CHICAGO — Many highly-rated sewer utility credits can weather federal consent decrees that mandate substantial upgrades with proper management and planning for the increased costs, Moody's Investors Service concludes in a new report.
The report "Most U.S. Sewer Utilities Can Weather Costs of Federal EPA Consent Decrees" looked at the management among utilities it rates of consent decrees in which the U.S. Environmental Protection Agency settles environmental regulatory disputes over the Clean Water Act.
"Most of the time, utilities can operate effectively under consent decrees if they manage and appropriately plan for the attendant increases in debt and user rates. They are able to implement the requirements of a federal consent decree, comply with environmental regulations, and pass the cost along to customers," says Moody's analyst Dan Seymour, one of the report's authors.
Moody's assigns 40 revenue ratings on municipal sewer systems that are under consent decree, representing about 7% of its rated sewer utilities. The median revenue rating for systems under consent decree is Aa2, higher than the municipal utility sector median of Aa3.
Aiding utilities in the consent decree process is the EPA's consideration of a utility's ability to fund upgrades required by a settlement. "An overly onerous consent decree that would place undue financial pressure on a public utility is unlikely to advance the EPA's interest in protecting the environment," the report found.
The EPA factors in a utility's bond rating, income levels, the local property tax burden, and the affordability of user rates. The EPA considers wastewater costs exceeding 2% of median household income to be a heavy burden and has extended deadlines if the costs of compliance near that threshold. The EPA also allows utilities to convert civil penalty payments into projects.
Consent decrees typically spread out the pain of financing upgrades over several decades, giving utilities flexibility in developing rate schedules. Compliance timelines of 15 years or more accompany most of the large consent decrees, Moody's said.
Though challenging, consent decrees may provide some positive features to a credit. Utilities typically submit to quarterly or semi-annual compliance reporting and commit to increasing rates to pay for capital upgrades, ensuring capital investment that might otherwise have been ignored or delayed. Some borrowers also benefit from prioritized participation in state revolving funds that offer low cost loans.
On the flipside, not all utilities can weather the increased fiscal pressure. Settlements typically require additional debt issuance which can weaken credits if revenues don't adequately support the borrowing and weaker debt structures, or weakened legal provisions might be used.
"The combination of higher debt and political resistance to higher rates can sometimes weaken debt service coverage," the report found. The median debt service coverage for sewer systems under consent decree is 1.6 times compared with a median of 1.84 times for sewer systems and 1.98 times for water/sewer systems.
Moody's has downgraded the Miami-Dade County Water and Sewer Enterprise and the East Baton Rouge Sewerage Commission, both to Aa3 from Aa2, in part due to consent decrees.
Jefferson County Sewer Enterprise, Ala., stands out as the most notable exception to credits surviving consent decrees after its default on $3.1 billion of sewer revenue debt. The county's default on its sewer warrants, however was more complex, and due to a complex and risky debt structure, a failure to abide by bond covenants, and a refusal to increase rates, Moody's said. Some of the individuals involved with structuring the bonds were charged with criminal corruption.
"Complying with a consent decree is primarily a management challenge, and occasionally systems do not manage capital upgrades or rate increases well," the report said. "The systems that have sustained the most credit pressure due to consent decrees are not the ones with the largest settlements but the ones least willing or able to pay for them."
Moody's stressed that a consent decree is rarely the sole reason behind severe credit deterioration and more commonly stems from a utility's unwillingness to fund capital upgrades or increase rates.
The Aa1-rated Metropolitan St. Louis Sewer District in Missouri, the Aa2-rated Kansas City Sewer Enterprise in Missouri, and the A1-rated Allegheny County Sanitary Authority in Pennsylvania all passed multiple consecutive rate increases of at least 10% annually following their settlements.
The Aa1-rated Hartford, Conn., County Metropolitan District implemented a special sewer surcharge based on flow. The district is issuing revenue bonds secured by the surcharge to fund an estimated $2.1 billion of projects under the settlement. Voters in Atlanta approved a one-cent sales tax in 2004 to help fund projects under the Atlanta Water and Wastewater Enterprise's more than $1.7 billion consent decree. Voters' willingness to reauthorize the tax helped win the system an upgrade last year.
Consent decrees typically arise when state regulators, environmental groups, or other stakeholders litigate against a utility for alleged CWA violations, which prohibits the discharge of untreated wastewater into waterways. The decrees typically lay out targets for overflow reductions, needed capital projects and improved maintenance programs, all to be completed during a designated time frame.
