Fitch Rates Memphis, Tennessee's $20MM 2009 Sanitary Sewer Revs 'AA-'; Outlook Stable

The 'AA-' rating reflects the sewer system's adequate but softening financial position; manageable capital needs relative to many older, urban sewerage systems; and favorable debt statistics, including rapid amortization. System rates are very low, despite recent increases, and collection rates are excellent, which aids in annual planning. However, the system's numerous industrial customers make it vulnerable to changing economic conditions, as was the case in fiscal 2009 when coverage and liquidity levels declined notably. Given the recent deterioration in financial performance it will be critical that the system achieve forecasted results, which point to near-steady improvement in system metrics over the next five fiscal years. Failure to meet these targets likely would result in negative rating action.

Financial results have improved in recent years, bolstered by rate increases in fiscal years 2005, 2009, and 2010, the first such increases since fiscal 1983. Coverage of annual debt service equaled a satisfactory 1.5 times (x) in fiscal 2008, which was in line with recent years' figures. However, the system maintained a below-average 144 days of cash on hand. The system remains exposed to economic downturns, given a concentration of industrial customers; Memphis's top 15 customers comprise nearly one-third of system revenues. The recent recessionary period highlighted this vulnerability, as average daily flows declined by 9.4% in fiscal 2009. Revenues grew by just 1.9%, despite a 9.5% increase in rates, and coverage of annual debt service fell to a low 1.2x (unaudited). The system's weak fiscal 2009 results are partially offset by its very low rate structure, which provides financial flexibility. However, the current economic environment could curtail a willingness to increase rates. Financial projections that include the most recently enacted 9.5% rate increase in fiscal 2010 show debt service coverage stabilizing at 1.3x in fiscal 2010 and then gradually improving to 1.5x by fiscal 2014. Coverage of at least these levels will be critical to maintaining the current rating.

The system's 2010-2014 capital improvement plan (CIP) totals just $97 million. The majority of planned spending will focus on routine maintenance and the expansion of interceptor lines, as well as the possible expansion of a treatment facility. Currently planned debt issuances are modest, which will keep leverage ratios low; the next borrowing of approximately $25 million will likely occur in fiscal 2012. However, annual depreciation far exceeds free cash, which could add considerably to future borrowing needs as the system's facilities continue to age. The system's rapid debt amortization rate is a credit strength, as essentially 100% of principal is retired within 20 years. The current offering and parity bonds are secured by net revenues of the system. Weak legal provisions on the bonds include a sum sufficient rate covenant and the inclusion of surplus revenues in the additional bonds test, which the system narrowly meets.

The system serves approximately 262,000 customers located mainly in the city of Memphis. Two wastewater treatment plants provide adequate treatment capacity of 225 millions of gallons per day (mgd) compared to an average daily flow of 154 mgd in fiscal 2009. The service area is diverse, with major employers in the transportation and warehousing and education and health services industries. Area economic indicators are slightly below state averages.

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