debt service payments and system maintenance.
Frequency of payments to the debt service fund
range from monthly to semiannual transfers. From
a financial perspective, monthly deposits are pre-
ferred, since this approach allows a smooth buildup
of the debt service fund and an early indication of
any shortfalls.
The flow of funds also enumerates the issuer’s
ability to transfer surplus funds out of the system.
A reliance on transfers from the utility to the gener-
al fund adds to a system’s revenue requirements
that can result in additional rate pressures for cus-
tomers. While the ability to retain all surplus funds
within a system is certainly a plus, transfers to
another fund are not necessarily a negative factor. A
well researched, flexible, consistent, and well com-
municated transfer policy is likely to offset the con-
cern that such transfers potentially can drain the
utility’s cash position or constrain management’s
ability to fund capital improvements from earnings.
In addition, the general government managers and
policy makers will have less room for disagreement
and debate if a transfer policy is well established
and maintained.
Whether a utility recognizes various overhead
costs through direct operational expenses or
through transfers to other governmental funds has
no effect on the rating analysis. Standard & Poor’s
review includes a calculation where transfers and
off-balance sheet debt are considered along with
direct operation and maintenance expenses when
calculating debt service coverage. This additional
coverage calculation provides further insight into a
system’s overall financial flexibility.
Debt service reserve and other reserve funds
A fully funded debt service reserve can provide an
additional level of financial cushion for bondhold-
ers. When an unexpected budget shortfall occurs,
the reserve fund gives the utility time to imple-
ment needed adjustments before bondholders are
adversely affected. The usual debt service reserve
requirement is equal to the lesser of 125% of
average annual debt service, 10% of bond pro-
ceeds, or maximum annual debt service. For sys-
tems with higher risk profiles, such as customer
concentration, cyclical economic bases, or con-
sumption and revenue volatility, a fully funded
debt service reserve will likely make a difference in
the rating and may be essential for an investment
grade rating. From a practical standpoint, howev-
er, the debt service reserve is really a liquidity
source and provides only limited additional securi-
ty to bondholders—-it essentially provides the util-
ity with time to address whatever issues have
pressured performance. It is also likely that if a
system needs to use the reserve, it is already in
technical default on the rate covenant.
For utilities that consistently maintain high oper-
ating reserves and sustain high debt service coverage
levels, the debt service reserve becomes less relevant.
Policies that maintain coverage above covenanted
levels, fund a defined percentage of infrastructure
requirements internally, and maintain contingency
or capital reserves at defined levels, reduce the likeli-
hood of the utility ever falling into a position where
it would need to use the reserve. In such cases, no
debt service reserve may be needed to sustain a rat-
ing. Because unforeseen circumstances can occur,Water And Sewer Ratingshttp://www.standardandpoors.com 119Wholesalers range in size from as small as three customers, to 50 or more. The precise rating approach will generally be determined
by, and may vary by, the size of the wholesaler’s customer base. Since a debt-issuing wholesale utility is reliant on the ability of its
customer base to pay all operating costs plus debt service, the credit quality of a wholesale utility’s participants (whether they are
considered members or customers) will affect the wholesale utility’s credit quality to varying degrees. If a wholesaler is made up of
10 or fewer participants, and there are no contractual provisions that require non-defaulting members or customers to increase their
payments to account for such delinquency, then Standard & Poor’s will employ a weak-link approach to the analysis. This is because
the failure by a single participant to fulfill its payment obligations to the wholesaler would result in a project deficiency, thereby
exposing bondholders to the credit quality of the project’s weakest participant.
In cases where a wholesale utility has about 10-25 members, there may be certain additional factors that allow the wholesale
utility’s credit rating to move up or down from its customers’ or members’ credit quality. These factors include the project or system’s
operating history; consistently high debt service coverage, which is uncommon for wholesalers; or the level of reserves typically
carried by the wholesaler.
Wholesale utilities with more than 25 members or customers, assuming there is not undue concentration among a very small
group of customers, can be expected to exhibit sufficient diversity to allow for a more system-oriented approach. Factors such as
debt service coverage, equity in the form of unrestricted cash and investments, and overall economic considerations will become
more prominent in the credit analysis, similar to the analysis of municipal retail utility providers. Wholesalers of this type do not
generally have limited step-up language in their governing agreements.Number Of Participants Also A Factor