Fitch Affirms Jefferson County, AL's Sewer Revs at 'BB+' & 'BB'; Outlook Stable

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings affirms the following ratings for Jefferson County, AL's (the county) warrants:

--$395.0 million senior lien sewer revenue current interest warrants series 2013-A at 'BB+';

--$55.0 million senior lien sewer revenue capital appreciation warrants series 2013-B at 'BB+';

--$150.0 million senior lien sewer revenue convertible capital appreciation warrants series 2013-C at 'BB+';

--$808.6 million subordinate lien sewer revenue current interest warrants series 2013-D at 'BB';

--$50.3 million subordinate lien sewer revenue capital appreciation warrants series 2013-E at 'BB'; and

--$324.3 million subordinate lien sewer revenue convertible capital appreciation warrants series 2013-F at 'BB'.

The Rating Outlook is Stable.

SECURITY

The senior lien warrants are payable from gross system revenues of the county's sanitary fund, which does not include sewer tax revenues that are used for operations. The subordinate lien warrants are payable from system revenues after payment of the senior lien warrants.

KEY RATING DRIVERS

FLAT CUSTOMER BASE: Jefferson County provides sewer service to a large service area across the entire county with an economy that continues to diversify. Flat customer trends precludes growth-related capital needs but burden the existing customer base with substantial existing debt and infrastructure reinvestment costs.

FINANCIAL SELF-SUFFICIENCY: The county's exit from bankruptcy in 2013 returned the county's sanitary sewer fund to an adequate financial position in fiscal 2014. The county's sewer fund ended fiscal 2014 with $9.7 million in unrestricted cash (or 67 days of operations) and all-in debt service coverage (DSC) of 1.8x.

INCLINING DEBT SERVICE STRUCTURE: Sewer system cash flows are sufficient to generate healthy all-in DSC of at least 1.6x and meet capital demands through 2023. In 2024 and beyond, DSC is projected to be modest at around 1.25x as a result of back-loaded debt service, which will provide insufficient remaining cash flow to support known capital needs.

EXCEEDINGLY HIGH DEBT BURDEN: System debt levels are exceptionally high, even with the substantial reduction in system debt achieved by the exit from bankruptcy in 2013. Further, the very slow pace of debt amortization and use of capital appreciation warrants will result in an elevated debt burden for decades even without additional borrowings.

COMMISSION SUPPORTED RATE INCREASES: The Approved Rate Structure (ARS) includes annual rate adjustments through final maturity of the warrants (2053). Ongoing support of the Commission to implement the annual rate increases authorized by the ARS, and any additional future rate adjustments that may be required to meet the rate covenant on the warrants, is key to the ratings.

ONGOING LITIGATION RISK: Litigation is ongoing regarding the bankruptcy court's authority to enforce the ARS. While Fitch continues to assess the risk of potential litigation to credit quality, the ratings reflect the political will and authority of the County Commission to enforce the ARS and produce sufficient revenues to pay warrantholders. Less rating support is placed on the authority of the bankruptcy court to enforce the ARS in the absence of Commission action to do so in the future.

RATING SENSITIVITIES

HINDRANCES TO APPROVED RATE STRUCTURE (ARS): Any action which limits or repeals the ARS would be viewed as a material weakening of Jefferson County's ability to operate the sewer system and meet obligations to warrantholders. Downward rating pressure would be expected to follow in turn.

UNLIKELY UPWARD RATING POTENTIAL: The rating is unlikely to move upwards given the long-term capital demands of the system, back-loaded debt and rate sensitivity beyond increases in the ARS.

CREDIT PROFILE

Jefferson County is located in northeastern Alabama and has an estimated population of around 660,000 people, which has been flat since at least 2000. The county provides retail wastewater collection, treatment, and disposal service to a 440-square-mile area that includes 23 municipalities within the county (including the cities of Birmingham and Bessemer) as well as unincorporated parts of the county and very small portions of Shelby and St. Clair Counties. The cities of Birmingham and Bessemer bill customers directly for sewer service on behalf of Jefferson County and account for 91% of customers.

The county declared bankruptcy in November 2011 following default on its sewer warrants, general obligation warrants and lease obligations. The chapter 9 plan of adjustment was approved by the bankruptcy court on Nov. 22, 2013 allowing the county to exit bankruptcy. The bankruptcy plan allowed the county to restructure its debt by issuing the senior and subordinate series 2013 warrants.

RETURN TO FINANCIAL SUFFICIENCY IN 2014

The county's 2014 audit indicated a return to financial sufficiency of the sewer system. The bankruptcy plan included the forgiveness of $1.4 billion in outstanding debt and the 2013 warrants restructured repayment of the remaining debt through 2053, providing significant debt service payment relief in the early years. As a result, full debt service was paid and all-in DSC was healthy at 1.8x.

In addition, the 2014 audit was completed by March 31, 2015 and newly required quarterly statements have also been provided in a timely manner. This represents improved disclosure from the past years of delayed audits with material concerns. The county continues to receive a qualified opinion in regards to the sewer fund since the value of the assets contributed in the 1990's from other sewer systems in the county cannot be verified through documentation. The qualification is not a rating concern since system assets may be understated, as a result. All other material audit concerns have been resolved.

