Fitch Rates Clarksville, TN's Sr Lien Water, Sewer, and Gas Revs 'AA' & Sub Lien 2013 Bonds 'A+'
Fitch Ratings assigns the following ratings to Clarksville (TN) water, sewer and gas revenue refunding bonds:
--Approximately $43.66 million senior lien, series 2013 'AA-';
--Approximately $22.25 million subordinate lien, series 2013 'A+'.
Proceeds from the senior lien 2013 bonds will refund a maturing loan agreement with the city that provided interim financing to begin repairs of the wastewater treatment plant. Proceeds from the subordinate lien bonds will refund subordinate lien state revolving fund loans for savings. The maturity date is not being extended. The senior bonds include a debt service reserve, funded from bond proceeds. The subordinate lien bonds do not provide a debt service reserve.
Both series are expected to price in a negotiated sale on June 18, 2013.
Fitch also affirms the 'AA-' rating on the following outstanding parity senior lien bonds:
--$125.15 million water, sewer and gas revenue refunding bonds, series 2002, 2007 and 2011.
The Rating Outlook is Stable.
The senior lien bonds are special obligations of the city payable from a priority lien on net revenues of the combined water, sewer, and gas system. The subordinate lien bonds are secured by a subordinate lien on system net revenues. Net revenues include all revenues, earnings, and income of the system.
KEY RATING DRIVERS
COMBINED PLEDGE PRIMARILY WATER/SEWER: The water and sewer systems provide the majority of revenues for bondholders. The natural gas fund is healthy but margins are modest and it accounts for very little of the combined debt.
FORT CAMPBELL SIGNIFICANCE: Fort Campbell is the largest employer in Tennessee and Kentucky and plays a vital role in the regional employment and economic picture. However, the base is not a direct customer of the city's three utility systems. The base previously purchased natural gas but switched to purchasing only transportation service in 2012.
UNEXPECTED ADDITIONAL DEBT: Following extensive damage to the wastewater treatment plant from an extreme flood event in 2010, the city was notified in 2011 that FEMA would not pay the repair costs. While an appeal with FEMA is pending, the city is borrowing funds to complete needed repairs. Debt levels will increase to above average for the rating as a result.
SIZABLE SEWER RATE INCREASES: The city expects to raise rates to fund the flood-related debt. Management expects a package of rate increases to be adopted as part of the Fiscal 2013 - 2014 budget process in July 2013. Rate flexibility appears to exist to absorb the planned sizable increases.
FINANCIAL MARGINS REMAIN ADEQUATE: Clarksville projects that its financial margins will be lower than those previously achieved by the city but should remain in the range of 'AA-' medians at around 1.9x for the senior lien revenue bonds. Liquidity levels are average.
HEMLOCK FACILITY CANCELS PRODUCTION: A state-funded expansion of the water treatment capacity and related facilities was completed in 2012 in anticipation of demand related to a new $1.2 billion manufacturing facility locating in the state. Hemlock Semiconductor announced in 2013 that it does not plan to open the completed facility due to tariff disputes with China over its product, a component of solar panels.
LOWER FINANCIAL MARGINS: The financial forecast provided by management indicates financial margins for senior bondholders that are in the range of Fitch's 'AA-' medians. If lower financial metrics appear likely, rating pressure could result.
Located 50 miles northeast of Nashville, Clarksville is the fifth largest city in the state of Tennessee and the county seat of Montgomery County (Fitch rates the city's GOs 'AA' with a Stable Outlook). The city continues to experience strong population growth (more than double the U.S. and state rates between 2000-2011) in part driven by the expansion at Fort Campbell, which includes more than 30,000 military personnel and 53,000 family members in the region.
The water, sewer and gas system serves approximately 58,400, 48,900 and 24,400 customers, respectively, primarily in the city and portions of Montgomery County. Officials expect 2% - 3% annual growth in customer accounts over the next few years, which appears manageable given the system's ample treatment capacity.
Fort Campbell is not a customer of the water or wastewater system. The base used to be the largest natural gas customer until 2012 when it began purchasing its own natural gas. It is still a transportation customer of the city, which covers related system infrastructure costs. The margin the city made on the natural gas commodity sales to the base was minimal, so financial performance of the natural gas utility was not impacted.
FEMA WILL NOT FUND FLOOD RELATED DAMAGE
In May 2010, the city's one wastewater treatment facility and related lift stations were submerged in an extreme flood event on the Cumberland River. The city estimates that the total cost of recovery will be around $100 million. Clarksville has applied to FEMA for reimbursement of $76 million, which consists primarily of replacement of the wastewater treatment plant.
