OREANDA-NEWS. Fitch Ratings has assigned the following ratings to bonds issued by the City of New Orleans, LA (the city) on behalf of the New Orleans Sewerage and Water Board (the board):

--Approximately $100 million water revenue bonds series 2015 at 'BBB+';
--Approximately $100 million sewerage service revenue bonds series 2015 at 'BBB+'.

Bonds are expected to price on Dec. 2, 2015. Proceeds of each series will be used to fund a portion of the board's overall capital program for its respective water and sewer systems.

In addition, Fitch upgrades the following ratings on parity debt:

--$103.5 million water revenue and refunding bonds series 2014 to 'BBB+' from 'BBB';
--$147.8 million sewerage service revenue and refunding bonds series 2014 to 'BBB+' from 'BBB'.

The Rating Outlook is revised to Stable from Positive.

SECURITY

The sewerage service revenue bonds are payable from net revenues of the board's sewer utility system. The water revenue bonds are payable from net revenues of the board's water utility system.

KEY RATING DRIVERS

RATINGS UPGRADE: The ratings upgrades reflect improving financial metrics following three years of implemented 10% rate increases for each system. The upgrades also reflect the board's progress in accelerating funding of its critical capital needs.

IMPROVED FINANCIAL MARGINS: Each system exhibits modest but adequate financial margins while also facing capital and operating pressures. Management financial projections indicate that both systems are expected to achieve at least 1.5x all-in coverage, which Fitch believes are based on reasonable assumptions. As financial margins exceed budgeted levels, management is able to accelerate capital spending although coverage is likely to remain around forecasted levels.

OPERATIONAL CHALLENGES PERSIST: Water supply is ample but a 75% non-revenue water rate remains a long-term cost challenge for the water system. The sewer system received some timing relief from the March 2014 Third Modified Consent Decree.

MASSIVE CAPITAL NEEDS: Capital needs for both systems are extremely large following decades of deferred investment in addition to repairs needed after Hurricane Katrina (Katrina). Debt levels are expected to increase rapidly as the board begins supplementing federal capital spending on the systems with its own debt issuance.

APPROVED RATE INCREASES THROUGH 2020: A series of eight
10% annual rate increases (2013 - 2020)for both the water and sewer utilities have begun to boost financial margins and should fund the most critical of capital needs. However, rate levels are high.

INTERDEPENDENCE OF TWO SYSTEMS: Fitch's maintenance of the same rating on the two separately secured bonds reflects a common governance structure, rate setting process, customer base, bill, and management team. In addition, the two systems have a close financial relationship as demonstrated by past intra-fund borrowings between the systems and the drainage fund, also operated by the board.

RATING SENSITIVITIES

CONTINUED FINANCIAL DISCIPLINE: The board has made progress in the last couple years toward establishing the financial health and discipline of each of the funds on a stand-alone basis. The Stable Outlook reflects Fitch's expectation that the board will consistently achieve increased revenues necessary to support the growing operating and debt service costs while executing its large capital plan.

CREDIT PROFILE

The board is an independent legal entity from the city (general obligation bonds 'A-' ). However, both the New Orleans City Council and the Board of Liquidation have approval responsibilities over the board's debt issuance and rate setting. The Board of Liquidation serves as the debt service custodian for all board debt.

The 2014 estimated population of New Orleans is 384,320, which is over 80% of the population prior to Katrina, up from a low point of around 30% of the prior population immediately following the storm. Economic recovery in the city continues. The board provides water and sewer service to around 125,000 customers in the city.

GOVERNANCE CHANGES APPEAR POSITIVE

A new Board of Directors was seated in summer 2014 as well as a new executive director. The board changes were recommended as part of the 2012 rate package to reform the governance of the utility by requiring professional qualifications of board members, shortening the terms, reducing the number of directors, and imposing term limits. The new board appears to be refining the definition of board and senior management roles. The executive director is prioritizing execution and acceleration of the capital improvement plan.

Utility management has worked over the past few years to improve fiscal discipline, achieve quick and high quality disclosure of financial information and to refine the budget and accounting processes. Financial planning is viewed by Fitch as prudent and includes timely updates of long-term financial, rate and capital models that inform capital spending.

AMPLE WATER SUPPLY; LARGE UNACCOUNTED FOR WATER LOSS

New Orleans has ample water supply provided by the Mississippi River, with four raw water intakes and two water treatment plants (one located on each side of the river). Treatment capacity is well in excess of the system average daily demand of 37 million gallons per day (mgd) in fiscal 2014, but flows through the plants are much higher (142 mgd in 2014) given the very high amount of water loss in the distribution system.

