Fitch Rates Milwaukee (WI) Water Revs 'AA'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a 'AA' to the following Milwaukee, WI (the city) revenue bonds:

--$10.0 million water system revenue bonds series 2016 W10.

The bonds are expected to sell via competitive sale on Dec. 1, 2016. Proceeds of the series 2016 bonds will be used to permanently finance $10 million principal amount of commercial paper notes previously issued for improvements to the system and to pay costs of issuance.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from net revenues of the Milwaukee water works city's system (MWW, or the system) and a mortgage lien on the system. Additionally, the city has pledged any legally available funds, subject to annual appropriation, to subsidize any revenue shortfall. However, the city will not be obligated to make such an appropriation over and above the reasonable cost and value of services rendered to the city.

KEY RATING DRIVERS

STRONG COVERAGE, ADEQUATE LIQUIDITY: MWW's historically low debt burden has led to very high debt service coverage (DSC) levels, although cash levels are low from a primarily cash-funded capital program. DSC will decline with additional planned debt issuances but remain strong over at least the near term. Liquidity should remain stable.

CAPITAL PROGRAM TO REMAIN ELEVATED: The system's capital improvement program (CIP) has increased significantly since 2014 primarily to fund a long-term, comprehensive water main replacement program required by the Wisconsin public service commission (PSC) as a condition for future rate increase approvals. Additional CIP projects include lead service line (LSL) replacements and water treatment plant improvements that are expected to remain non-deferrable priorities.

INCREASING DEBT TO REMAIN MANAGEABLE: Currently low debt levels will escalate to fund the system's large CIP. Amortization should remain favorable as most future debt is expected to be funded by 20-year state revolving fund (SRF) loans.

CURRENTLY LOW, PSC-REGULATED RATES: System's rates are currently affordable relative to median household income (MHI) but are expected to rise to meet increased debt service over time. Rate increases are subject to Wisconsin PSC review and approval.

REGIONAL ECONOMIC ENGINE AND EMPLOYMENT CENTER: Milwaukee serves as the economic engine for the surrounding region. While the greater Milwaukee area has seen a measure of economic recovery, the city still exhibits persistent economic stress.

REVENUE PLEDGE SUPPORTS RATING: The 'AA' rating is supported by the strength of the net revenue pledge of the system and does not rely on the strength of the city's annual appropriation pledge.

RATING SENSITIVITIES

PUBLIC SERVICE COMMISSION RATE INCREASE APPROVAL: Milwaukee's ability as a rate-regulated utility to achieve timely rate relief to fund the sizeable capital program and maintain strong debt service will be critical to rating stability.

CREDIT PROFILE

MWW provides water to 865,000 people in 16 communities in Milwaukee, Ozaukee, and Waukesha Counties, Wisconsin. The system's customer base of 162,100 accounts includes retail customers in the city of Milwaukee and in five adjacent communities, as well as 11 wholesale customers. The customer base is primarily residential and customer concentration is minimal. MWW derives water from Lake Michigan which is then treated at two in-city treatment plants. Average daily demand of 81 million gallons per day (mgd) comprises a very low 21% of combined treatment capacity.

LONG-TERM FINANCIAL OUTLOOK

Financial results have been characterized by healthy operating flexibility but relatively weak cash levels. Recurring revenue growth has largely outpaced annual expenditures and low annual debt service has minimized the system's annual fixed cost burden, yielding exceptionally high DSC levels. Fiscal 2015 net revenues produced 21.2x DSC and since 2011 the system's operating margin has approximated 40%.

The system's low debt is due to a primarily cash-funded capital program. Unrestricted cash totaled $15.4 million in fiscal 2015 was a marked improvement from only $3.4 million in fiscal 2011 due to substantial interim rate increases but still a relatively weak 103 days cash on hand (DCOH), low compared to Fitch's 'AA' median of 485 DCOH. Annual cash levels have nonetheless exceeded the system's annual rate of depreciation in each year since fiscal 2011, indicative of a largely depreciated and aging system.

Management forecasts liquidity to approximate fiscal 2015 levels over the next five years, still weak for the rating but likely stable considering that nearly 75% of capital needs should be debt-financed. Additionally, the system makes payments in lieu of taxes to the general fund (averaging $12 million since 2011) as well as interfund loans to the city's sewer fund (rated 'AA'/Stable Outlook) and therefore cash levels are unlikely to improve beyond management's current expectations.

