Fitch Ratings - Austin - 20 Sep 2022: Fitch Ratings has affirmed the 'AAA' rating assigned to the following bonds issued by the City and County of Denver, CO:
--Approximately $220.8 million wastewater enterprise revenue bonds.
In addition, Fitch has assessed the combined sanitary sewerage and storm drainage system (the system) standalone credit profile (SCP) at 'aaa'.
The Rating Outlook is Stable.
The affirmation of the 'AAA' rating and 'aaa' SCP assessment reflect the system's extremely strong financial profile in the context of very strong revenue defensibility and operating risk profile, both assessed at 'aa'. Leverage, as measured by net adjusted debt to adjusted funds available for debt service (FADS), was 2.7x in fiscal 2021, continuing the declining trend seen since 2016.
Fitch's scenario analysis, which is informed by management projections, shows leverage remaining below 5.0x over the next five-year period. Strong margins and a manageable capital improvement plan (CIP) should further result in leverage ratios remaining very robust and consistent with the rating through at least fiscal 2026.
The system provides sanitary sewerage service and storm drainage to approximately 700,000 residents within the city and county of Denver. The city is the site of state government, and it is also the cultural, distribution, entertainment, financial, service and transportation hub of the Rocky Mountain region, a large 10-county metropolitan area.
The system is one of Metro Water Recovery's (MWR) largest customers, representing approximately 45.6% of MWR's 2021 revenues. MWR collects 130 MGD through its existing treatment plant and has ample 220 MGD capacity. Annual expenses are paid in advance and quarterly true-up/true-downs occur. The contract with MWR remains outstanding until bond maturity.
Revenue Defensibility 'aa'
Very Favorable Service Area; Affordable Rates and Fees
The system's revenue is derived 100% from monopolistic revenue sources: wastewater treatment rates and stormwater fees. The strength of the service area reflects Denver's position as an economic anchor. Income and growth rates are midrange and unemployment, while historically very low, continues to improve from recent midrange levels. Customer bills are affordable for the large majority of customers.
Operating Risks 'aa'
Very Strong Operating Risk Profile
The operating cost burden is very low. Capital investment has been very strong and thus results in a favorable life cycle ratio.
Financial Profile 'aaa'
Exceptionally Low Leverage; Neutral Liquidity
Leverage is exceptionally low and should remain below 5.0x for the next five years. Coverage of full obligations (COFO) and liquidity are both favorable, and are thereby neutral to the financial profile.
No asymmetric additional risk considerations affected this rating determination.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--The ratings are at the highest level on Fitch's scale and cannot be upgraded.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Capital pressure including but not limited to the South Platte restoration project resulting in leverage exceeding 5.0x on a sustained basis;
--Material weakening in the service area combined with reduced affordability.
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
The bonds are secured by a first lien on revenues derived from the city's combined sanitary sewerage and storm drainage systems, after payment of operations and maintenance expenses. Connection fees are not pledged to the bonds.
Revenue defensibility is very strong, with all revenue derived from business lines exhibiting monopolistic characteristics in a service area with very favorable demand characteristics. The service area continues to show healthy customer growth, with continued development in professional and business services sector, education and healthcare, and tourism. Customer growth has likewise been sound, with a five-year average CAGR of about 1%. In 2021, the county's unemployment rate was higher than the national average, but has begun to decline; unemployment has averaged about 81% of the national average over the past five years. Area median household income levels are about 112% of the national average.
As of fiscal 2021, assuming Fitch's standard monthly usage of 6,000 gallons of flows, combined monthly user charges equaled about $65, which Fitch considers affordable for the vast majority of customers (around 84%). After the most recent 2016-2020 rate package, rates beginning in fiscal 2021 will increase based on the percentage increase of the Consumer Price Index (CPI). For 2021 and 2022, these increases were about 3.1% and 3.2%, respectively. The 2023 rate increase is 8.2%, which helps offset inflationary pressure on costs. A new rate study was recently completed in the last year, although there have been no material policy changes to the system yet. Until this occurs, inflationary-based adjustments are automatic for both systems. Nonetheless, rate increases are not expected to materially affect affordability.
Taking into consideration the very low operating cost burden and a similarly low life cycle ratio, the system's operating risk profile is assessed at 'aa'. Specifically, after adjusting for estimated costs associated with the sewer system (60.5% of revenues) and excluding the estimated stormwater portion (39.5%), the operating cost burden was very low at just $4,354 per million gallons (mg) in fiscal 2021. The burden should remain very low given Fitch's expectation for operating cost growth through fiscal 2026.
Capital planning and management is also very strong, with a very low life cycle ratio of 29% in fiscal 2021. The system has historically invested in capital enough to keep this ratio very favorable, as evidenced by a five-year capex-to-depreciation ratio of 373%. The same is expected going forward, as the system's CIP shows capital spending of $346.4 million through 2026, or an average of $69.3 million annually. This is slightly lower than the prior five-year average of $81.6 million, but should help to keep the system investment favorable. The CIP will fund projects to update aging infrastructure, including projects to address citywide storm drainage maintenance, which will help protect against serious drainage problems that may result in flooding.
Along with several partners, the city has been engaged in a planning effort to restore an approximately 6.5 miles of the South Platte. This potential project is initially estimated to cost $700 million, of which 50% are anticipated to be Federally funded. The city and its partners would be responsible for the remaining costs; Denver's share of these costs has yet to be finalized and is not included in the current CIP.
The financial profile is extremely strong, and is assessed at 'aaa'. Leverage finished at an exceptional 2.7x in fiscal 2021, and has remained below 4.0x over the past five years. With over 200 days cash on hand (and approximately 663 days including non-current unrestricted cash) and COFO at 2.6x in fiscal 2021, the liquidity profile is robust although neutral to the financial profile assessment.
Fitch's Analytical Stress Test (FAST)
The FAST considers the potential trend of key ratios in a base case and a stress case. The stress case is designed to impose a capital cost increase of 10% above expected levels and evaluate potential variability in projected key ratios.
Fitch's scenario is informed by management's latest forecast, which includes forecast results for 2022-2026, and the latest CIP. It also includes Fitch's standard assumptions with respect to the treatment of purchases service costs from MWR.
The base case shows leverage improving through fiscal 2026 to 2.1x due to principal amortization and stronger FADS. The FAST stress case shows a similar trend with leverage finishing 2026 at a slightly higher but still extremely low 2.4x.
While the treatment of off-balance sheet debt using Fitch's standard methodology may understate the system's true leverage ratios, leverage assuming the inclusion of the system's allocable share of MWR's debt is expected to be consistent with the financial profile assessment and current rating.
No asymmetric rating factor considerations affected this rating determination.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.
The principal sources of information used in the analysis are described in the Applicable Criteria.
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