Jan 30 - Fitch Ratings affirms the following ratings on Puerto Rico Aqueduct
and Sewer Authority, Puerto Rico (PRASA, or the authority):
--Approximately $3.5 billion of outstanding revenue bonds, series A, B, 2012A
and 2012B (senior lien), at 'BBB'.
The Rating Outlook is Stable.
The bonds are secured by a gross lien of all authority revenues related to
PRASA's combined water and sewer system (the system), as defined in the amended
master agreement of trust (MAT), senior to all other debt or expenses of PRASA.
Authority revenues include operating revenues, as defined in the amended MAT
(e.g. user charges and impact fees), as well as governmental funds available to
pay current expenses; amounts from the Commonwealth of Puerto Rico (the
commonwealth) for payment of commonwealth guaranteed indebtedness (CGI) or
commonwealth supported obligations (CSO); and any amounts transferred from the
budgetary reserve fund (BRF), as created in the amended and restated Fiscal
Oversight Agreement (FOA) between PRASA, the commonwealth and the Government
Development Bank for Puerto Rico (GDB). The authority revenues received from the
commonwealth for CGI and CSO are not subject to lien of the MAT and are not
available to pay debt service on the bonds.
MARGINAL FINANCIAL RESULTS: Major improvements in operations and financial
performance have occurred since the change in governance structure in 2004.
However, financial margins remain minimal and there are significant revenue and
expense challenges that could pressure results over the next several years.
EXTENSIVE CAPITAL NEEDS: The capital improvement program (CIP) is substantial
and fairly rigid over the near term. Resulting borrowing demands are sizeable
and will continue to pressure PRASA's debt profile over the long term.
SOLID MANAGEMENT AND COMMONWEALTH SUPPORT: PRASA management is strong and the
system also benefits from GDB advisory support and interim funding as well as
historical support from the commonwealth.
WEAK BUT EXTENSIVE SERVICE AREA: The service territory is diverse, although weak
economic conditions have been protracted and customer wealth levels are limited.
ESSENTIAL UTILITY: The system provides an essential service to the residents of
WHAT COULD TRIGGER A RATING ACTION
CHANGE IN THE COMMONWEALTH RATING: Any deterioration in the commonwealth's
credit quality would likely affect the rating on the bonds given the historical
and expected support of the system by the commonwealth, both directly and
INABILITY TO ELIMINATE BUDGETARY SHORTFALLS: Failure to identify and enact
revenue solutions to meet forecasted budgetary gaps beginning in fiscal 2014
would have negative rating implications.
LACK OF COMMONWEALTH SUPPORT: A reduction or elimination of commonwealth
support, either from direct appropriations or support from the GDB, that
jeopardizes PRASA's current operating capacity would negatively affect the
GROWTH IN CAPITAL COSTS: Acceleration or escalation of the large and complex CIP
without accompanying financial improvement could add negative rating pressure.
PRASA provides water service to virtually the entire island, including the
roughly 4 million residents and 5 million annual tourists; sewer service is
limited to around one-half of the island. After a decade of privatization,
operations were transitioned back to the public side in 2004 and the
commonwealth reorganized PRASA's board and executive management with the goals
of limiting political interference, improving the organizational structure, and
returning the authority to financial viability without commonwealth
subsidization. Since this change, operating, financial, and regulatory
performance have improved overall, although significant challenges persist and
are expected to be ongoing for the foreseeable future.
RECENT FINANCIAL RESULTS CHALLENGING
For fiscal 2010, net revenues based on audited figures (consistent with prior
MAT requirements) provided senior lien debt service coverage (DSC) of a
reasonable 1.6x. However, PRASA was unable to meet its obligation to pay debt
service on the commonwealth-supported Superaqueduct bonds (PRASA's fifth lien
debt) in July 2009 given PRASA's depleted balance sheet position. Instead, debt
service on these bonds (around $27 million) was paid by the commonwealth;
failure by PRASA to pay CGI or CSO does not constitute an event of default under
the MAT. For fiscal 2011, senior lien DSC from net revenues improved to 2.5x
based solely on funds from operations. But again, PRASA was reliant on the
commonwealth and GDB for sufficient funding to pay subordinate debt service. In
total, PRASA received $105 million from these two sources.
For unaudited fiscal 2012, net revenues improved by $9 million despite operating
expenses rising 14% for the year. Increased operating expenses were driven by
rising power and personnel expenses (up $44 million and $25 million
respectively), but were offset by$70 million in commonwealth appropriations and
$95 million in draws on the BRF. Nevertheless, PRASA experienced a $20 million
increase in total debt service costs for the year, which continued to pressure
DSC for the year.
