S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Water And Sewer Ratingsdebt service payments and system maintenance.Frequency of payments to the debt service fundrange from monthly to semiannual transfers. Froma financial perspective, monthly deposits are preferred,since this approach allows a smooth buildupof the debt service fund and an early indication ofany shortfalls.The flow of funds also enumerates the issuer’sability to transfer surplus funds out of the system.A reliance on transfers from the utility to the generalfund adds to a system’s revenue requirementsthat can result in additional rate pressures for customers.While the ability to retain all surplus fundswithin a system is certainly a plus, transfers toanother fund are not necessarily a negative factor. Awell researched, flexible, consistent, and well communicatedtransfer policy is likely to offset the concernthat such transfers potentially can drain theutility’s cash position or constrain management’sability to fund capital improvements from earnings.In addition, the general government managers andpolicy makers will have less room for disagreementand debate if a transfer policy is well establishedand maintained.Whether a utility recognizes various overheadcosts through direct operational expenses orthrough transfers to other governmental funds hasno effect on the rating analysis. Standard & Poor’sreview includes a calculation where transfers andoff-balance sheet debt are considered along withdirect operation and maintenance expenses whencalculating debt service coverage. This additionalcoverage calculation provides further insight into asystem’s overall financial flexibility.Debt service reserve and other reserve fundsA fully funded debt service reserve can provide anadditional level of financial cushion for bondholders.When an unexpected budget shortfall occurs,the reserve fund gives the utility time to implementneeded adjustments before bondholders areadversely affected. The usual debt service reserverequirement is equal to the lesser of 125% ofaverage annual debt service, 10% of bond proceeds,or maximum annual debt service. For systemswith higher risk profiles, such as customerconcentration, cyclical economic bases, or consumptionand revenue volatility, a fully fundeddebt service reserve will likely make a difference inthe rating and may be essential for an investmentgrade rating. From a practical standpoint, however,the debt service reserve is really a liquiditysource and provides only limited additional securityto bondholders—-it essentially provides the utilitywith time to address whatever issues havepressured performance. It is also likely that if asystem needs to use the reserve, it is already intechnical default on the rate covenant.For utilities that consistently maintain high operatingreserves and sustain high debt service coveragelevels, the debt service reserve becomes less relevant.Policies that maintain coverage above covenantedlevels, fund a defined percentage of infrastructurerequirements internally, and maintain contingencyor capital reserves at defined levels, reduce the likelihoodof the utility ever falling into a position whereit would need to use the reserve. In such cases, nodebt service reserve may be needed to sustain a rating.Because unforeseen circumstances can occur,Number Of Participants Also A FactorWholesalers range in size from as small as three customers, to 50 or more. The precise rating approach will generally be determinedby, and may vary by, the size of the wholesaler’s customer base. Since a debt-issuing wholesale utility is reliant on the ability of itscustomer base to pay all operating costs plus debt service, the credit quality of a wholesale utility’s participants (whether they areconsidered members or customers) will affect the wholesale utility’s credit quality to varying degrees. If a wholesaler is made up of10 or fewer participants, and there are no contractual provisions that require non-defaulting members or customers to increase theirpayments to account for such delinquency, then Standard & Poor’s will employ a weak-link approach to the analysis. This is becausethe failure by a single participant to fulfill its payment obligations to the wholesaler would result in a project deficiency, therebyexposing bondholders to the credit quality of the project’s weakest participant.In cases where a wholesale utility has about 10-25 members, there may be certain additional factors that allow the wholesaleutility’s credit rating to move up or down from its customers’ or members’ credit quality. These factors include the project or system’soperating history; consistently high debt service coverage, which is uncommon for wholesalers; or the level of reserves typicallycarried by the wholesaler.Wholesale utilities with more than 25 members or customers, assuming there is not undue concentration among a very smallgroup of customers, can be expected to exhibit sufficient diversity to allow for a more system-oriented approach. Factors such asdebt service coverage, equity in the form of unrestricted cash and investments, and overall economic considerations will becomemore prominent in the credit analysis, similar to the analysis of municipal retail utility providers. Wholesalers of this type do notgenerally have limited step-up language in their governing agreements.www.standardandpoors.com119