Initially, FEMA indicated to the city that it would fund the typical 75% of repair costs. However, FEMA indicated to the city in May 2011 that it would not fund the repairs and cited an unwritten internal policy. The city is appealing FEMA's decision. The city will use proceeds from the senior lien 2013 bonds to refund an interim state loan used to fund construction to date and to finance additional improvements (including a plant expansion). The city plans to use a similar $50 million interim state loan authorization to complete repairs of the plant over the next few years. Upon completion, the loan is expected to be refinanced as senior lien debt.
Planned capital spending for the wastewater system will address the damage sustained in the flood, but will also address permit violations that prompted the assignment of a Consent Order by the Tennessee Department of Environment and Conservation (TDEC) in 2012. The 2012 order replaced the 2004 order that dealt with similar violations.
Once the treatment plant expansion is complete, the dry weather treatment capacity will be 25 MGD and short-term wet weather treatment will be 75 MGD. The capacity will be sufficient to handle the storm water inflows that occur a few times during the year as a result of the combined sewer and stormwater system.
SEWER RATE INCREASES PLANNED TO FUND NEW DEBT
Residential sewer rates have not been changed since July 2009. Clarksville initially discussed rate increases in spring 2012 but decided to undergo a rate study first. The rate study recommended annual 9.5% rate increases over the next four years to support both system repairs and regulatory compliance needs. Management requested a four-year rate package consistent with the rate study recommendation in spring 2013 and final approval by City Council is anticipated to occur in July. Residential water rates have not been changed since July 2008 and no increases are anticipated. Industrial rates for both systems are established annually.
FINANCIAL MARGINS DECLINE BUT ADEQUATE FOR RATING
Combined system financial performance has been strong, with debt service coverage in fiscal 2012 of 2.6x for utility revenue bonds. The city has around $100 million in subordinate lien state loans in addition to $130 million in revenue bonds. Coverage of all obligations was 1.7x in fiscal 2012, or 1.5x after transfers each utility system makes to the general fund in lieu of taxes. Liquidity was below average for the rating but adequate at $35 million, or 271 days operating cash.
Debt service coverage levels are projected to decline with the issuance of the 2013 bonds and an estimated $57 million in parity revenue bonds in fiscal 2016. Debt service coverage of senior lien revenue bonds may decline to around 1.9x and all-in coverage including subordinate lien bonds and state loans to 1.3x, or 1.2x after general fund transfers, even with additional rate increases. Fitch views this decline as an indication that capital spending related to flood damage is pressuring the system's financial margins; however, these projected margins remain consistent with the rating category.
Combined system rates are currently around 1.7% of median household income but could increase to over 2.0% with the planned rate increases. Rate affordability in the community could influence the decisions regarding rate increases. Substantial differences in debt structure or rate increases may result in lower margins for bondholders, which could put pressure on the 'AA-' rating.
DEBT LEVELS ABOVE AVERAGE
Capital spending over the next five years (2014 - 2018) is expected to total about $150 million. The majority ($117 million) of planned spending will be for the wastewater system. Debt levels include approximately $168.8 million in senior lien revenue bonds with the issuance of the 2013 bonds and $63.5 million is subordinate lien obligations, including the 2013 bonds and two state loans. Debt levels are currently slightly above average for the rating and will increase. Amortization is slow given the recent issuance of much of the debt. However, future capital needs should be modest given the ample treatment capacity that will exist in each of the systems and the new age of the facilities. The overall debt service schedule remains fairly level through 2025 when there is a large decline, indicating available future debt capacity.
ADEQUATE WATER SYSTEM CAPACITY
The water system maintains an abundant supply drawn from the Cumberland River without permitted limitation. The existing water treatment plant has ample capacity of 30 million gallons per day (MGD) following the recent expansion in 2012 from 24 MGD. The expansion was funded by the state to absorb previously anticipated flows from the planned Hemlock Semiconductor Site. Clarksville is not assuming the Hemlock facility will open for revenue planning but the capacity is in place should the company decide to begin production. Average daily demand has ranged between 11 - 12 mgd over the last four years, and water loss has averaged almost 22% over the same period.
GAS SYSTEM OPERATIONS LOW RISK
The gas system accounts for very little (8%) of funds available for debt service, reflecting a healthy system that is relatively modest in terms of overall cash flow and debt burden. The gas utility has monthly adjustments in its rate structure, which recover actual commodity costs on a real-time basis. Large reductions in natural gas commodity prices over the past few years have been passed directly through to customers. The system's gas supply is procured almost entirely through a pre-paid gas transaction in 2006, which provides a fixed discount to market gas prices through 2021.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria' (June 12, 2012);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012);
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
Kathy Masterson, +1 415-732-5622
Fitch Ratings, Inc.
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Sara Ketchum, +1 212-908-0744
Steve Murray, +1 512-215-3729
Elizabeth Fogerty, +1 212-908-0526