GWA Revenue Bonds Get ‘BB’ Rating and Stable Outlook from Fitch

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Guam – Fitch Ratings has assigned a ‘BB’ rating to the latest bonds which will soon be issued by the Guam Waterworks Authority [GWA]. The rating has been assigned to $118.8 million water and wastewater system revenue bonds, series 2010.

The bonds are expected to price the week of November 8. Proceeds will be used to fund capital improvements, provide for capitalized interest, fund a debt service reserve, and pay costs of issuance.

At this time, Fitch also affirms the ‘BB’ rating on the following GWA bonds:

–$95.3 million in outstanding water and wastewater system revenue bonds, series 2005.

The Rating Outlook is Stable.

RATING RATIONALE:

–Financial performance of GWA’s combined water and wastewater system (the system) is marginal but is expected to improve over the near term.
–Debt levels are high and significant capital needs remain to meet ongoing regulatory requirements.
–Rate affordability will be limited over the long term based on the level of increases required to fund the capital improvement program (CIP) and the low wealth levels.
–Management has made substantial progress to date in addressing remedial actions and improving operating performance.
–The service territory is isolated and limited and has had a historical disposition to natural disasters.

KEY RATING DRIVERS:

–Continued timeliness of rate relief in light of mandated capital costs and other identified needs will be paramount.
–Maintenance of adequate financial performance despite capital and operating pressures will be key.
–Required contributions by the authority to address capital needs associated with the military build-up could pressure operations and possibly result in deferral of necessary projects already identified.
–Preservation of groundwater supplies and water quality is critical to operations.

SECURITY:

The bonds are senior lien bonds secured by the authority’s net system revenues.

CREDIT SUMMARY:

Historically, the system has been plagued with weak financial performance and violations of the federal Clean Water Act (CWA) and Safe Drinking Water Act (SDWA), which necessitated involvement at the federal regulatory level. However, since 2002 when the authority’s governance was changed from an appointed board to an elected governing board, significant strides have been made towards returning the system to regulatory compliance and ensuring stable operations. Nevertheless, significant challenges persist which will pressure utility operations over the long term.

Over each of the most recent two audited fiscal years (2008 and 2009), senior lien annual debt service (ADS) coverage fell below 1.0 times (x) based on the bond indenture’s methodology for calculating net revenues, resulting in violations of the rate covenant. Despite these results, GWA made all debt service payments for both years as scheduled without drawing on its debt service reserve fund. However, this was accomplished through a drawdown of GWA’s cash position, which in turn prohibited the authority from depositing sufficient monies in its operations and replacement reserves as required under the bond indenture.

Given the authority’s financial results for these years and as prescribed by the indenture, the authority engaged a consulting engineer to make recommendations as to necessary revisions in rates and changes to operating methods. Based on these recommendations and in conformance with GWA’s five-year financial plan, the Consolidated Commission on Utilities (the CCU, GWA’s governing body) and the Public Utilities Commission (the PUC) approved a series of base rate adjustments, including a 14% hike (effective August 2009) and an 8% increase (effective October 2011). In total, rates will rise nearly 40% by fiscal 2013 from fiscal 2008 levels; rate increases for fiscals 2012 and 2013 are subject to annual review by the PUC prior to implementation.

With these adjustments and changes to operating methods recommended by the consulting engineer, GWA forecasts – and GWA’s consulting engineer concurs – that it comfortably will be able to meet its rate covenant and that it should be able to reach its 1.75x ADS target coverage as well starting in fiscal 2011. Indeed, unaudited results for fiscal 2010 are much improved from the prior year, with senior lien ADS coverage estimated at over 1.4x on a cash basis. In addition, GWA recently procured a $30 million loan from the Bank of Guam, a portion of which was used to fully fund the operations and replacement reserves requirements.

While financial performance appears to be improving, GWA faces significant capital needs to meet regulatory requirements. In 2003 the authority negotiated a stipulated order (SO) with the U.S. Environmental Protection Agency (EPA) as a result of violations to the CWA and SDWA. To date, GWA has completed close to 90% of the deliverables associated with the SO and remaining items are addressed in the fiscal 2010-2014 CIP. However, to address system-wide deficiencies and ensure ongoing regulatory compliance, GWA and EPA are in the process of negotiating a new consent decree. At present, it is unknown what capital and operating requirements may be required from any new consent decree or whether or not these items would add to or cause an acceleration of GWA’s 20-year financial plan, which identifies as much as $893 million in capital needs (2007 dollars); the fiscal 2010-2014 CIP totals around $201 million and is a subset of the 20-year plan.

Compounding GWA’s operating and capital pressures, an immense military troop build-up is expected on the island over the next several years that is expected to increase the island’s permanent population by around 32,000 people (approximately a 20% rise). This will necessitate significant additional capital investment that currently is not included in the authority’s CIP. While GWA and the U.S. Department of Defense (DOD) have been working together to identify system needs and funding resources to service this influx of population, it is currently unclear what the ramifications will be to GWA’s operations or the form of capital funding; the CCU maintains that none of the costs will be borne by the island’s current customer base.

There is a possibility that some of the capital costs associated with the 20-year financial plan as well as possible costs from the consent decree under negotiation could be paid by the DOD. Fitch believes that this would be a positive development as it would alleviate some rate pressure on GWA’s existing customers. Currently, the monthly residential bill is estimated at a relatively high 2.7% of 2008 median household income (the most recent statistics available). This will continue to rise as approved rate hikes are adopted. In addition, annual forecasted adjustments are currently envisioned as needed to support the 20-year financial plan. Apart from the capital needs associated with the military build-up, there is the potential that the additional population could strain water supplies or lead to water quality degradation, although it appears that GWA and DOD are effectively coordinating their efforts to alleviate these concerns.

Additional information is available at www.fitchratings.com.