CHICAGO – Fitch Ratings downgraded nearly $5.9 billion of Detroit water and sewer revenue bonds Monday due to the systems’ weakened financials, but they remain in investment-grade territory due to insulation from the junk-rated city of Detroit’s operations.
“Financial results have trended positive in recent years, but key metrics remain inconsistent with Fitch’s ‘A’ category medians,” analysts wrote of their action lowering $1.9 billion of senior lien water revenue bonds two notches to BBB-plus from A and $1.1 billion of second lien bonds to BBB from A-minus.
The agency lowered $1.9 billion of senior lien sewer revenue bonds one notch to BBB-plus from A-minus and another $974 million of second lien bonds to BBB from BBB-plus.
On the city’s sewer revenue bonds, Fitch wrote the downgrade “reflects weak financial performance below prior expectations as well as rising capital needs that could pressure the system’s already highly leveraged debt profile.”
Detroit owns the utility systems but they are operated as separate enterprise funds by the Detroit Water and Sewerage Department, and most of their revenues come from customers outside the city limits. The bonds are secured by revenues of each individual system.
Fitch rates the city’s unlimited general obligation debt CCC, several levels below the investment grade level of BBB-minus. While the water and sewer debt remains insulated from the weak credit profile of the city, which is now under state-imposed emergency fiscal management, Fitch “is concerned that potential actions to improve the city’s financial position could negatively impact the system’s long-term credit characteristics.” Fitch expressed the same concern in its downgrades of both the water and the sewer bond reports.
On the water bonds, Fitch said the credit rating reflects elevated debt levels with slow principal repayment but manageable capital needs that ease future borrowing pressures. Debt service coverage in fiscal 2012 barely exceeded 1 times while the median for an A level credit is 1.5 times. Days cash on hand in fiscal 2012 was 183 compared to 285 days for a single-A credit.
The water system provides an essential service to an expansive region of 4.2 million people or about 43% of the state’s population, Fitch said. About 70% of operating revenues come from wealthier suburban customers. The service territory consists of an area of 138 square miles in Detroit and 981 square miles in eight counties. Annual rate hikes have been imposed to support operating and capital needs. The fiscal 2013-2017 capital improvement plan totals $504 million, down from the prior five years.
The sewer system’s financials also fall below A medians. Fiscal 2012 debt service coverage equaled just over 1 times, below the 1.5 times median and days cash on hand was 131 days, which is short of the 285 median. Debt levels are high with slow principal repayment.
The system’s $736 million 2013-2017 capital improvement program is up by 28% from the prior five year plan due primarily to the department’s new long-term biosolids management program.
The sewer credit is supported by its expansive service area that covers 2.8 million people or 30% of the state’s population with more than 50% of operating revenues coming from wealthier suburban customers. Near annual rate hikes have also been made to support operating and capital needs.
On both credits, analysts said they are concerned over the potential impact of decisions the Detroit emergency manager may impose on operations or governance, especially ones that undercut the insulation the credit enjoys from city operations.
“Consequently, any actions taken that directly or indirectly change the historical paradigm could exert immediate and significant credit pressure on system bonds, particularly given the city’s very weak credit quality,” Fitch said.
Emergency financial manager Kevyn Orr began his new job in late March following his appointment by Michigan Gov. Rick Snyder under the state’s emergency management law due to the severity of the city’s fiscal woes. Officials from the water/sewer department were not immediately available to comment on the downgrade.