OREANDA-NEWS. Fitch Ratings has assigned its 'AA-' rating to Pima County, Arizona's (the county) revenue obligations as follows:

--Approximately $139.53 million sewer system revenue refunding obligations, series 2016.

The bonds are scheduled to sell via negotiation the week of May 30. Proceeds will be used to refund outstanding obligations for debt service savings and to pay issuance costs.

In addition, Fitch affirms the county's sewer system revenue obligations as follows (pre-refunding):

--$114.9 million in outstanding senior lien revenue bonds at 'AA';
--$477.5 million in outstanding subordinate lien sewer system revenue obligations at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The senior bonds are payable from payments made by the county to the trustee. The county's obligation to make payments is secured by net revenues of the county's sewer system (the system). The senior lien is closed. The subordinate obligations have a subordinate security interest in the pledged revenues and are additionally secured by the system's unrestricted cash balances.

KEY RATING DRIVERS

BELOW-AVERAGE DEBT SERVICE COVERAGE: Debt service coverage (DSC), exclusive of pledged unrestricted cash balances, has weakened in recent years due to increased debt service costs. Ongoing DSC is expected to remain below-average in the near to mid-term as maximum annual debt service costs occur in fiscal 2023 and then descend thereafter.

HIGH LIQUIDITY ENHANCES FINANCIAL PROFILE: The system's very strong cash balances, combined with a very rapid pay-out, somewhat mitigates near to mid-term below-average DSC levels.

HIGH DEBT AND CAPITAL COSTS DECLINING: Debt levels are high but are expected to decline rapidly in the coming years due to declining capital needs and very rapid amortization schedule.

PRESSURED RATE BASE: Upon embarking on its large capital plan in 2010, the county prudently adopted a series of automatic annual rate increases to counter the rise in fixed costs. However, user charges at 1.1% of median household income (MHI) now slightly exceed Fitch's affordability threshold, somewhat limiting future rate flexibility.

STABLE ECONOMY: The service area is anchored by the presence of the military and defense industry that provide some stability. County unemployment rates are below state but above national levels.

RATING SENSITIVITIES

STRONG CASH BALANCES KEY: Maintenance of strong liquidity is key to the rating given the system's below-average DSC through the forecast period.

CREDIT PROFILE

The system provides wastewater service to a population of more than 1 million through more than 265,000 connections in the Tucson metropolitan statistical area (MSA) and separate outlying areas in eastern Pima County (general obligation [GO] bonds rated 'AA'/Stable). Tucson (GO bonds rated 'AA-'/Negative) is the county seat and Arizona's second largest city. The system wastewater facilities have ample combined capacity of 91.6 million gallons per day (MGD), with sewer flows averaging 61 MGD.

MIXED FINANCIAL METRICS

The county embarked on a substantial capital program six years ago that resulted in the issuance of $531 million subordinate revenue obligations since 2010. The debt was issued in four installments from 2010 to 2014, with relatively short maturity schedules. The county adopted large service rate increases to cover the corresponding rise in fixed costs associated with the new debt. This rapid pace of debt issuance resulted in debt service requirements that more than doubled from 2010 levels.

While the county adopted large rate increases for this capital undertaking, coverage has declined gradually as previously forecast, with total DSC (exclusive of pledged unrestricted cash balances) coming in at 1.3x in fiscal 2015. Including planned issuances totaling $150 million over the next five years and assuming moderate annual rate increases, Fitch-calculated all-in DSC is forecast to hover around 1.2x to 1.4x (excluding pledged unrestricted cash). Given the county's history of enacting rate increases, in some cases up to two rate hikes within one fiscal year, Fitch believes management will take the necessary steps to maintain the system's good financial performance.

Counterbalancing the downward DSC trend, unrestricted cash levels steadily rose from $11.2 million in fiscal 2010 to $110.7 million in fiscal 2015. The county also maintained $39.4 million in available restricted emergency and operating reserves as of fiscal 2015, which combined with unrestricted cash, equaled 657 days cash on hand for the year.

Unrestricted cash balances are legally pledged to the subordinate lien sewer system revenue obligations and can only be used to pay debt service or provide rate relief. The increase in reserve amounts, combined with the unrestricted cash spending limitations, should help maintain strong liquidity levels and/or facilitate the acceleration of debt payments. In fact, the county plans to use some of its excess cash reserves to retire between $10 million and $38 million in debt when it becomes callable in fiscal 2017.

CAPITAL IMPROVEMENT PLAN RAMPING DOWN

The county is in the seventh year of implementation of its capital improvement plan (CIP) that was projected to cost a total of $974 million. The massive capital undertaking was necessary to address its aging infrastructure and comply with regulatory requirements. Some of the major projects included the demolition and replacement of one of the county's wastewater reclamation facilities that was more than 50 years old as well as major rehab and expansion of another wastewater treatment plant. These projects were completed ahead of schedule and below budget. To date the system has spent about $750 million of the total project costs.

Capital needs over the next five years are expected to cost an estimated $200 million and are primarily for conveyance system upgrades and replacements. The county has substantially met future permitting requirements for environmental compliance, and consequently most of its major capacity and compliance needs will have been met when this plan is completed unless growth-related pressures emerge.

DEBT LEVELS TEMPERED BY RAPID AMORTIZATION

Given the constitutional limitations on cash spending for capital, the county plans to primarily debt-fund its CIP over the next five years. Debt levels currently are high with debt per customer at $2,430. The county plans to issue an additional $150 million in subordinate lien debt over the next five years.

However, due to the rapid amortization of debt and the decline in capital needs, debt levels are projected to descend at a moderately rapid pace post-2016, assuming future capital needs remain low as currently planned. Debt per customer is projected at $2,277 in fiscal 2020. Amortization of debt is very rapid, with principal payout at 47% in five years and 91% in 10 years. Moreover, management utilizes excess reserves to retire debt early.

GROWING DEBT SERVICE REQUIREMENTS PRESSURE RATES

To cover the anticipated rise in debt service costs, the county enacted automatic annual rate hikes over fiscal years 2011-2014. No rate increases were implemented in fiscals 2015 or 2016, but management is proposing 4% or greater rate increases for calendar years 2017, 2018, and 2019. Management performs a monthly comprehensive review of rate adequacy and has indicated it would recommend larger rate increases if deemed necessary. The current monthly bill at $40.90 (assuming sewer flows of 6,000 gallons per month) is now at 1.1% of MHI, slightly above Fitch's 1.0% affordability threshold.

SERVICE AREA BENEFITS FROM STABLE ECONOMY

The area's economy is diverse, featuring military and defense, higher education, healthcare, government, and manufacturing as primary anchors. County unemployment levels at 4.8% as of February 2016 are below the 5.2% state and national average. County wealth levels are slightly below state and national levels.