Water Online the Magazine gives Water & Wastewater Engineers and end-users a venue to find project solutions and source valuable product information. We aim to educate the engineering and operations community on important issues and trends.
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Capital Funding Understanding Municipal Bonds And Their Benefits An analysis of tax-exempt bonds, the water/wastewater market, and infrastructure funding wateronline.com ■ Water Online The Magazine 16 I t's pretty amazing when one stops to think about the fact that Americans typically pay two to three times for cable and Internet what they pay for water service. Cable and Internet services can easily run the average family nearly $200 per month, while rates for water and sewer services usually don't crack $100 per month and often are below $50. Yet when one thinks about the necessity, capital intensity, and reliability of water as compared to other utilities, it ranks among the most vital, most consistent, and most capital-intensive. In a nutshell, water is by far the best value in utility services from both a rate and need perspective. So what drives this value? In part, in the U.S., we've subsidized water rates for public utilities through the use of tax-exempt bonds. As with most developed nations, we place a high value on having a safe drinking water supply. We find it worthwhile to subsidize the capital investments made in our water infrastructure by excluding interest earnings on debt used to finance capital projects from taxation at the federal level. There's been much discussion about privatization and/or public-private partnerships in the water and sewer sector, but many of these models appear to be based on European or developing nation models that lack the fundamental subsidy we provide to a capital-intensive sector. While public- private partnerships and privatization can be useful in certain circumstances, it's important to understand the fundamental impact of tax-exempt debt on this sector. Water and sewer entities are capital-intensive. Fixed assets tend to be a large component of most water and sewer utility balance sheets. As such, one would expect debt to be a major component of capital funding. On an asset-based approach, Fitch Ratings provides data that show the median debt-to-net-asset ratio is just below 50 percent across the industry. Based on Moody's data, we find debt service payments average over 20 percent of revenue, or the annual cash flow requirements of a public utility, and this excludes any cash spent annually on capital needs. Funding Costs Capital funding for utilities comes in a variety of forms. Most common for public utilities is some combination of the following: pay- go (or cash financed); direct debt; state revolving fund loans (or grants); and pos- sibly short-term financ- ing of construction in process. Direct debt of water and sewer utili- ties tends to be fairly consistent at about 10 percent of the overall tax-exempt bond mar- ket. From 2010 to 2013, annual water and sewer debt issuance ranged from $27.9 billion to $39.9 billion. Annual debt issuance can be further divided into refi- nancings and new debt for new projects. New capital project funding through debt ranged from about $15 billion to $28 billion over the same period. The rating agencies perform an independent review of a utility's credit worthiness. The results of their analysis are shown through the use of let- ter grades, with "AAA" or "Aaa" being the highest, or best quality, and "BBB-" or "Baa3" being the lowest investment By Kevin Thompson and Jay Gorman Moody's Ratings S&P; Ratings Fitch Ratings Aaa AAA AAA Aa AA AA A A A Baa BBB BBB Ba BB BB B B B Caa CCC CCC Ca CC CC C C C C1 RD D D Moody's also supplies numerical modifiers — 1, 2, and 3 — in each generic category classification from Aa through C. 1 — higher end; 2 — midrange; and 3 — lower end. S&P; also supplies modifiers, "+" and "-" in each generic category classification from AA through C. "AA+" — higher end; "AA" — midrange; and "AA-" — lower end. Fitch also supplies modifiers "+" and "-" in each generic category classification from AA through C. "AA+" — higher end; "AA" — midrange; and "AA-" — lower end. Figure 1. Ratings table, highest credit to lowest 1 6 _ V E R T _ 0 2 1 4 E Z i n e _ R a y m o n d J a m e s _ D G . i n d d 1 16_VERT_0214 EZine_Raymond James_DG.indd 1 1 / 3 1 / 2 0 1 4 1 : 0 6 : 0 5 P M 1/31/2014 1:06:05 PM