November 9, 2016 - 5:18 PM EST
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Fitch Rates Richmond, VA's Public Utility Revs 'AA'; Outlook Stable

Fitch Ratings has assigned a 'AA' rating to the following city of Richmond, VA revenue bonds:

--$500 million public utility revenue and refunding bonds, series 2016A.

The bonds are expected to sell via negotiation during the week of Nov. 14.

Proceeds of the series 2016A bonds will be used to current and/or advance refund outstanding series 2007A, 2009A and 2013B for debt service savings, finance various capital improvements (or reimburse the city for amounts previously spent on capital investments) and pay issuance costs.

In addition, Fitch affirms the following ratings:

--$670 million outstanding (prior to the refunding) public utility revenue bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by and payable from the net operating revenues of the city of Richmond's water, sewer and gas utility systems (together, the system).

KEY RATING DRIVERS

REGIONAL SERVICE PROVIDER: The city plays an important role as a large regional water, sewer, and natural gas service provider to a broad and mainly residential customer base.

CAPITAL CITY, ECONOMIC HUB: The local economy consists of a diverse mix of employment including manufacturing, retail, services, distribution, and banking. The presence of the commonwealth's main state offices, as well as several institutions of higher education adds to employment diversity.

HEALTHY FINANCES: System finances are well-managed. Revenue bond coverage has been strong and liquidity is robust. Financial results are projected to remain sound despite weaker results in fiscal 2016 and expectations for additional debt over the next five years.

ELEVATED DEBT BURDEN, HIGH RATES: Debt remains high and the capital improvement plan (CIP) is comprehensive. The combined monthly residential bill for water and sewer service is very high and additional rate increases appear necessary to fund the CIP. The city expects to issue additional debt, ensuring debt ratios and user charges remain high for the foreseeable future.

SUFFICIENT SUPPLY AND TREATMENT CAPACITY: Water supply is ample and water and wastewater treatment capacity is sufficient for demand, which has experienced slight declines over time, consistent with the national trend. The city is in compliance with a state order to reduce its combined sewer overflows.

RATING SENSITIVITIES

COST RECOVERY AND SUSTAINED PERFORMANCE: The rating on Richmond's public utility system's bonds will remain stable as long as long-term costs continue to be recovered and historical margins sustained. A change in policy direction or failure to increase rates that impacts the sufficiency of cost recovery and pressures coverage metrics could lead to rating pressure going forward.

HIGHER-THAN-EXPECTED LEVERAGE: The system's debt burden is anticipated to rise over the next five years to still manageable levels, but above those of similarly rated peer utility systems. Additional bonding greater than current CIP estimates could place downward pressure on the rating.

CREDIT PROFILE

Richmond (GOs rated 'AA+') owns and operates a combined utility system consisting of natural gas distribution, potable water treatment and distribution, and wastewater collection, treatment and disposal. Each of the utilities is operated as a separate self-supporting enterprise under the auspices of the department of public works. Service is provided to a mostly residential and mostly retail customer base.

REGIONAL SERVICE PROVIDER WITH STRONG ECONOMIC UNDERPINNINGS

The water and sewer utilities serve roughly 63,000 water and 60,000 sewer customers and an estimated additional 80,000 additional retail customers through wholesale water supply agreements with Henrico, Hanover and Chesterfield Counties. In total, the system served a population base of over 700,000 area residents.

The natural gas utility provides service to about 112,000 direct retail customers, including customers living in adjacent counties. Natural gas is purchased on a wholesale basis from three suppliers who deliver gas to the city's eight gate stations through major transmission pipelines.

As the capital of the commonwealth of Virginia, Richmond is the hub of economic activity for a growing metropolitan area. State and federal employment provide stability to the city's economy, and large employers, including several large health systems and multi-national financial firms offer significant employment opportunities. At 4.7% in August 2016, the city's unemployment rate continues to trend positively. Income levels remain comparatively low, although system collection rates remain strong.

HEALTHY FINANCES

Financial results remain sound, characterized by strong debt service coverage (DSC) of senior lien revenue bonds and improved liquidity over the past two fiscal years. For fiscal 2015, Fitch-calculated DSC was again strong at 2.7x from all available revenues, and coverage of all debt, including general obligation bonds issued on behalf of the system, increased to 1.9x, which is an improvement over the system's 1.6x historical level. Unaudited results for fiscal 2016 show a decline in net revenues available for debt service, and lower but still solid DSC of 2.1x on the senior bonds and 1.5x all-in.