FISCAL 2015 PERFORMANCE TO DATE AS EXPECTED

Audited results for fiscal 2015 will not be complete until March 31, 2016 but third quarter financials show revenues and cash levels in line with fiscal 2014 performance and expenditures trending lower. Coverage is expected to meet or exceed the original 2013 feasibility forecast in fiscal 2016 of 1.6x DSC.

The county's financial staff, under the direction of the chief financial officer, continues to build upon work done in the past two years to modernize and clean up the internal accounting processes within the county. In 2015, the county implemented a new accounting system that it believes will further improve financial reporting.

INCLINING DEBT SERVICE STRUCTURE CREATES OUT-YEAR PRESSURE

Favorable financial performance through fiscal 2023 is in large part due to a back-loaded debt structure and the use of capital appreciation bonds. Debt service increases nearly 70% in fiscal 2024 from the prior year to over $140 million and then continues to escalate 3% annually through fiscal 2039. This large jump in debt service costs is concerning. Based on the 2013 feasibility report (the most recent forecast available), all-in DSC is projected to fall to 1.25x, with annual rate increases, but cash flow will be inadequate to fund the system's known capital needs.

Fitch is concerned about the system's practical ability to increase rates above those contemplated in the ARS to cover the shortfall in meeting basic ongoing capital expenses in 2024 and thereafter. Fitch further believes the risk of enhanced environmental requirements regarding sewer treatment and discharges is likely over the long term. To the extent these regulations translate into additional capital and/or operating expenses, system financial projections will be strained even further.

COMMISSION SUPPORT FOR APPROVED RATE INCREASES IS KEY

Implementation of the ARS is a key credit factor supporting the ratings on the 2013 warrants. The ARS was adopted by the County Commission (the commission) in October 2013. The October 2013 resolution enacting the ARS approved four annual rate increases of 7.89% effective on Nov. 1, 2014 and Oct. 1, 2015-2017. Thereafter, the October 2013 resolution provides for annual 3.49% increases beginning Oct. 1, 2018 and continuing as long as the 2013 sewer revenue warrants are outstanding. The commission retains its ability to make additional rate adjustments through the enactment of adjusting resolutions as long as the rate covenant is maintained.

The adoption of the ARS is a credit positive in that it alleviates some political pressure to act on raising rates in the future. Nevertheless, Fitch remains concerned regarding the implementation of future rate increases given the political backlash that may ensue from the prolonged escalation in rates associated with the ARS. In addition, Fitch is concerned that the resulting cost of service from the ARS implementation severely limits the county's ability to increase rates beyond the level permitted by the ARS to meet expected shortfalls in capital spending needs in fiscal 2024 and thereafter through either pay-as-you-go capital or through servicing additional debt. An average sewer bill in fiscal 2014 is approximately $56 per month (based on Fitch's standard usage of 6,000 gallons), which accounts for 1.5% of median household income.

The ARS was incorporated into the plan of adjustment, at the county's request, in order to allow the bankruptcy court to retain jurisdiction. The county believes that, as a result, the ARS will be enforceable by the court. Litigation is ongoing that challenges the bankruptcy court's authority to enforce the ARS. Fitch's ratings are based on ongoing support of the elected County Commission to enforce and uphold the ARS and the rate covenant with warrantholders. Any indication of the commission's intent to do otherwise would pressure the rating. Fitch views the ongoing community discord and legal challenges regarding the ARS as concerns to credit quality in that they could pressure future support from the commission to uphold the ARS.

SIGNIFICANT LEVERAGE REMAINS

System leverage ratios are exceptionally high despite the reduction in system obligations negotiated with creditors under the plan of adjustment. Debt per customer is $12,975 (as compared to Fitch's national median or $1,650 per customer) while debt to net plant is high at 80% (Fitch sector median is 47%).

System leverage will be a key credit concern for some time given the use of CABs and the back-loaded debt structure that yields a minimal principal amortization rate of 4% and 8% in the 10-year and 20-year horizons, respectively. Such slow amortization will constrict the system's capacity to absorb any future debt that may be needed for system capital purposes and will also absorb much of the annual rate increases approved in the ARS through the term of the warrants. Favorably, the system has no variable interest rate risk or exposure to swap termination payments, both of which were major contributors to the county's prior bankruptcy filing.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223

Additional Disclosures

Dodd-Frank Rating Information Disclosure Formhttps://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994234

Solicitation Statushttps://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994234

Endorsement Policyhttps://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

View source version on businesswire.com: http://www.businesswire.com/news/home/20151117006482/en/

Fitch Ratings
Primary Analyst:
Kathy Masterson, +1-512-215-3730
Senior Director
Fitch Ratings, Inc.
111 Congress Ave., Ste. 2010
Austin, TX 78701
or
Secondary Analyst:
Larry Levitz, +1-212-908-9174
Director
or
Committee Chairperson:
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
New York
[email protected]

Source: Fitch Ratings

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