Fitch Rates Milwaukee Metropolitan Sewerage Dist (WI) GO Bonds ‘AAA’; Outlook Stable

NEW YORK

Fitch Ratings has assigned an ‘AAA’ rating to the following unlimited tax general obligations (ULTGO) of Milwaukee Metropolitan Sewerage District, WI (MMSD, the district):

–$47.5 million general obligation sewerage system refunding bonds, series 2015C.

The proceeds of the bonds will be used to advance refund certain outstanding obligations of the district for present value savings. The bonds are expected to sell via negotiation the week of Oct. 5, 2015.

The Rating Outlook is Stable.

SECURITY

The notes and bonds are supported by the full faith and credit and unlimited taxing power of the district.

KEY RATING DRIVERS

ESSENTIAL SERVICE PROVIDER: The ‘AAA’ rating reflects the utility’s role as a large regional sewer service provider, its stable operating profile, and its ability to levy ad valorem taxes for capital-related spending and debt service.

BROAD, DIVERSE ECONOMY: The service area is an economic engine for the state with a broad and diversified economy although post-recession recovery has been slow. District tax base growth has turned positive over the past two years following several years of declines.

BELOW AVERAGE SOCIOECONOMIC INDICATORS: Per capita income and market value levels are below average. The unemployment rate remains somewhat elevated, typical of areas historically dependent upon manufacturing. The region’s economy has an above-average manufacturing presence which has experienced modest positive improvement over the past year.

SOUND OPERATING PERFORMANCE: Long-term planning and prudent financial and debt policies support sound operating performance and competitive rates.

DEBT POSITION TO REMAIN SOMEWHAT HIGH: Fitch believes the district’s debt profile will not increase materially despite substantial capital plans through 2021, given the district’s annual pay-as-you-go (paygo) capital practices as well as rapid debt retirement.

MANAGEABLE PENSION AND OPEB: Actuarial pension funding requirements have been low, offset in part by increases in employee contributions. Future overall pension costs to the district should remain at manageable levels. Other post-employment benefits (OPEB) for the district are minimal.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics including the district’s strong financial management practices. The Stable Outlook reflects Fitch’s expectation that such shifts are highly unlikely.

CREDIT PROFILE

The district is a regional government agency that provides wholesale wastewater treatment and flood management services for 28 communities (18 in the district and 10 outside) in the greater Milwaukee area covering 411 square miles.

STABLE REGIONAL ECONOMY

The Milwaukee County (ULTGO rated ‘AA+’, Outlook Stable) economy is broad and diverse with a large presence of education and health services. Durable goods manufacturing employment remained stable at 177% of the national average in 2015.

The district’s economic base exhibited cyclical declines during the recent downturn but trends in overall employment and labor force over the past decade have been positive and in 2014 exceeded state and national growth rates. Both the county and metropolitan statistical area (MSA) unemployment rate show a marginal year-over-year decline, to 6.4% and 5.5% respectively for June 2015 but remain above state and national levels. Wealth and income levels are below national and state averages.

The district’s tax base is diverse and recorded a cumulative decline of 16.1% between 2008 and 2013. A 1.9% tax base increase was realized for 2014 and a further 0.7% tax base increase for 2015. District officials’ tax base growth projections in their long-range financial plans range from 2% to 3% annually, which Fitch believes is optimistic in the short term.

REGULAR REVENUE INCREASES; STABLE OPERATIONS

The district’s unrestricted cash and investments declined for the second consecutive year in fiscal 2014 due to its contractual obligation to return certain surplus revenues to retail customers. Cash levels remain within management’s target range of 60-90 days cash on hand (DCOH), totaling 77 days in fiscal 2014. Management expects a slight improvement in cash levels for fiscal 2016.

User charges are the primary revenue source for the district’s operating and maintenance (O&M) budget and have remained low and stable for individual users over time. Direct retail users represented 89% of fiscal 2014 operating revenues. The district remains willing to raise user charges; charges were increased 3.25% in 2015 and are expected to increase 2.5% in both fiscal years 2016 and 2017. Fitch expects that O&M rate increases should be manageable through the district’s current long-term forecast.

Rates and charges are not subject to regulatory approval. The average combined 2014 tax levy and user changes represent just under 1% of median household income, approximating Fitch’s affordability threshold. Fitch believes that projected rate increases should not adversely impact affordability concerns.

Budget surpluses are returned to retailers via a budgeted deficit in the following two years, which additionally helps to restrain user charge growth. Additionally, the district’s sale of its proprietary fertilizer, an economically sensitive revenue source, represented 10.1% of operating revenues in 2014.

Operating expenses net of depreciation remained stable from 2012 to 2014. The district selected a new operator, Veolia Water North America-Central LLC, through a competitive bidding process in 2008. The 10-year contract is expected to save $35 million across the life of the contract.

The district benefits from a dedicated unlimited property tax levied and collected by its members and contributions from 10 non-member communities restricted for capital expenditures. In fiscal 2014, these sources totaled $126.9 million or 1.2 times (x) principal and interest payments due in the same year.

The district is not subject to state tax levy limitations, and has shown a willingness to maintain or raise its tax levy to ensure continued adequate funding of its capital and debt programs. The district’s average annual levy increase from 2010 through 2015 was 2.2% with another 2.5% budgeted for fiscal 2016. The district projects continued 4% annual increases through 2020 which Fitch believes should be manageable.

SUBSTANTIAL CAPITAL PLANS; MANAGEABLE DEBT

Fitch believes debt levels will remain stable at the relatively high level given a sizeable capital plan, rapid amortization and Fitch’s expectation that even little to no tax base growth should result in comfortably absorbing the additional debt within the district’s policy limiting direct debt to 2.5% of market value. The overall debt burden for the district is average at $3,562 or a high 6.2% of full market value. A significant 72.9% of outstanding debt is retired within 10 years.

The district’s six year, fiscal 2016-2021 capital improvement plan (CIP) totals $596.2 million and includes enhancements to the water reclamation facilities, conveyance systems and improvements to address inflow and infiltration. The district will cash-fund 26% of its capital needs and require an additional $227 million in GO bonds, $163 million in additional clean water loans (all of which is repaid from the tax levy), and expects to receive about $23 million in interest earnings and $9.4 million in state aid and grants. In total, the district’s tax levy will provide $637 million and non-member billings $202 million to support both capital and debt service payments through fiscal 2021.

OTHER LONG-TERM LIABILITIES REMAIN AFFORDABLE

The district participates in the city of Milwaukee’s pension system, which was 97% funded on an actuarial basis in fiscal 2015, assuming an 8.25% rate of return. The funded ratio drops to an estimated 85% funded when adjusted by Fitch to reflect a 7% rate of return that same year.

The district annually funds actuarially required pension payments which have been low over the past three years, most recently $1.4 million or 2% of the 2014 operating budget. Investment smoothing has resulted in an increase in the annual required contribution when no contribution was required. However, changes in state legislation now require the employees to make the 5.5% of payroll employee contributions, formerly made by the employer on their behalf, largely offsetting pension budgetary pressure to the district.

The district’s annual OPEB pay-go payment is moderate at $4.6 million (3% of 2014 budget) and its unfunded actuarial liability is a manageable 0.3% of market value.

Date of Relevant Rating Committee: March 31, 2015.

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

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in Fitch’s Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991291

Endorsement Policy

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

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