The city's updated financial forecast for the system indicates better results driven mainly by a temporary decrease in annual debt service due to some extent by the 2016 refunding. The 2016A bonds are anticipated to provide significant annual debt service savings of roughly $5 million. DSC reaches 2.9x on the senior bonds in 2017, while all-in coverage totals 1.8x.

In the following years, the high coverage projected in 2017 slowly moderates throughout the rest of the forecast as annual debt service (ADS) normalizes and new debt is issued (in 2019). The updated forecast is slightly healthier than the forecast provided to Fitch in early 2015, likely a result of the debt service savings from the refunding and expectations of future rate increases.

Liquidity has significantly improved over the past few years. Since fiscal 2013, unrestricted cash and equivalents has increased by slightly more than $100 million. The system ended fiscal 2015 with approximately $177 million, or 320 days cash on hand (DCOH). When the cost of purchased natural gas, which is passed on dollar for dollar directly to the customer, is netted out of the calculation, liquidity improves to a more robust 535 DCOH. Fitch expects the city will maintain sound liquidity levels going forward. Continued solid financial management is key to long-term rating stability.

HIGH AND RISING DEBT BURDEN

The majority of the system's outstanding debt consists of long-term, fixed-rate parity revenue bonds secured by the system's net revenues. The system also pays the debt service for an approximately $145 million of general obligation bonds and fixed-rate state loans.

Despite a decline in total debt outstanding over the past several years, the debt burden remains elevated, pressuring the system's solid credit profile. In 2015, outstanding debt was equal to an elevated $2,714 per customer when direct customers of all three systems as well as an estimate of retail customers served through bulk contract are included - which is well above the median for retail-only utility systems rated in the 'AA' category of $2,050. Debt-to-net-plant, at 72% in 2015 is also above the median for retail systems (50%). However, debt carrying costs are a more reasonable 20% of fiscal 2015 gross revenues.

The debt burden is expected to rise as a result of the current issuance, which includes approximately $150 million in new money, and the addition of approximately $300 million in new debt beginning in 2019. Fitch projects debt per customer will increase to roughly $3,100 by the end of the forecasted capital program. However, the city's longstanding track record of successfully managing a large capital program while maintaining a strong financial profile helps mitigate the high debt burden. Fitch expects this to continue.

HIGH USER CHARGES COULD DIMINISH FINANCIAL FLEXIBILITY

Customer bills include base and volumetric charges, and a purchased natural gas cost adjustment mechanism to offset commodity price volatility. Base charges represent a significant portion of the monthly bill, providing a level of predictability to the revenue base. Rates have been on the rise and are high relative to neighboring systems and to median household income (MHI).

In 2016, the average residential water and wastewater customer's bill assuming 5,200 gallons of water per month was $99 for combined service, which is high at 2.9% of MHI. Fitch expects that combined charges above 2% of MHI for consumption totaling 7,500 gallons per month - which is the national average - may be financially burdensome from an affordability standpoint. If residential customers in Richmond consumed 7,500 gallons per month, charges would be closer to 4% of MHI.

The city has local rate-setting authority, an important consideration given additional rate increases are likely necessary to meet the system's ongoing capital needs. City council has consistently approved rate increases as needed historically. Nonetheless, Fitch acknowledges the potential for reduced consumption as well as rate-raising flexibility as rates continue to rise.

LARGE, MAINLY DEBT-FUNDED CAPITAL PROGRAM

The system's five-year $711 million capital improvement program (CIP) is comprehensive, funding necessary system upkeep while ensuring compliance with state and federal mandates. Roughly 42% of the CIP consists of sewer system projects, including wastewater treatment plant upgrades and collection system repair and replacement, while the remainder of the CIP is will fund various water system upgrades (42% of the total) and natural gas projects. In addition, the city will continue to fund projects to mitigate combined sewer overflows (CSO). Including the 2016 bonds, the CIP is projected to be roughly 70% debt-financed.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/site/re/869223

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014566

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014566

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Business Wire (November 9, 2016 - 5:18 PM EST)

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