10 ppb standard, which now appears tighter than the likely final rule, 10 additional wells would be affected. Remediation could require additional capital investment on the order of $60 million.
Current capital improvement plan is relatively modest
The Authority's five-year $101 million capital improvement plan is fairly modest for a system of its size. The plan represents treatment, distribution, and supply improvements planned by Sierra Pacific plus about $17 million in systemwide improvements recommended by the consulting engineer retained by the Authority for this transaction.
The initial $40 million of this plan will be funded with proceeds from the current offering. Additional financing plans are not yet firmly established but will likely include a mix of pay-go and debt financing.
Standard legal covenants
The Authority has covenanted to maintain rates sufficient to generate gross revenues equal to at least the sum of O&M expenses and 1.25x debt service. As a municipal utility the Authority has independent rate setting power, unlike Sierra Pacific whose rates were subject to approval by the Nevada Public Utility Commission.
The 1.25x additional bonds test is consistent with the rate covenant, though the debt service measure is of maximum annual debt service. The debt service reserve requirement is standard and expected to be cash funded from proceeds of the current offering.
The outlook for this rating is positive, reflecting the likely resolution in the next few years of transition related uncertainties. In conjunction with the firm establishment of the Authority's own billing and collection system, credit quality would likely be improved, all else being equal.