Fitch Ratings - Austin - 14 Nov 2022: Fitch Ratings has a assigned a 'AA' rating to the following obligations issued by the city of Arvada, CO (the city):
--$47.3 million wastewater enterprise revenue bonds, series 2022.
Proceeds from the issuance will be used to fund capital improvement projects associated with the wastewater system (the system) and pay costs of issuance. The bonds will be sold via competitive bid on Dec. 6.
In addition, Fitch has assessed the system's Standalone Credit Profile (SCP) at 'aa'. The SCP represents the credit profile of the system on a stand-alone basis irrespective of its relationship with, and the credit quality of, the city.
The Rating Outlook is Stable.
The 'AA' rating and 'aa' SCP assessment reflect the system's very strong financial profile in the context of its very strong revenue defensibility and low operating risk profile assessments. The system's current leverage, as measured by net adjusted debt to adjusted funds available for debt service (FADS), was an exceptionally low 1.9x in 2021 (FYE Dec. 31), but is expected to increase materially with the issuance of the series 2022 bonds. However, after peaking next year, leverage should start to improve with increases in FADS driven by higher rates and the amortization of debt, ultimately returning to levels consistent with the rating.
The 'aa' revenue defensibility assessment is supported by the system's fundamental role as the sole water provider to a service area with very favorable demographics. The 'aa' operating risk assessment is highlighted by a very low operating cost burden and a history of sound capital reinvestment.
The system serves the city of Arvada and the Ralston Valley Water and Sanitation District (RVWSD), which the city surrounds. The service area encompasses around 38-square miles with population of 123,436 residents, serving a total of 39,273 customers. The city lies around 10 miles northwest of Denver, CO. As result of its proximity to the Denver, the city has very favorable service area characteristics, exhibiting above-average income, low rates of unemployment, and midrange customer growth.
The system consists of collection infrastructure with treatment provided by Metro Water Recovery (Metro) pursuant to a service contract. Proceeds from the 2022 bond sale will be mainly used to expand and repair two trunk-line interceptors that feed into Metro facilities, as they are aging and currently over capacity. These expansions are intended to provide for build-out needs.
Fitch considers the system a related entity of the city for rating purposes given the city's oversight of the system, including the authority to establish rates and direct operations. The credit quality of the city does not currently constrain the bond rating. However, as a result of being a related entity, the issue rating could become constrained by a material decline in the general credit quality of the city.
Revenue Defensibility 'aa'
Monopolistic Service Provider, Very Favorable Service Area Characteristics
All revenues are generated from monopolistic sources. Service area characteristics are very strong with high income levels, midrange population growth, and low unemployment rates. Rates are affordable for the vast majority of the population the system serves.
Operating Risks 'aa'
Very Low Cost Burden; Moderate Life Cycle Investment Needs
Operating costs are very low, and the district's life cycle investment needs are moderate given that capital spending has consistently exceeded the pace of annual depreciation. Increased spending will continue to 2026, as the system goes through a capital-intensive cycle.
Financial Profile 'aa'
Very Strong Financial Profile and Rising Leverage
The system's financial profile is very strong, and current leverage is exceptionally low. However, leverage will rise significantly with debt issuance, but decline as the system goes through the peak of capital spending. Coverage of full obligations (COFO) and liquidity levels are robust and are considered neutral to the assessment.
No asymmetric additive risk considerations affected this rating determination.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Leverage sustained below 7.0x, assuming stability in the revenue defensibility and financial profile assessments.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Leverage sustained above 9.0x, assuming stability in the revenue defensibility and financial profile assessments.
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 the net revenues of the wastewater enterprise system.
Revenue Defensibility is very strong, assessed at 'aa', with all of revenues derived from services or business lines exhibiting monopolistic characteristics in a service area with very favorable demographic trends. The city has the independent legal ability to increase service rates without external approval and system rates are affordable for the vast majority of the population, or around 93%.
Customer growth has been moderate; the three-year CAGR was around 0.8%. This rate of growth is forecasted to increase in the future, as the city expects to issue the largest number of building permits ever issued during a single year in 2022. Based on the permit numbers, system accounts are forecasted to increase by 6% in fiscal 2023, 3% in fiscals 2024-2026, and 2% thereafter. The city's income levels and unemployment are both considered very strong as they consistently significantly outperform national averages. Recently elevated unemployment rates are expected to revert to historical levels.
From fiscals 2013 to 2022, sewer rates have increased on average around 3%. In 2023, the sewer revenues will increase 12%. Sewer rates are projected to increase at around 6% beyond fiscal 2023.
In addition to the bimonthly bill, the system received council approval to increase its 2023 connection charge from $1,579 to $10,400, reflecting the need to support capex over the next five years. Given the city's strong service area characteristics, affordability should not be an issue in the medium term.
The system's operating risk is assessed at 'aa', which takes into consideration a very low operating cost burden and moderate life cycle investment needs. The operating cost burden was $3,591 per million gallons in 2021, a level largely consistent with results since fiscal 2017. The operating cost burden falls well below Fitch's very strong assessment range which, per criteria, is less than $6,500. Lastly, Fitch's calculated life cycle ratio is 29% and is reflective of the current condition of the system.
The system is in the process of implementing two trunk line repair/improvement projects, the North Trunk Program (NTP) and the Central Ralston Trunk Program (CRTP). These projects are intended to provide sufficient sewer capacity to serve build-out flow for the entire service area. The system expects to fund these projects by issuing wastewater revenue bonds.
The financial profile is assessed at 'aa'. Fitch's leverage calculation was 1.9x at the end of 2021, a decline from 3.2x in 2017. The liquidity profile is neutral with coverage of full obligations at 2.4x and liquidity cushion of 164 days at the close of fiscal 2021.
Fitch Analytical Stress Test (FAST)
The FAST considers the potential trend of key ratios in a base case and a stress case. The base case reflects Fitch's expectation of both historical financial results and expected performance in a normal operating cost environment, while the stress case is designed to impose capital costs 10% above expected base case levels and evaluate potential variability in projected key ratios.
Fitch's base case was informed by the system's forecast and CIP from its 2023 budget. The forecast includes the recent rate increase and the new connection fee revenue in fiscal 2023. The CIP includes $72.6 million in spending through 2026, financed entirely with the $50 million series 2022 issuance and an expected $30 million issuance in 2024. Although historical capital spending has been lower than budgeted, Fitch assumed a 75% capital execution rate, which considers the potential for inflationary pressure.
Leverage is expected to increase materially over the five-year horizon period, largely due to the issuance of the series 2022 bonds. As bond proceeds are spent to fund capital expenditures, base-case leverage is decline to around 8.5x in the base case and 9.0x in the stress case by 2026. When considering available bond proceeds, leverage is more consistent with the financial profile and rating through the five years. Over time, leverage absent bond proceeds should begin to converge at the lower level as such funds are spent.
10 November 2022
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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