Based on PRASA's amended MAT, which provides for a gross revenue pledge for
senior lien bonds, PRASA was able to generate senior and total DSC of 8.1x and
1.0x, respectively, for fiscal 2012, results that were in line with prior
expectations and in compliance with PRASA's rate covenants; under the amended
MAT, the rate covenant includes revenues on a cash basis and expenditures on an
accrual basis net of applicable non-cash reserve adjustments. However, in
comparison to prior year coverage calculations, net revenues covered senior lien
DSC by just 2.0x while total DSC was below 0.8x, similar to fiscal 2011 results.
Despite the net revenue calculation, PRASA was able to pay all debt service and
operating costs from available funds given certain expenses included in the net
revenue calculation relate to non-cash accruals.
INCREASING BUDGETARY GAP
Throughout the financial challenges PRASA has faced over the last several years,
management has actively identified and implemented targeted revenue enhancements
and expenditure reductions and continues this process with favorable success.
Continuation and enhancement of these initiatives will be important to the
ongoing financial health of the utility. However, even with these initiatives,
management continues to forecast the need for sizeable additional revenues to
meet all operating and increasing debt service obligations.
While the funding of the BRF from 2012 bond proceeds has alleviated immediate
cash flow pressures through fiscal 2013, PRASA is forecasting significant budget
deficits beginning in fiscal 2014 that greatly exceed prior year appropriations
by the commonwealth. Fitch remains concerned that these deficits may place a
significant financial strain on commonwealth resources. Alternatively, if PRASA
were to fund these shortfalls entirely through increased user rates, required
increases would be substantial and may be difficult to fully achieve given the
currently elevated utility rates and the high poverty level on the island.
Fitch has developed a stress scenario to evaluate the rate hikes necessary to
recover these unidentified revenues based on a bad debt rate of 10%, forecasted
operating revenues, and planned debt issuances. Based on these assumptions and
no commonwealth appropriations in fiscals 2014-2017, rates would need to
increase by over 50% for fiscal 2014 followed by additional annual hikes in the
5%-10% range for fiscals 2015-2017, respectively, to generate the $342
million-$485 million of annual unidentified revenues projected by PRASA; it
would be expected that additional rate hikes would also be necessary beyond
Fitch will closely monitor the identification and implementation of revenue
sources and could take negative rating action in the future if budgetary
deficits continue to escalate and/or clear plans for the generation of such
revenues is lacking. Furthermore, given that PRASA's rating is enhanced by the
historical support of the commonwealth - both directly and indirectly through
the GDB - a reduction or cessation of commonwealth support that would hinder
PRASA's ability to generate sufficient revenues for operations would diminish
PRASA's credit quality and lead to negative rating action.
CAPITAL NEEDS REMAIN SIZEABLE
Central to PRASA's challenges are the scope of needed capital investment to
maintain regulatory compliance and renew system assets given the limited
historical investment in the system's infrastructure and the resulting pressure
this places on operations. While PRASA's management has successfully executed
key components of the CIP, particularly those required by regulators, projected
capital spending over the fiscal 2013-2017 CIP period remains sizeable at $1.5
billion and is expected to remain elevated well beyond fiscal 2017 as PRASA
carries out improvements related to its 2011-2030 master plan. PRASA is in the
process of renegotiating its existing consent decrees with regulators in an
effort to establish a prioritization of projects and smooth the economic impact
of the CIP on an annual basis. If approved, this would likely alleviate
near-term capital pressures to some extent and provide a longer period with
which to meet regulatory milestones but may also include additional required
projects over time.
RISING DEBT TO KEEP MARGINS LOW
With minimal surplus revenues available for equity funding of capital, PRASA
anticipates relying almost exclusively on borrowable sources. Consequently, debt
levels, which are already elevated, will rise further as the CIP progresses and
continue to place pressure on the authority's already weak financial margins.
Overall, PRASA expects total revenues, as well as the unidentified revenues
previously mentioned, to cover all flow of fund requirements by around 1.0x-1.1x
through fiscal 2017. Senior lien DSC is expected to be higher at 2.8x-7.2x based
on the new gross revenue for senior lien bonds but a more modest 1.4x-1.9x using
the more traditional net revenue basis. Given the rising debt burden, debt
carrying costs are expected to increase from 20% of gross revenues experienced
in fiscal 2009 to around 34% expected by fiscal 2015.