Individual examination is given to audited finan-
cial results, including debt factors, accounts receiv-
able, liquidity, and net revenues available for debt
service. Debt factors are examined for overall debt
levels and historical and projected debt service cov-
erage. Debt service coverage tests not only include
debt service on the utility’s own revenue bond debt
plus any off-balance sheet debt obligations associ-
ated with unconditional contractual obligations,
and any GO debt issued on behalf of the utility
and paid from utility revenues. Standard & Poor’s
focus is the adequacy of a cushion to ensure unin-
terrupted payment.
Credit judgment of debt service coverage levels
incorporates economic and operational factors. A
debt service coverage ratio shows the multiple of
net revenues to debt service, with higher coverage
generally indicating an affordable debt burden. As a
measure of debt capacity, the ratio is effective in
differentiating those systems that have a revenue
stream that comfortably covers debt obligations
versus those systems that do not. Systems that have
a very low coverage ratio may indeed be struggling
to meet rising operations and maintenance expens-
es, or be experiencing difficulty raising customer
rates, or simply have a high level of indebtedness.
Lower coverage is generally more acceptable in sys-
tems with lower risk; generally those with a diverse
customer base, low revenue and expense volatility,
and a well-maintained infrastructure.
Another consideration in assessing debt service
coverage ratios is the structure of a utility’s debt;
while back-loaded debt may reduce the short-term
debt burden and make more debt seem affordable
in the near-term, it increases overall debt service
costs. In cases where a system is counting on cus-
tomer growth to occur in order to help pay for
rising debt levels through either connection fee
revenue or rates, this may be considered a nega-
tive credit factor since future growth trends are
never assured.
Revenues and net income levels are examined to
ensure that all costs, including annual renewals and
replacements, are recovered through adequate rates.
This means that two coverage ratios will be deter-
mined, as they are applicable:
■Annual debt service coverage—simply, the ratio
of revenues available for debt service to the
actual principal, interest and other requirements
currently due within that fiscal year.
Standard & Poor’s uses net revenues, rather
than gross revenues, to calculate the debt service
coverage ratio.
■Fixed charge coverage—water and sewer sys-
tems have different levels of financial and oper-
ational risk. More traditional systems may havetheir own water supply, treatment plants, etc.
Increasingly common is some form of regional
service from a wholesale provider or joint
action agency. Obligations to such regional
providers are typically treated as operating
expenses of the retail system and thus do not
appear on the balance sheet as long-term debt
of that retail system. In such cases, Standard &
Poor’s calculates an adjusted debt service cover-
age ratio that treats these off-balance sheet obli-
gations as debt-like, since they are still
recurring, or “fixed,” long-term obligations.
This allows for more logical comparison to util-
ities with on-balance sheet debt.
Given the recent emphasis on recognition and
funding of long-term liabilities for both pension
(GASB Statement 27) and other post-employment
benefits (GASB Statement 45), effects on debt serv-
ice coverage would be dependent upon how the
funding of the liability is handled. This ultimately
will depend on the flow of funds as to whether or
not revenues available for debt service are affected.
Standard & Poor’s scrutiny also covers the utili-
ty’s liquidity position. Accounts receivable to oper-
ating income is reviewed to gain an understanding
of the collections environment. A cash flow history
and forecast may be required if receivables consis-
tently total more than 15% of operating revenues,
assuming a monthly collections cycle. Another
measure of liquidity, days’ cash on hand compares
available liquidity with annual operating expenses
and other system needs to determine sufficiency.
The level of short-term debt, including variable-
rate bonds, relative to total debt also is assessed to
determine sensitivity to changes in interest rates or
an inability to remarket short-term paper.
Derivatives may hedge this exposure, but they may
also introduce additional risks. As far as long-term
debt, the debt to plant ratio is considered, as a
measure of a utility system’s leverage. This ratio,
however, must be considered in the context of a
utility’s debt history and future capital needs. While
a low debt to plant ratio is generally considered a
positive credit factor, it would not be a strength in
cases where the low ratio is the result of under-
investment in physical assets. Higher debt to plant
ratios, moreover, may not be considered a credit
weakness if infrastructure is in good condition, and
capital needs are therefore minimal. Systems that
engage in asset-liability management programs
intended to quantify optimal investment levels in
infrastructure are generally seen as being able to
better manage debt levels. Management practices,
such as a defined schedule of capital spending from
reserves and debt issues, are often as important as
any particular ratio.General Government Utilities114 Standard & Poor’s Public Finance Criteria 2007