Fitch Rates Guam Waterworks Authority Revs ‘BB’; Outlook Positive

AUSTIN, Texas–(BUSINESS WIRE)–Fitch Ratings has assigned the following rating to Guam Waterworks Authority (GWA, or the authority)–$84.5 million water and wastewater system revenue refunding bonds, series 2014A and series 2014B (taxable) ‘BB’.
The bonds are expected to sell on or around the week of July 21, 2014. Proceeds will be used to refund all or a portion of the authority’s outstanding series 2005 bonds and pay costs of issuance.
In addition, Fitch affirms the following:
–$377.4 million outstanding water and wastewater revenue bonds at ‘BB’.
The Rating Outlook is Positive.
The bonds are secured by a senior lien on the authority’s gross revenues excluding development charges.
OUTLOOK REFLECTS REGULATORY COMPLIANCE PROGRESS: The Positive Outlook reflects the authority’s substantial progress to date in addressing remedial actions and improving operating performance. After a lengthy period of non-compliance and regulatory actions, the authority is in compliance with all regulatory requirements and has proactively addressed recent additional United States Environmental Protection Agency (USEPA) findings.
FINANCIAL FORECAST POSITIVE: The Positive Outlook further reflects GWA’s recent more consistent financial performance and positive financial forecast aided by the approval of a five-year rate package through fiscal 2018.
POLITICAL WILLINGNESS TO RAISE RATES: The five-year rate package to support the authority’s substantial capital needs, effective Nov. 1 2013, demonstrates continued political willingness to raise rates. Significant additional rate hikes will likely be necessary, which will further pressure customers and could ultimately test rate flexibility.
ELEVATED DEBT AND CAPITAL PRESSURES: Debt levels are high and significant capital needs remain to meet ongoing regulatory requirements, which could challenge future financial results.
MILITARY BUILD-UP DELAY CONTINUES: Additional capital projects will ultimately be needed to meet expected military build-up demands, although actual needs are not incorporated into GWA’s capital improvement program (CIP). However, GWA expects capital costs incurred as a result of the eventual build up will be funded by the U.S. Department of Defense (DOD), including a recent $106 million appropriation.
LIMITED ECONOMIC PROFILE: The service territory is isolated and limited and has had a historical disposition to natural disasters. However, tourism has continued to diversify and recover from the economic downturn, reaching near peak levels in 2013 which are continuing into 2014.
CONSISTENT COMPLIANCE AND FINANCIAL PERFORMANCE: Positive rating action is contingent upon the authority’s continued compliance with regulatory requirements as well as its ability to produce fiscal 2014 results and maintain favorable out-year expectations in line with its financial forecast.
The system has recently taken a number of actions to bring it into regulatory compliance and ensure stable operations and finances. A history of weak financial performance and violations of the federal Clean Water Act (CWA) and Safe Drinking Water Act (SDWA) necessitated involvement at the federal regulatory level.
Structural changes, which began in 2002 when the authority’s governance was changed from an appointed to an elected governing board, resulted in the system’s full compliance to date with the 2011 USEPA Court Order (the order) and the recent compliance of its two largest wastewater treatment plants for the first time since enactment of the CWA in 1972. Nevertheless, significant capital needs persist which will challenge utility operations over the long term.
GWA ended fiscal 2013 in line with prior expectations. Fitch-calculated senior lien debt service coverage (DSC), which is based on audited results and includes accruals, was almost 2.3x while total DSC was 1.4x. DSC was aided by a 9% rate increase effective in February 2013. Revenue gains were partially offset by a 6% increase in operating expenses, even as water purchases from the Navy fell by 13%. The positive operations increased cash balances for the year but with the increase in operating costs, days of operations in cash remained virtually unchanged for the year at 169.
GWA projections for fiscals 2014 2018 are in line with its last forecast from October 2013, with fiscal 2014 results expected to be marginally higher than prior estimates. Overall, the authority projects senior DSC of 1.8x to 2.2x through fiscal 2018 despite rising debt service payments with the inclusion of the approved five-year rate plan. Positive rating action is contingent upon continued demonstration of meeting results within forecasted ranges and maintenance of adequate liquidity levels.