The system's near-term financial forecast shows DSC declining to lower but still very strong levels. By fiscal 2021 senior lien DSC, including debt service of the current series 2016 issue and a potential issue in 2018, is shown to approximate 16.2x. Coverage of all debt service (senior lien and SRF loans) should approximate 5.8x. DSC levels will continue to decline in the longer-term as management expects to issue upwards of $35 million in debt annually for at least the

10-year outlook. Likewise, currently low debt service as a percent of gross revenues, (2% in fiscal 2015), is shown to increase to almost 8% in 2021 and should rise steadily with additional debt in the long term.

Fitch expects that, on balance, the system's increasing capital and debt levels, declining but still robust DSC and relatively weak cash levels will more closely approximate credits within Fitch's 'AA' median portfolio over the long term.

LOW RATES TO RISE, REGULATED BY PSC

The system's water rates are billed quarterly and are comprised of both fixed and volumetric charges. The average customer pays about $26 per month, or about 0.8% of the Milwaukee MHI. This is reasonably below Fitch's affordability threshold of 1% of MHI for a single utility bill, but Fitch expects rates to rise over time to support planned additional debt and potentially pressure rate affordability. Though not definite, rate increases in the near-term could approximate between 3% to 6% to sustain revenue growth of about 3% annually while offsetting a continued trend in water usage declines due to greater conservation.

Rates are regulated by the Wisconsin PSC. In most years, the system requests rate increases based on the PSC's published cost of living increase (typically around 3%) with rates generally approved within a month or two. Full rate increases beyond cost of living adjustments are requested less frequently, requiring significantly more time to prosecute the case. The most recent full rate increase was requested in fiscal 2013 and not approved for nearly a year, with the increase primarily impacting fiscal 2015 revenues. Fitch views the presence of a third party regulator of rate increases as a rating limitation and restraint on revenue flexibility.

LARGE, LONG-TERM PRESCRIBED CAPITAL PROGRAM

The system's five year, fiscal 2017 - 2021 CIP totals $195 million and is on the rise from prior years' spending plans. The majority of the plan (74%) will support an extensive, long-term water main replacement program in order to fulfill a requirement set forth by the Wisconsin PSC as a condition for receiving additional full rate increases. The system must replace 15 miles of water mains per year beginning in 2015 and then increase to 20 miles per year by 2020 (roughly a 100-year replacement cycle) at a cost of around $30 million annually.

The CIP also includes $14.4 million (7% of CIP costs) to address a portion of the city's substantial prevalence of LSLs. Management estimates there are approximately 70,000 customers with LSLs and total replacement costs for the municipally-owned portion of the LSLs alone (not including the privately-owned portion) is estimated at up to $350 million, making LSL replacement a long-term priority. Remaining CIP funding addresses various water plant improvement projects, including storage and pump facility rehabilitations.

LOW DEBT TO RISE, REMAIN MANAGEABLE

The system's current debt load is minimal and primarily comprised of junior lien low-interest SRF loans. The system also repays general obligation (GO) debt and short-term extendable municipal commercial paper issued by the general fund on a basis subordinate to the bonds and SRF loans. As of fiscal 2015, total debt equated to only 8% of the system's net assets and a low $42 per capita.

Over the past 10 years the system has only intermittently used borrowings to fund capital spending, relying predominantly on internally-generated resources. The system now is transitioning to funding most capital needs with borrowable funds and projects issuing upwards of $164 million (approximately $27 million per year) from fiscal 2016 through 2021. This includes the current series 2016 issuance as well as another series of senior lien bonds in 2018 and around $100 million in SRF loans. Based on the long-term importance of the capital program's water main and LSL replacement projects beyond the current five year window, management expects leveraging to increase at around $35 million annually over the subsequent five year time frame. Debt per capita will rise moderately to a still low $166 by fiscal 2020 but could more than double by fiscal 2026 and more closely approximate the 'AA' medians.

REGIONAL ECONOMIC ENGINE AND EMPLOYMENT CENTER

Milwaukee, the largest city in Wisconsin, encompasses a 97 square mile area located adjacent to Lake Michigan and 90 miles north of Chicago. The city's population of nearly 600,000 has shown stability or marginal growth since the 2000 census, reversing a multi-decade trend of decline. Milwaukee serves as the economic engine for the surrounding region and has a fairly diverse economic and employment base. However, residents exhibit below-average wealth and a relatively large proportion earn below the poverty level. The local economy maintains a reduced but still above-average reliance upon manufacturing that in the past has created vulnerabilities to recessionary employment shifts.

Unemployment has shown declines in recent years (the city's rate was 6.3% in August 2016 compared to 6.8% the year prior) but in-city unemployment continues to exceed the rates of the state and nation.

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 Lumesis.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/site/re/869223

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1015119

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015119

Endorsement Policy

https://www.fitchratings.com/regulatory

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