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Fitch Assigns A ‘aa’ Rating To Tacoma, Wa’s $13 Million In Solid Waste Revenues, With A Stable Outlook

New York, 14 March 2022: Fitch Ratings: Tacoma, Washington’s $13 million solid waste revenue bonds, 2022 have been granted a ‘AA’ rating by Fitch Ratings. Fitch also maintains its ‘AA’ rating on the outstanding series 2015, 2016A, and 2016B solid waste utility revenue and refunding bonds. During the week of March 23, 2022, the 2022 bonds will be priced in a negotiated sale. The revenues from the bonds will be used to purchase compressed natural gas collection trucks and diesel semi-tractor transfer vehicles, as well as containers, compactors, and upgrades to solid waste facilities.

The outlook for the rating is stable.

SECURITY

The bonds are secured by net revenues from the city’s solid waste system, as well as a cash-funded debt service reserve fund for the series 2015 bonds.

CONCLUSION OF THE ANALYSIS

The ‘AA’ rating is based on strong revenue defensibility, with financial operations derived primarily from a fixed-rate structure, a pattern of steady but moderate rate increases, and population and general economic growth, all of which have contributed to long-term solid revenue trends and sound liquidity levels. Rates are set by the municipal council, which has final say. A good operational profile is also reflected in the grade.

Solid waste operations largely consist of waste collection, with waste delivery to a private landfill contracted out by the utility. In 2013, the system’s own landfill was closed. A good net leverage metric, as defined by net adjusted debt to cash flow available for debt service (CFADS), solid debt service coverage, and acceptable bond covenants, including additional leverage limits and rate-setting requirements, are also reflected in the grade.

The Present Situation

COVID was initially expected to have a greater impact on operations, with revenue decreases of roughly 4% forecast for 2020. (FYE December 31). Instead, operating revenues in 2020 increased by roughly 2.8 percent, with higher residential revenue growth offsetting losses in disposal fees to the city’s transfer station, which were harmed by COVID-related restrictions.

Preliminary forecasts for 2021 show a 10.3% year-on-year increase in operating revenue, owing to higher commercial and disposal revenues. This is higher than previous estimates of 6% annual growth. Sales growth is predicted to be just under 1% in 2022, but predictions have not yet been updated to fully reflect greater than expected revenue growth in 2021. Annual growth of 2.5 percent to 3% is forecast from 2023 to 2026, which appears acceptable given current performance and expected rate hikes.

Revenue Defensibility: ‘Stronger’ KEY RATING DRIVERS

The system’s economics are mostly reliant on a fixed-rate structure based on waste container fees rather than volume. The city council sets the rates, and the system has seen stable and reasonable rate increases in recent years. The number of payers is modest, and money is split evenly between residential and commercial consumers. Longer-term revenue growth is predicted due to expected future annual rate hikes and general economic growth.

‘Stronger’ Operating Risk

Given the closure of the system’s landfill in 2013, the system’s scope of operations has a lower operating risk. The utility gathers solid trash and has a contract with a private landfill to deliver it.

‘Stronger’ financial profile

The debt-to-CFADS net leverage ratio is impressive. Debt service coverage has been strong, with enough extra bonds tests, rate covenants, and policy requirements to back it up.

Additive Risk Considerations for Asymmetric Risk
This grade is not influenced by asymmetric additive risk concerns.

SENSITIVITIES RATING

Factors that could lead to a positive rating action/upgrade, individually or collectively:

—The city’s ‘AA’ Issuer Default Rating (IDR) was upgraded as a result of ongoing solid revenue and operating performance, as well as low leverage.

Factors that could lead to a negative rating action/downgrade, individually or collectively:

—Debt service coverage has deteriorated, and the net adjusted debt-to-CFADS ratio has risen above 8.0x;

—Liquidity cushion has weakened;

—The city’s ‘AA’ IDR has been downgraded.

SCENARIO FOR RATING THE BEST AND WORST CASE

The best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) for sovereigns, public finance, and infrastructure issuers over a three-year rating horizon is three notches, and the worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) is three notches over three years. For all rating categories, the range of best- and worst-case scenario credit ratings is from ‘AAA’ to ‘D.’ Credit ratings for the best- and worst-case scenarios are based on past performance. Visit https://www.fitchratings.com/site/re/10111579 for more information on the methodology used to calculate sector-specific best- and worst-case scenario credit ratings.

PROFILE OF CREDIT

Tacoma (IDR ‘AA’/Stable) is the second largest city in the Puget Sound region, located about 33 miles south of Seattle in Pierce County. The city owns and operates the city’s solid waste system, which provides collection services to all residential and business clients within municipal borders. The city owns the entire collection fleet, which transports waste to a county-owned landfill.

