Source: Business Wire

.--$193 million wastewater system revenue bonds, series 2010-A (taxable Build America Bonds), rated 'AA+';

--$80 million wastewater system revenue bonds, series 2010-B (taxable Recovery Zone Economic Development Bonds), rated 'AA+';

--$136 million wastewater system subordinate revenue bonds, series 2010-C (tax-exempt), rated 'AA'.

The bonds are expected to sell via negotiation as early as the week of July 26. Proceeds will be used to refund a portion of the city's wastewater system (the system) outstanding debt, including $300 million in outstanding commercial paper; provide funding for system construction; fund a debt service reserve for the series 2010-A and 2010-B bonds; and pay costs of issuance. At this time, Fitch also affirms the following ratings on the city outstanding parity debt as follows:

--$1.25 billion (pre-refunding) in outstanding wastewater system revenue bonds, affirmed at 'AA+';

--$987 million in outstanding wastewater system subordinate revenue bonds, affirmed at 'AA'.

The Rating Outlook is Stable.

RATING RATIONALE:

--The system exhibits sound financial metrics, although recent performance has weakened somewhat.

--Rates are competitive with other jurisdictions providing sufficient room for upward adjustment.

--Debt levels remain high and planned capital expenditures continue to be large, but capital costs are down significantly over the next several years.

--The service area is large with diverse economic underpinnings, despite recessionary pressures.

KEY RATING DRIVERS:

--Over the near term, Fitch will be looking for maintenance of sound financial metrics and a return to the city's prior commitment of funding capital through increased equity sources so as to limit increases to the system's already high debt levels and address aging infrastructure.

--Because ongoing rate increases will be needed to maintain financial results and boost equity capital funding, a trend of forestalling rate hikes beyond what is currently expected would be viewed negatively.

SECURITY:

The 2010-A and 2010-B bonds are senior lien obligations payable from net revenues of the system. The 2010-C bonds are payable from net system revenues on a basis that is subordinate to 2010-A and 2010-B bonds.

CREDIT SUMMARY:

Financial performance historically has been good and has yielded solid annual debt service (ADS) coverage and sound liquidity. Despite recessionary pressures that reduced flows somewhat for fiscals 2008 and 2009, ADS coverage of senior lien debt remained above 3.0 times (x) and ADS coverage of all debt was around 1.6x. For unaudited fiscal 2010, the city expects a slight improvement in ADS coverage as revenue decline from an even weaker sales environment was more than offset by operating expenditure cuts and lower debt service costs. Liquidity remains favorable, although reserves dropped to just 97 days cash in fiscal 2009 as outlays for capital were made in advance of debt issuances. However, for fiscal 2010, bond proceeds were the predominant funding source used for construction projects, which have allowed reserves largely to rebound; unaudited fiscal 2010 reserves are in excess of 200 days cash.

Despite the system's recent financial performance during the recession, the city projects some softening over the next few years based on flat sales growth, a deferral of rate hikes until fiscal 2012, and rising debt service costs. Senior lien and total ADS are forecasted to decline to minimum levels of 2.2x and 1.3x, respectively, in fiscal 2011 before steadily improving through the fiscal 2014 forecast period to more historical patterns. Reserve levels should remain intact or even improve through this timeframe. Fitch regards the projected financial performance as adequate given that the drop in ADS coverage is expected to be relatively short-lived.

In 2009, it was envisioned that the city would adopt a multi-year rate package for fiscals 2010-2013. However, as economic conditions remained weak in the city, staff refrained from recommending rate adjustments to the city council in order to limit pressure on the rate base. To offset the lack of revenue growth over the next several years, planned capital spending has been cut dramatically; the system's fiscal 2010-2014 capital improvement program (CIP) was reduced over 30% to $1.2 billion from the fiscal 2009-2013 CIP of $1.7 billion. While the current CIP continues to address required regulatory infrastructure needs, there is some concern that a prolonged period of reduced capital outlays could lead to deferred maintenance and a rising age of facilities, which ultimately could increase infrastructure renewal costs over the long term.

Another change with the current CIP is the debt-to-equity funding ratio. Leading up to the recession, the system had gradually been projecting a greater percentage of equity funding, with these sources reaching 50% for the fiscal 2009-2013 CIP. However, as expected surplus revenues were reduced through the forecast period, the equity component of the fiscal 2010-2014 CIP was cut significantly and debt sources are now expected to comprise 62% of capital dollars. Despite this shift, planned borrowings are approximately $120 million lower in the fiscal 2010-2014 CIP than the prior year's CIP, which limits some concern over this change. However, it remains important that the system continue to minimize the use of additional debt given leverage ratios are already high for the rating level and amortization of principal is relatively slow.

The system provides wastewater collection, treatment, and disposal services for an area of about 600 square miles, including most of the city. Normal drainage patterns, which do not generally conform to political boundaries, define the service area. As a result, other agencies serve some areas of the city and the city's system serves areas outside of the city. Customer levels have declined slightly from fiscal 2004-2009, with total connections at around 638,500 for fiscal 2009.

Applicable criteria available on Fitch's website at 'www.fitchratings.com':

--'Revenue-Supported Rating Criteria', dated Dec. 29, 2009;

--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 6, 2008.

Considerations for Taxable/Build America Bonds Investors

This sector credit profile is provided as background for investors new to the municipal market.

Water and Sewer Utility Revenue Bonds

Municipal water and sewer utilities in the U.S. are enduring natural monopolies that typically have autonomous rate setting ability and provide highly essential services. The bonds are secured by a pledge of net revenues generated by the water and/or sewer system and typically include structural legal protections, such as rate covenants, debt service reserve requirements, and antidilution tests. As such, the sector exhibits extremely strong credit characteristics with minimal defaults. Reflective of this strong performance, the average water and sewer revenue bond rating is 'A+' with 53% at or above 'AA-' and approximately 6% rated 'BBB+' or below. Those with low investment-grade or below-investment-grade ratings generally have substantial capital programs, a high degree of leverage, or weak financial flexibility, as reflected in low cash levels, narrow debt service coverage, and/or limited rate-raising flexibility. For additional information on these ratings, see Fitch Research on "Water and Sewer Revenue Bond Rating Guidelines," dated Aug. 6, 2008, available on Fitch's Web site at www.fitchratings.com.

Additional information is available at www.fitchratings.com. 

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Contact:
Fitch Ratings
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Kathy Masterson, 415-732-5622, San Francisco
or
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Email: cindy.stoller@fitchratings.com  

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