12-May-2014

In our annual update of the key statistics underlying our assessments of debt issues in the U.S. municipal water and sewer sector, we’re focusing on the medians and means of several widely used variables. As in previous reports, we present data for economic and financial measures to offer insight into correlations that exist between these measures and the ratings we’ve assigned to issuers in this sector.

When assigning a bond rating, Standard & Poor’s Ratings Services takes into account a variety of factors, both qualitative and quantitative. We believe a thorough examination of the quantitative information sheds light on the strengths and weaknesses of individual issuers relative to others. By providing this information, we hope to increase transparency and continue our open and accurate discussions about credit quality among all participants in the municipal water and sewer bond sector.

It is important to remember that the ratios and other measures we provide here are not the sole determinants of our rating assignments, nor can they serve as rating benchmarks because they do not account for the issuer’s complete financial, operating environment, or sector risk. Moreover, these means and medians reflect recent historical information, while we intend our credit ratings to be forward-looking. Also, because our long-term ratings are designed to hold up through business cycles, a particular issuer’s ratios may appear to be inconsistent with its assigned debt rating at a particular point within a cycle. We also exercise some degree of caution when making national comparisons of revenue bond issuers because the operating environments may differ from state to state. Issuers often face differences in regulations that determine their ability to raise rates and issue debt, what their required service provisions may be, and the regulatory environment in which they operate. However, these differences tend to be minor.

Rating Distributions Continue To Cluster In The ‘AA’ And ‘A’ Categories

Given the stability of the municipal water and sewer sector, a quick look at the overall rating distributions for municipal water and sewer bonds reveals two immediate conclusions: (1) the ratings are almost exclusively investment-grade, with only 0.3% of all bonds rated below ‘BBB-‘, and (2) nearly half of the ratings are now in the ‘AA’ category. In this year’s report, we focus on exclusively, or predominantly, retail systems and exclude ratings on larger wholesale systems. However, we do include data for the systems that determine a wholesaler rating. For example, we have excluded the ratings on certain debt issued by Trinity River Authority, Texas, but have added the data related to its principal wholesale customers. This explains some of the differences in ratings counts from last year’s report.

Of our total rated universe of more than 1,500 issuers, just over 90% fall in either the ‘AA’ or ‘A’ category. Approximately 47% of the ratings are in the ‘AA’ category, with 45% in the ‘A’ category. Currently, about 6% of the ratings in this report are ‘AAA’, with only 2% rated ‘BBB+’ or lower (see chart 1). While ratings cluster around the ‘AA’ and ‘A’ categories, with a median rating of ‘A+’, a self-selection bias admittedly affects the distributions. Many water and sewer systems of potentially poorer self-assessed credit quality may choose not to apply for a public Standard & Poor’s rating, or they may access capital though state revolving funds. The absence of those potentially lower-rated issuers may artificially elevate the rating distribution.

When we dive deeper into the rating distributions according to the systems’ service area population, some differences begin to emerge. As in previous years, for systems with populations of less than 20,000, the ratings are predominantly in the ‘A’ category (72%). The ‘BBB’ category is now home to less than 5% of systems with service areas with populations under 20,000, while 24% are rated ‘AA’ and less than 1% are ‘AAA’ (see chart 2).

For systems with populations between 20,000 and 150,000, the spread between those in the ‘AA’ category (57%) and those in the ‘A’ category (39%) has widened in recent years. Approximately 5% of those in this population range are rated ‘AAA’, while less than 1% are ‘BBB+’ or lower (see chart 3).

As population levels increase, so does the percentage of higher-rated issuers. For systems with a service area population ranging between 150,000 and 500,000, the majority of the ratings are in the ‘AA’ category (64%), while only about one-third are ‘A+’ or lower. In this range, about 25% are rated ‘AAA’ (see chart 4). Similarly, for very large systems with populations above 500,000, about 20% are ‘AAA’, 60% are ‘AA’, and about 20% are rated ‘A+’ or lower (see chart 5).