The proceeds promised to the solid waste revenue bonds do not match Fitch’s criteria for being treated as “pledged special revenue” under section 902(2) of the bankruptcy code, and they are not otherwise protected from the city’s operating risk. As a result, the debt’s rating is capped at the city’s IDR.

Defensibility of Revenue

Characteristics of Demand

The system’s financial operations are based on a mostly fixed-rate structure, with fluctuating container fees rather than waste flow volume as the primary determinant. The system has a low level of revenue concentration, with only roughly 7% of operational revenues coming from the top ten payers. Residential and business users account for roughly 41 percent and 43 percent of system revenues in 2021, respectively, with private excursions to the city’s transfer station for drop-off accounting for 14 percent of system operating revenues in 2021.

Solid waste taxes are added to a combined utility statement that includes water, sewer, and electric rates every two months. Rates are set by the municipal council after an advisory group’s input is taken into account. In the past, collection rates have been good, with delinquencies for the combined utility bill averaging less than 1% in recent years. The rate has risen to around 2% due to a COVID-related utility disconnect restriction. With the moratorium ending at the end of March, management expects the rate to improve.

The system’s financial performance has been strong, with rate hikes that have been constant and mild. Since 2014, annual pricing increases have been instituted. Initially, 2% rate increases were proposed for 2021 and 2022, but a lesser 1.5 percent increase was chosen for 2021. For the years 2023 through 2026, annual rate hikes of 2% to 3% are projected, resulting in revenue increases of 2% to 3%. Rates are generally comparable to regional rivals, and management has stated that Tacoma offers several services that other local systems do not.

Operating Cost Flexibility Operating Risk

The utility gathers solid trash and has a contract with a private landfill to transport its municipal waste. The principal contract for trash disposal with a privately managed landfill was renewed through 2030, thus changes in expenses are not likely to be considerable. Annual disposal costs are mostly affected by fluctuations in the Consumer Price Index (CPI). Contracts for recycling (until 2026) and composting/yard waste disposal are also in place (current through November 2022, with proposed new contract expected to run through 2028). Despite the fact that contracts do not last the entire term of the loan, Fitch believes that contract renewal will not be a problem, based on past experience.

The capital requirements for the next five years are expected to be around $71 million, with the majority of the funds going toward facility and equipment upkeep. Capital costs are projected to be reimbursed through pay-go spending, which we believe is fair given the system’s past and forecasted cashflows. There are no plans to issue further debt at this time.

Leverage Profile Financial Profile

In the last five years, debt service coverage has been greater than 2.0x. In 2020, coverage was around 4.6x, and in 2021, it is expected to be over 5.4x. Coverage of maximum annual debt service ([MADS] $6.4 million in 2023 after issue of the 2022 bonds) is expected to be around 3.9x based on estimated 2021 revenues. Issuer predictions through 2026 show ongoing strong net revenue coverage (about 4.0x).

Additional bonds testing and rate covenant requirements of 1.25x are sufficient, with rate covenant terms permitting partial usage of rate stabilization fund funds. These are bolstered by management’s policy of maintaining a 1.7x debt service coverage ratio.

Required revenue transfers to the city’s general budget are not included in debt service coverage calculations. The transfer is capped at 8% of gross solid waste system income, according to the city charter. The city transfers the maximum amount allowed by the charter, and any changes to the charter would require voter approval. The transfer is paid after the debt service installments are made. After accounting for the $6.6 million transfer, debt service coverage in 2021 is expected to be around 4.0x. Following issue, MADS would have around 2.9x coverage.

Based on predicted income and expenditure performance, Fitch’s base case scenario forecasts financial performance over the next three years. The stress case scenario varies in that it assumes a yearly revenue fall of 10%, which is roughly twice the biggest consecutive annual revenue decline in history, similar to Fitch stress assumptions for other solid waste credits.

Although debt service coverage remains above 1.0x under the stress scenario, it is possible that debt service coverage will be reduced. Fitch believes management to be able to address possible revenue decreases and stabilize finances due to the system’s excellent revenue flexibility and controlled operations.

Profile of Liquidity

The liquidity profile is strong, and the rating considers it to be neutral. In 2021, total operating cash is expected to be $54.7 million, with $7 million in the rate stabilization fund. This equates to around 343 days of cash for operations. Minimum operating cash levels of 60 to 120 days of running expenses are required by management, with a target of 90 days. Cash balances are expected to drop in the coming year as a result of capital project spending, but levels should stay stable.

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