Overall, the Consolidated Commission on Utilities (GWA’s governing body) and the Public Utility Commission (the PUC) have shown a demonstrated commitment to raising rates to enhance system financial performance, approving cumulative increases of over 95% since fiscal 2007. Residential charges currently exceed Fitch’s affordability threshold with combined water and wastewater rates of $90.42 per month at 7,500 gallons of usage, equal to 2.6% of median household income (MHI).
GWA’s five-year rate proposal that covers fiscals 2014-2018 was approved by the PUC on Oct. 29, 2013. Remaining base annual rate increases range from 4% to 16.5% along with additional surcharges. As such, rates will increase to about 3.0% of median household income (MHI) by fiscal 2018, which is well above Fitch’s affordability threshold, assuming an increase in income of 2% per year from 2010 levels, at usage of 7,500 gallons per month. Despite GWA’s ratemaking bodies’ continued commitment to necessary rate hikes, the level of service charges could limit future rate flexibility to address expected capital needs.
In 2003 the authority negotiated a stipulated order (SO) with the USEPA as a result of violations to the CWA and SDWA. To cure system-wide deficiencies, the SO was subsequently amended and superseded by the order, which added several major projects to be constructed. Projects included in the order are expected to cost $269 million over the next five years. To date, GWA has completed or has programmed into the fiscal 2014-2018 CIP all but one of the 100 projects required under the order.
The USEPA also issued a notice of Findings of Significant Deficiencies for the water system in 2012 and for the wastewater system in 2013. Notably, the authority has addressed 26 of the 40 items identified for water, 10 are in progress, and four are long-term continuing actions. The authority has addressed 76 of the 88 items identified for wastewater and is developing corrective action plans for the remaining 12 items.
GWA’s progress in addressing regulatory requirements is a positive, but the authority faces significant capital needs to meet remaining requirements. The fiscal 2014-2018 CIP totals $403 million, with the order accounting for 67% of expected expenditures. Funding will be derived largely from ongoing issuances and remaining 2013 bond proceeds (84% of sources), which will drive GWA’s currently high debt ratios even higher, to an estimated 4x-5x Fitch’s median for investment grade credits.
The authority’s two largest wastewater treatment plants (WWTPs) have historically operated under secondary treatment variances issued by the USEPA under the CWA, allowing the authority to discharge primary effluent into the Philippine Sea. As part of their June 1, 2013 renewals, the discharge permits for both WWTPs include secondary treatment requirements.
The authority estimates the cost of upgrading both treatment plants at $279 million and is currently negotiating a schedule for compliance with the USEPA. The authority expects to receive approval to delay implementation until after completion of projects required under the order and notes that other agencies have negotiated extended compliance schedules of 20-25 years. However, if a shorter timeframe is required, there would likely be significant pressure on the system. The CIP through fiscal 2018 does not include the secondary treatment upgrade projects or the appropriations from the federal government.
Currently, the DOD build-up is expected to result in an increase of 7,400 military and civilian personnel after 2018. This compares to previous estimates of an ultimate increase to the island’s permanent population of around 32,000 people (approximately a 20% increase from the current level) as part of its relocation of troops from the nation of Japan.
Positively, the federal government recently appropriated $106 million for civilian water and sewer improvements on the island associated with an expected military build-up, the first time the federal government has actually appropriated money towards such action. Receipt of the monies is uncertain, but GWA expects to use the monies to bring one of the WWTPs up to secondary treatment. GWA continues to expect that any additional costs incurred as a result of the build-up will be borne by the military.
The island’s economy is driven by the military and tourism sectors. Most tourists are Japanese citizens, although there has been an increasing percentage of South Koreans visiting the island. The year 1997 was the peak year for visitors to the island before a series of setbacks from the Asian economic decline throughout the last decade and various natural disasters, continuing through the recent worldwide economic downturn. However, a recovery is evident with fiscal 2013 marking the second highest year for visitor arrivals and hotel occupancy rates at 85%, the highest in more than a decade; fiscal 2014 is on track to meet or exceed these numbers.
Unemployment on the island is mixed depending on the source, ranging from historically very high (in excess of 20%) to only moderately high. Wealth levels are low, with estimated MHI around 75% of the U.S. average.
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