Water losses were high prior to Katrina at around 56%, reflecting an aging system of water mains and distribution pipelines, underground pipes below sea level, and years of deferred investment in the system. Many additional leaks and ruptures have occurred post-Katrina, bringing the rate up to 75%. This represents a cost to the water system in terms of water treatment and delivery (pumping) costs. However, it also represents a significant cost to the board's drainage utility that must continuously pump all excess water out of the city's service area. The board, with the aid of Federal Emergency Management Agency (FEMA) funding, continues to detect and repair leaks and replace distribution pipelines.

CONSENT DECREE DRIVES SEWER CAPITAL SPENDING

The sanitary sewer system also consists of two treatment plants: one on the west bank of the Mississippi (40 mgd) and one on the east bank (122 mgd). Similar to the water system, the treatment capacity is in excess of current flows (combined average daily flow was 102.2 mgd while metered sewer sales were 30.7 mgd in 2014). The sewer system is under a consent decree from the U.S. Environmental Protection Agency (EPA) to reduce sanitary sewer overflows, which can occur during wet-weather events when the treatment plants are overwhelmed from high levels of influent.

EXTREMELY LARGE CAPITAL NEEDS; DEBT LEVELS WILL INCREASE

Estimated five-year capital costs for the water system
(2016 - 2020) total around $426 million, while costs for the sewer system during this period total $317 million. Much but not all of the spending on the sewer system is related to the consent decree. The board has been spending significant capital on the systems since Katrina but much of the money has been federal dollars. The management and staff processes are being put into place to ramp up to the level of capital spending assumed in the forecast.

Management expects that based on its approved 10% rate increases for both systems through 2020 it can support limited amounts of pay-go funding in the next five years for capital for each system (7% for water and 22% for sewer). However, continued funding for a portion of the capital plan is expected to come from outside sources, primarily FEMA.

Debt levels on both systems will increase dramatically over the next five years. In addition to the series 2015 bonds, management expects to issue another $130 million in water revenue bonds and $190 million in sewerage service revenue bonds. Based on these issuance levels, debt per customer is expected to increase to around $2,000 and $3,500 per customer for the water and sewer systems, respectively, within five years. In comparison, Fitch's median for the sector is around $1,800 debt per customer. Capital needs extend beyond the current five-year capital plans, with higher amounts for the water system related to needs at the treatment plants. Continued debt increases are likely.

IMPROVED FINANCIAL PERFORMANCE DRIVE RATINGS UPGRADE

While margins are still modest, financial metrics have improved in the past two years with the 10% rate increases on each system in fiscals 2013 and 2014. The improvement in financial performance is the driver for the rating upgrade. While continued revenue increases will be required to support existing debt issuance, the board's track record of actual revenues received from annual 10% rate increases indicates financial margins should remain adequate, with all-in debt service coverage of between 1.5x and 1.6x.

Debt service coverage of water revenue bonds in fiscal 2014 was 1.59x, although this ratio benefited from lower debt service in that year as a result of the 2014 refunding. Fiscal 2014 revenues were insufficient to coverage maximum annual debt service on existing debt, which occurs in fiscal 2018, but the additional revenues from approved 10% annual rate increases should provide the needed revenues. Coverage of all obligations in fiscal 2014 (including the state debt service assistance loan made in 2006) was 1.30x.

The water system produced free cash flow to annual depreciation of 5% in fiscal 2014. Although this is projected to improve in management's financial forecast, the ratio is not projected to reach annual depreciation levels, limiting the amount of free cash available for pay-go capital sources. Water system unrestricted cash was $12.2 million at the end of fiscal 2014, or equal to 64 days operating cash. Cash declined from higher levels in fiscal 2013 with the final repayment of funds owed to the drainage fund.

SLIGHTLY STRONGER SEWER SYSTEM FINANCIAL PERFORMANCE

Debt service coverage of sewer revenue bonds in fiscal 2014 was 2.19x. Fiscal 2014 revenues were sufficient to cover maximum annual debt service on existing debt, which occurs in fiscal 2017. Coverage of all obligations in fiscal 2014 (including the state debt service assistance loan made in 2006) was 1.64x. Similar to the water system, all-in debt service coverage is projected to hover between 1.5x and 1.6x in upcoming years with the planned debt issuance and amounts owed on the debt service assistance loan.

The sewer system produced free cash flow to annual depreciation of 105% in fiscal 2014 and is projected to continue to exceed 100% in management's financial forecast. Fitch expects this to generate funds to contribute to sewer system capital. Cash reserves at the end of fiscal 2014 were $21.9 million, equal to 165 days operating cash.