also reviewed. Holding rate levels constant for mul-
tiple years does not benefit ratepayers if inflation-
ary increases in operating costs and other expense
pressures eventually compound to force a rate
increase of such magnitude that ratepayers have
extreme difficulty in budgeting for this expense.
Such patterns of irregular rate increases increase
the risk that ratepayers will pressure ratemakers to
resist needed changes, thus increasing credit risk to
bondholders. This is not to say that minimizing any
negative economic development consequences of
rate increases, and pursuit of lower rates from fur-
ther efficiencies should be ignored; they should be
goals that are judged from a long-term perspective
rather than exclusive targets to be met in the cur-
rent year regardless of long-term consequences.
When managed from a long-term perspective,
sound policies usually benefit both bondholders
and ratepayers, and the interests of these two con-
stituencies are more consistently aligned.
■Investment and liquidity policies—seasonal cash
flow needs, capital requirements, risk manage-
ment and emergencies are among the many rea-
sons a utility will keep certain levels of cash on
hand. Standard & Poor’s also gives credit to
alternative liquidity in the form of designated—
but ultimately lawfully available—cash in the
form of rate stabilization, depreciation, or other
funds. Utilities tend to have larger cash reserves
than general governments, in which case invest-
ment income is often material and significant.
This includes not only unrestricted cash and des-
ignated funds, but also various different restricted
funds such as debt service reserves and unused
bond proceeds. Standard & Poor’s will ask if the
organization has established policies pertaining to
investments, such as investment objectives, matu-
rities, portfolio diversification, etc. Furthermore,
reporting and monitoring mechanisms and fre-
quency will also be examined.
■Debt management policies—while it is assumed
that investment grade utilities will not fund
operating and maintenance requirements with
the use of long-term debt, there are many ways
to fund identified capital needs. Stronger deci-
sion-making environments are those in which
policies exist that have correlation to between
the debt and the asset type, the asset’s useful life,
and debt levels that are appropriate to the situa-
tion. For utilities in which the use of derivatives
(such as an interest rate swap) is permitted,
Standard & Poor’s will ask for a copy of the for-
mal swap management plan as adopted.Legal Provisions
As defined in a bond indenture or resolution, the
legal provisions make clear the issuer’s responsibili-
ties and the bondholder’s recourse in the event of
the issuer’s noncompliance. The role of legal provi-
sions in Standard & Poor’s credit analyses ofWater and Sewer Ratings.................................................................................................. IV. General Government Utilities
over time as the bond market’s experience with
water-sewer revenue debt has increased and legal
covenants have become more varied. As these
trends have evolved, legal covenants have become
more liberal, often without a resulting downgrade
in the issuer’s credit rating.
Variables such as service area stability, operational
capacity, financial and operational stability, and
transparent and effective rate setting practices have
proven to be strong indicators of water-sewer credit
quality, often more so than the particular legal
covenants constraining the utility. However, utilities
cannot strip bondholders of traditional protections
and expect to preserve ratings unless they show that
their ongoing cash flows, balance sheets, and opera-
tional strategies will support credit quality, in other
words, ongoing operational results must consistently
outperform legal covenant requirements.
Legal provisions are analyzed in conjunction with
assessments of a utility’s customer base, rate com-
petitiveness, operational flexibility, management,
financial strength, and regulatory pressures. When
these assessments indicate that the utility’s expected
ongoing performance will be well in excess of the
minimal levels guaranteed by the legal covenants,
the degree of strength granted by these protections
becomes much less relevant to the rating. In con-
trast, when future performance is expected to be
closer to levels guaranteed by the covenants, the
legal protections themselves become important to
the assumptions of continued stability at that level.
In such cases, legal covenants can play an impor-
tant role in the rating.
Standard & Poor’s considers each legal provision
separately and examines the conditions under
which different variations do or do not result in dif-
ferent credit ratings. It is important to remember
that while weaker legal covenants may not have a
rating impact when performance is strong, if credit
quality starts to deteriorate, it is likely that a lack
of strong covenants will increase the potential and
degree of a downgrade.
Security
Standard & Poor’s does not distinguish between a
gross and a net revenue pledge. It is Standard &Water And Sewer Ratingshttp://www.standardandpoors.com 117