Summary Of Key Economic, Financial, And Debt Ratios

The ratios we provide below reflect three of the four main areas Standard & Poor’s evaluates when rating issuers: economic, financial, and debt factors. Measures for the fourth factor, administration and management, are generally more qualitative. The ratios include:

• Median household effective buying income: Commonly known as “disposable income,” or a household’s wages, salaries, dividends, and transfer payments, less all applicable taxes and withholdings.
• Customer concentration (top 10%): The percent of total operating revenues from the top 10 customers.
• Liquidity ratio (days’ cash on hand): Enterprise fund cash and cash equivalents, divided by annual enterprise fund expenses and multiplied by 365, expressed in the number of days of cash on hand. Standard & Poor’s excludes depreciation.
• Senior-lien debt service coverage (DSC): The total amount of senior-lien debt divided by the net revenues available to service the debt.
• All-in DSC: Total senior, junior, and self-supported debt, coupled with other obligations routinely covered by the enterprise fund, divided by the net revenues available for debt service. DSC ratios, however, are internally adjusted for utilities that are distribution-only and/or collection-only systems versus those that are vertically integrated. For utilities that are not vertically integrated, we impute a pro rata share of the wholesale provider’s fixed costs onto the utility. While it is probable that the wholesale provider may have once issued debt on the utility’s behalf, it also makes DSC comparisons more meaningful and allows better insight into the true financial capacity of all obligations.

Table 1  |  Download Table

U.S. Water And Sewer Credit Ratios: Medians And Means By Rating Category
	AAA		AA		A		BBB or lower
	Median	Mean	Median	Mean	Median	Mean	Median	Mean
Population	237,492	575,254	74,051	227,882	18,919	64,802	12,500	476,784
Median household effective buying income as % of U.S.	120	128	103	108	85	90	83	92
Unemployment rate (%)	6.1	6.3	7.1	7.4	7.5	8.1	7.8	8.8
Concentration (%)	6.4	10.2	8.7	12.6	10.3	15.6	8.9	13.5
Water rate ($)	30.88	31.55	32.84	35.63	40.84	42.68	34.95	39.70
Sewer rate ($)	36.26	39.91	38.81	41.38	40.45	44.02	43.21	44.40
Total operating revenues* ($)	65,116	125,725	15,835	41,096	4,245	12,311	3,472	52,513
Days’ cash*	472	629	417	556	283	402	144	261
Senior-lien debt service coverage* (x)	3.30	3.97	2.40	3.65	1.73	2.45	1.35	1.50
All-in debt service coverage* (x)	2.35	2.96	1.87	2.29	1.43	1.66	0.97	1.19
*Average of last three years.

Table 2  |  Download Table

U.S. Water And Sewer Credit Ratios: Medians And Means By Population
	Pop Above 500,000		Pop 150,000 to 500,000		Pop 20,000 to 150,000		Pop Below 20,000
	Median	Mean	Median	Mean	Median	Mean	Median	Mean
Population	998,454	1,459,872	241,934	268,001	50,095	61,715	9,164	9,529
Median household effective buying income as % of U.S.	98	104	99	103	97	103	85	94
Unemployment rate (%)	7.6	7.9	7.3	7.6	7.2	7.8	7.2	7.5
Concentration (%)	8.0	15.4	7.5	11.5	9.0	12.2	12.1	16.7
Water rate ($)	30.12	33.66	31.2	33.1	33.6	36.0	40.36	42.27
Sewer rate ($)	42.54	44.48	41.15	42.58	37.64	40.03	40.56	44.93
Total operating revenues* ($)	174,087	243,840	49,140	58,055	13,017	16,453	2,692	3,890
Days’ cash*	281	353	404	537	375	508	349	422
Senior-lien debt service coverage* (x)	2.02	3.04	2.15	3.32	2.27	2.98	1.91	2.63
All-in debt service coverage* (x)	1.53	1.81	1.80	2.33	1.75	2.15	1.43	1.65
*Average of last three years.

Table 3  |  Download Table

U.S. Water And Sewer Credit Ratios: Medians And Means Within The ‘AA’ Category
	AA+		AA		AA-
	Median	Mean	Median	Mean	Median	Mean
Population	172,038	419,393	86,642	252,853	43,871	128,640
Median household effective buying income as % of U.S.	107	115	107	113	97	100
Unemployment rate (%)	6.5	6.9	7.3	7.4	7.2	7.6
Concentration (%)	7.8	13.9	8.0	10.9	9.6	13.4
Water rate ($)	31.85	34.98	31.95	33.94	34.30	37.30
Sewer rate ($)	38.50	42.70	37.20	38.62	40.81	43.16
Total operating revenues* ($)	32,382	75,292	18,140	45,206	11,391	23,623
Days’ cash*	443	501	431	583	397	555
Senior-lien debt service coverage* (x)	2.32	3.44	2.46	3.74	2.39	3.66
All-in debt service coverage* (x)	1.96	2.42	1.93	2.44	1.80	2.13
*Average of last three years.

