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Affordability and Utility Revenue Bond Rating Criteria
Ted Chapman Senior Director
Standard & Poor’s Ratings Services
(214) 871-1401
[email protected] Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.
Today’s Agenda
• Summary of the Proposed Criteria • What’s New • What’s Staying the Same • Market Position and Management Assessments
Summary
Holders of Municipal Debt
Households 42%
Mutual Funds 16%
Insurance Companies 12%
Banks and Credit Unions
10%
Everything Else 15%
Closed-End Funds and ETFs 3%
State & Local Gov't and GSEs
1%
Corporate and Small Businesses
1%
Source: Bond Buyer
• We want to make sure that the framework that supports the methodology and assumptions in our criteria for assigning ratings is clear and transparent
• The criteria continues to reflect a current and accurate picture of the risks associated with the sector, today and into the future
• In our opinion, the industry risk is very low
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Why?
What’s New?
Proposed Municipal
Water Utility criteria
Existing Municipal
Pools criteria
The Matrix
FinancialRiskProfile 1 2 3 4 5 6
EnterpriseRiskProfile
ExtremelyStrong VeryStrong Strong Adequate Vulnerable HighlyVulnerable1
Extremely aaa aa+ aa- a bbb+/bbb bb+/bbStrong
2 Very aa+ aa/aa- a+ a- bbb/bbb- bb/bb-Strong
3 aa- a+ a bbb+/bbb bbb-/bb+ bb-
Strong 4 a a/a- a-/bbb+ bbb/bbb- bb b+
Adequate 5 bbb+ bbb/bbb- bbb-/bb+ bb bb- b
Vulnerable 6
Highly bbb- bb bb- b+ b b-Vulnerable
The RATING Matrix
Bill Affordability • Assesses the burden of the utility bill against median household
effective buying income • Because median income represents an “average” customer, true
affordability assessment would be incomplete
• The proposed criteria therefore also incorporates the local poverty rate of the utility’s service area
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Market Position
All-In Coverage is the Best Assessment of True Financial Capacity and Use of All Utility Revenues
Operating Revenues
Operating Expenses
Debt Service
General Fund and Other Transfers Out
Self-Support of Tax-Backed Debt
Other
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All-In Coverage Defined
(Revenues – Expenses – Net Transfers Out) + Fixed Costs
All Revenue Bond Debt Service + Fixed Costs + Self Supporting Debt
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What’s Staying the Same?
• Economic fundamentals • Customer base, demographics, major employers, unemployment
rate, trends in local economy • Remains the most heavily weighted factor
• Liquidity and reserves • Not just days cash, but also how much actual cash (in dollars)
• Total debt • How is it allocated by lien? • How quickly does it roll off? • Has management been what we would view as aggressive in the
type of debt instruments used, so much so that contingent risks have been introduced?
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Rating Factors
Market Position
The Delicate Balance
90
100
110
120
130
140
150
160
170
180
Sour
ce: U
.S. B
urea
u of
Lab
or S
tatis
tics
Con
sum
er P
rice
Inde
x fo
r All
Urb
an C
onsu
mer
s (C
PI-U
) ad
just
ed to
bas
e ye
ar 2
000
= 10
0
Selected Inflation Rates Since 2000
CPI, All Items
Real Disposable Income
All Utilities + Public Transportation
Water, Sewer & Trash
Electricity
Public Transportation
Cable TV and Satellite Service
Annualized Utility Bill as a Percent of Median Household Effective Buying Income (i.e. take-
home pay) Less than
2.25% 2.25% to
4.50% 4.50% or More
Percent of the County’s
Population Living in Poverty
10% or less 1 2 3
10% to 20% 2 3 4
20% to 30% 3 4 5
30% or more 4 5 6
Market Position Assessment (1-6, lowest score is most favorable)
Operational Management Assessment
The OMA
40%
20%
40% Asset Adequacy & Identification of Operational Risks
Organizational Effectiveness, Management Expertise & Drought Mgmt Planning
Rate Setting Practices
Asset Adequacy
• Raw Water Supply • Quantity
• Quality
• Regulatory Compliance • Treatment Capacity • T&D, Collection System • NRW • Climate Risk • Other Vulnerabilities
• Organizational Effectiveness • How proactive does management seem in its communication and public education? • How open is the process?
• Ex. Town halls, social media • Do the political officials have reasonable discretion and autonomy? Does staff? • Votes on rates, budgets, debt, etc.?
• Management Expertise • Who is answering your questions? • Do they know what they don’t know? • Greying of the workforce and succession planning? • Ask how they balance the triple bottom line
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Organizational Effectiveness, Management Expertise and Drought Management Planning
Financial
Social
Environmental
• Drought Contingencies • Water conservation is an unusual business model
• Voluntary • Mandatory • Mainly targets outdoor watering: time of day, day(s) of the week
• Generally, a drought management plan either supplements the water conservation program, or supersedes it
• Most drought plans focus only on the resource management, not on the revenue requirements
• Some states or regional / wholesale providers require retail systems to have drought plans that we would probably view as “strong”. For the local utility to achieve that, they must have their own ordinance or policy that at least mimics if not exceeds the state’s or wholesaler’s or else it is a “good”
• Ex. the state of Georgia has very robust drought management planning with well-delineated contingencies depending on the severity of the drought. If we were to view this as “strong” then the city of Atlanta would at least be “good” by default. If Atlanta had equivalent or even stronger policies of its own, it could be viewed as a “strong”
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Organizational Effectiveness, Management Expertise and Drought Management Planning
Evidence-Based Anecdote
Strong When rate increases have been needed, the decision-making body has been supportive and timely; even to the extent that multi-year pre-approved rate increases are common if not standard. What we view as financially prudent decisions are made rather than decisions that are politically expedient that could possibly be to the detriment of the utility’s near-term financial health. Periodic rate studies (internal or external) are common.
Good Rate considerations are done on a year-to-year planning horizon rather than over a long-term time frame, but generally are apolitically approved if and when necessary.
Standard The rate covenant and/or additional bonds test are the de facto guide as to when rate adjustments are necessary, but that is still enough for the political decision-makers to agree to a rate increase.
Vulnerable Rate increases are often in reaction to a weakened financial position, including a technical default or some other legal covenant violation, even if the recent debt service payments were made on time and in full. There is clear evidence of recent political decisions to defer or downsize needed rate increases.
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Rate Setting Practices
Questions?
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For More Information
Geoff Buswick, Managing Director and Lead Analytical Manager Boston, 1 (617) 530-8311; [email protected]
James Breeding, Senior Director and Analytical Manager
Dallas, 1 (214) 871-1407; [email protected]
Scott Garrigan, Director and SRF Sector Leader
Chicago, 1 (312) 233-7014; [email protected]
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