Fitch Assigns 'AA-' to Pearland, Texas' Water & Sewer Revs; Outlook Stable

Fitch Ratings assigns an 'AA-' rating on the following City of Pearland, Texas (the city) bonds:

--Approximately $9.21 million of water and sewer system revenue bonds, series 2014.

The bonds are scheduled to sell via competitive bid the week of Sept. 22. Proceeds will be used to pay for waterworks and sanitary sewer system (the system) improvements and to pay the costs of issuance.

At this time, Fitch also affirms rating on the following bonds:

--$2.6 million in water and sewer system adjustable rate revenue bonds, series 1999 at 'AA-';

--$60.7 million water and sewer system revenue bonds, series 2007, 2008, 2009 at 'AA-';

--$10.2 million water and sewer system revenue refunding bonds, series 2006 at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a first lien on the net revenues of the city's system, excluding impact fees. A cash funded debt service reserve will be funded over a 60-month period.

KEY RATING DRIVERS

ADEQUATE FINANCIAL PERFORMANCE: System liquidity has softened slightly over the last two years, registering at just under 200 days of cash on hand (DCOH) for fiscal 2013, falling from over 270 DCOH in fiscal 2011. Senior lien debt service coverage (DSC) remains sound at 1.8x, with all-in DSC an adequate 1.5x.

GROWTH DRIVEN CAPITAL: Capital improvements are driven by the need provide capacity for future growth and the conversion of water supplies to surface water from groundwater to address regional subsidence issues.

RISING DEBT BURDEN: The system's growing capital needs will be largely debt financed and will add to the system's debt burden. Debt per customer levels are on par with 'AA' category medians but will somewhat outpace expected growth in the medians over the next five years.

STRONG, GROWING SERVICE AREA: The area is a rapidly growing community and benefits from close proximity to the Houston metropolitan area. Wealth levels are very high and city unemployment levels are favorable.

AMPLE RATE FLEXIBILITY: The city retains abundant rate flexibility as user charges fall well below Fitch's affordability threshold of 2% of median household income (MHI).

RATING SENSITIVITIES

DEBT BURDEN PRESSURES RATING: Significant increases to the system's debt burden would push debt ratios to high levels that would not be commensurate with the current rating level.

DETERIORATION OF FINANCIAL PROFILE: Failure to maintain sound coverage levels and cash position while balancing its long-term capital needs could cause downward pressure on the system's rating.

CREDIT PROFILE

The system provides retail service to an expanding population of approximately 100,000 residents, representing over 32,000 water and 33,000 sewer connections. The city has undergone rapid growth recently, averaging 3.7% annually since 2009. Due to these growth pressures, the system's focus has been on ensuring that adequate water supplies are available to meet the current population and projected demands.

Current water supplies are derived from groundwater pumped with system wells and surface water purchased from the City of Houston. Groundwater wells supplied around 60% of the system's 2014 water needs and surface water accounts for the remaining balance. The Gulf Coast region is prone to land subsidence as a result of ground water pumping, with many municipalities in the region being required by the state to convert to predominantly surface water supplies. While the system is not under any regulatory directive to reduce its groundwater pumping, they are proactively converting to surface water to address the wider regional subsidence issues. Future water supplies will be surface-water in nature and will be derived from Houston via participation in Houston's southeast water purification plant as well as raw water purchased from the Gulf Coast Water Authority to be used at the city's planned surface water treatment plant.

GROWTH NEEDS SPUR CAPITAL AND INCREASE DEBT

The system's five-year capital improvement program (CIP) for fiscals 2015-2019 totals $165 million, up over 45% from the fiscal 2013-2017 CIP. Included in the plan are sizable projects related to the construction of a surface water treatment plant to address regional subsidence issues and expansion of two of the city's five wastewater treatment plants. System debt ratios align closely to 'AA' category median now with debt per customer of $1,860 just above the 'AA' median of $1,812 and debt to net plant assets at 43%. The system's debt profile will grow as a result of the debt financed capital expansion plans. Debt per customer will grow to $2,806 by 2019, compared to the 'AA' median of $1,973.

ABUNDANT RATE FLEXIBILITY

System charges have remained flat following substantial double digit rate increases from fiscals 2007 to 2009. Management is forecasting annual rate increases that will range from 4% to 9% annual through fiscal 2019 in support of the CIP. Rates as a percent of MHI are currently a very affordable 0.8% MHI. Despite planned annual increases, rates will register at only 1% of MHI by fiscal 2019, well under Fitch's 2% MHI affordability threshold. The system rate structure provides for a significant 47% in a fixed base rate charge. Fitch views both the significant base rate percentage and the system ample rate flexibility as positive credit factors. The city's ample rate flexibility and council's historical support of rate increases in support of debt carrying costs mitigate some of Fitch's concern over debt burden growth.

DECLINING COVERAGE

Historically senior lien DSC was strong at over 2.0x prior to debt costs ramping up in fiscal 2011. Since then senior lien coverage has declined, but remains healthy at 1.9x and 1.8x for fiscal years 2012 and 2013, respectively. The city has also added system-supported general obligation debt to its portfolio since fiscal 2011. This resulted in all-in DSC dropping to a slightly weaker 1.5x, but still adequate for the rating level. Liquidity for fiscal 2013 is down to just under 200 DCOH after peaking at 277 days in fiscal 2011. Cash levels for the system should remain relatively stable given city's plan to largely debt finance its CIP.

Management's policy is to adopt a system budget annually to achieve a 1.4x average annual DSC on its senior lien debt per bond ordinance. Management calculated projections indicate DSC of 1.4x to 1.5x excluding the use of impact fees through fiscal 2019, in line with its policy. The system also has approximately $7 million in impact fee reserves that can be transferred to assist with the payment of debt service.

STRONG, GROWING SERVICE AREA

The city (general obligation debt rated 'AA' by Fitch) is a commercial center located in the northeast corner of Brazoria County, with small portions in Harris and Fort Bend Counties, 15 miles south of downtown Houston. Population expansion has been rapid in the last decade, growing by nearly 150% since 2000. Due to the city's proximity to downtown Houston it has become an area of continuing growth in residential, commercial and some light industrial. Wealth levels are high at 73% and 68% above the state and nation, respectively. Area unemployment is also low at 4.2% for June 2014, well under the state (5.6%) and the nation (6.5%).

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

In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and the Municipal Advisory Council of Texas.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Sector Outlook: Water and Sewer' (December 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=872754

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