The Relationships Between Our Ratings And Select Ratios

As in previous years, the data show correlations between several ratios-—including the issuer’s population, income levels, and liquidity—-and our ratings on these debt issues. This is not surprising because the economic base (i.e., the population and income levels) tends to provide the foundation for credit quality in general. What’s more, larger systems tend to enjoy the benefits of economies of scale because they can tap into a larger base to generate revenue, address system emergencies, and adapt to fluctuations in demand often more expeditiously and efficiently than smaller systems. Similar to population, a system’s total operating revenues correlate to rating level: Systems with larger budgets generally get rated higher.

Given the overwhelming majority of ratings are ‘A-‘ or higher, ratings below this level usually have a unique set of credit factors associated with them. This year, ratings at the ‘BBB’ level or lower include those on Detroit; Jefferson County, Ala.; Stockton, Calif.; New Orleans; and Atwater, Calif. Each of these issuers has experienced significant stress related to either their enterprise fund, general government operations, or both.

A direct correlation exists between our issue ratings and ratios such as median and mean population, days’ cash on hand, and coverage ratios. For several of the data points, we used the average of the previous three years for analysis. Although the sector is extremely stable and only minor deviations typically occur from year to year, using a three-year average tends to smooth any atypical year-over-year changes.

Across all rating categories, the range from the minimum value to the maximum value is, for almost every data point, extremely large. For example, days’ cash levels for ‘AAA’ issuers range from less than 100 days to more than 2,000 days. Given the size differences between the smallest issuers and the exceptionally large issuers, the means may be skewed but can nevertheless provide some insight.

Income levels, unemployment rates, and population

In general, better economic indicators correlate with higher ratings. From the ‘BBB’ category to the ‘AAA’ category, median household effective buying income increases to 120% of the national average from 83%, while the median unemployment rate declines to 6.1% from 7.8%. Additionally, the median population for ‘AAA’ rated issuers is significantly higher than those in any other rating category.

Liquidity ratios

The issuers’ days’ cash on hand, a measure of liquidity, are also stronger at the higher rating levels, although median liquidity levels remain healthy, in our view, for each category. However, for smaller systems, a high days’ cash number does not always equal a nominally high amount of cash. For example, a very small system with 180 days’ cash may have a nominally low amount of cash available to address any emergencies or wet weather conditions that cause a decline in demand.

The median days’ cash level is about 144 days for ‘BBB’ category issuers and rises to 283 for those in the ‘A’ category, 417 for those in the ‘AA’ category, and 472 for ‘AAA’ issuers. When aggregating by population, the correlations are not quite as strong, with median liquidity levels of the midsize issuers greater than those of the larger issuers. Again, liquidity measures are typically strong across all rating categories despite population levels.

Coverage ratios

As with days’ cash on hand, the coverage ratios also have strong correlations with credit quality because the higher-rated issuers tended to have better debt service coverage. Mean and median coverage levels improved noticeably between each rating category. The median senior-lien coverage ratio is 1.3x for ‘BBB’ credits and rises to 3.3x for ‘AAA’ credits. However, these correlations do not exist when taking population ranges into account because issuers in the 20,000 to 150,000 range had higher coverage means and medians than larger systems. These trends are consistent with previous years.

A closer look at the ‘AA’ category

While ‘A+’ remains the median rating level, a slightly greater percentage of ratings are in the ‘AA’ category versus the ‘A’ category. Within the ‘AA’ category, a slightly higher percentage of ratings are at ‘AA-‘ (20%) than ‘AA’ (17%), with about 8% at ‘AA+’. Some of the correlations that were evident from category to category are still evident within the ‘AA’ category itself. Specifically, median population levels and unemployment rates improve with rating quality. Financial indicators, such as days’ cash and debt service coverage, do not differ significantly from ‘AA-‘ to ‘AA+’, though the liquidity ratio rises slightly (see table 3).

As Always, Numbers Don’t Tell the Whole Story

While the ratios presented here may show particular trends from category to category, or even within certain categories, they are not the sole determinants for the assignment of a rating. Management policies and practices, coupled with the environment in which the utility operates, will often lead to higher coverage or liquidity ratios. Those governance factors may be the primary reason for a higher rating, with the operating performance a result of higher-quality management. While strong financial metrics can certainly lead to higher ratings, it is also the underlying management of the system, the resources available to staff and the ability to maintain those strong financial metrics that ultimately underpins the rating assignment.

Primary Credit Analyst:	James M Breeding, Dallas (1) 214-871-1407; james.breeding@standardandpoors.com
Secondary Contact:	Theodore A Chapman, Dallas (1) 214-871-1401; theodore.chapman@standardandpoors.com