OREANDA-NEWS. Fitch Ratings has affirmed the 'A' rating on the following North Hudson Sewerage Authority, NJ's (the authority) obligations:

--Approximately $350 million in outstanding gross revenue pledge senior lien lease certificates, series 2012A, 2012B, and 2012C.

The Rating Outlook is Stable.

SECURITY

The certificates are secured by fixed monthly rental payments payable by the authority pursuant to a master lease agreement. All revenues of the authority are irrevocably pledged to the payment of the rental payments, which are an unconditional obligation and are not subject to appropriation. Such pledge is a first lien on the authority's gross system revenues, and includes all fees and charges for service and annual charges, if any, received from the municipalities served by the authority pursuant to the terms of an existing service agreement (ESA).

Under the ESA each municipality is obligated to fund any shortfall in authority revenues based on pro rata usage. This characteristic of the ESA provides some additional bondholder security, although the operations of the authority provide the basis for the rating.

KEY RATING DRIVERS

ESSENTIAL SERVICE PROVIDER: The authority provides an essential service to a demographically mixed, but stable service area proximate to New York City. The system remains in regulatory compliance and the operating profile is sound.

VERY HIGH DEBT BURDEN: Debt ratios are well above average compared to similarly rated utility systems. Near-term capital needs focus on system renewal and replacement thereby alleviating future debt pressures. But the debt profile is projected to remain high as a result of slow amortization of existing debt.

MANAGEABLE CAPITAL NEEDS: Over the next six years, capital needs total $74 million and will continue to focus on system upkeep and renewal, including projects to address combined sewer overflows. Approximately 60% of the funding for the capital plan is expected to come from pay-as-you-go sources. The only additional borrowing anticipated by the Authority through fiscal 2021 is an average of $5 million per year in new loans from the New Jersey Environmental Infrastructure Trust (the State revolving fund with subsidized interest rates).

MIXED FINANCIAL RESULTS: A debt restructuring coupled with rate increases helped reverse very weak historical financial performance. Finances improved in 2013 - 2015 from a combination of revenue growth, including increased connection fees and other one-time revenues, improved collection of customer billings and lower debt service than originally anticipated in those years. Fiscal 2016 results, which are preliminary, anticipate lower margins and ratios that are more typical for the current rating.

RISING RATES, ROBUST LIQUIDITY: Rates have been on a steady ascent and are projected to increase further, raising affordability concerns and potential rate fatigue. However, liquidity is very strong, providing a significant offset to the current rate trajectory and modest expected financial margins going forward.

RATING SENSITIVITIES

FINANCIAL PERFORMANCE: The rating is sensitive to changes in various credit characteristics including financial performance and rate flexibility. A decline in the authority's financial metrics below pro forma expectations could result in a negative rating action. However, results that are consistently positive could result in an upward rating action.

DEBT BURDEN: A significant shift in capital needs to address regulatory requirements from current expectations, and that causes a rise in the debt burden, could lead to a rating downgrade.

CREDIT PROFILE

AUTHORITY CREATED TO PROVIDE ESSENTIAL SANITARY SEWER SERVICES

The authority was established in 1988 to provide sewer conveyance and treatment services to four cities located in the northern part of Hudson County, N.J. (general obligation debt rated 'AA-'). Prior to the creation of the authority, the sewer systems of the four cities had fallen into substantial disrepair, resulting in the need for significant capital investment upon the authority taking ownership and control of the assets. The substantial capital spending left the authority's combined system highly leveraged.

The four municipalities served by the authority include: Union City, which accounts for about 35% of annual flows; Hoboken (29%); West New York (29%); and Weehawken (7%). Each municipality is located along the Hudson River, directly across from New York City, N.Y. The system serves approximately 22,100 retail accounts, many of which are multi-family units spread out over the four densely populated cities. The customer and revenue bases are diverse with no single customer accounting for more than 1% of demand or revenue. The authority serves an estimated resident population of approximately 185,000.

The system is divided into two geographical areas with assets consisting of about 100 miles of sewer mains and two wastewater treatment plants (WWTP). Combined treatment capacity totals nearly 31 million gallons daily (mgd), which leaves about 30% excess capacity on a combined basis (based on 22 mgd current flows). Given the limited growth expectations, treatment capacity is sufficient for the long term.

IMPROVED FINANCES FROM RESTRUCTURING AND REVENUE PERFORMANCE

The certificates were issued in 2012 to refinance and restructure all of the authority's outstanding debt with capitalized interest and lower near-term annual debt service. The certificates mature fully in 2044, which is 10 years later than the original revenue bonds. The restructuring improved the authority's previously very weak financial performance.

While the certificates contain a gross pledge of revenues, Fitch calculates debt service coverage (DSC) using net revenues after payment of system operating costs. Financial results in fiscal 2015, on a net basis, were strong with 2.6x coverage on the certificates and 1.7x coverage of all debt service (includes low interest state loans); fiscal 2015 represented the first full year of certificate debt service. While the results were strong, much of the revenue growth in 2015 versus previous years resulted from greater one-time revenues including connection fees and grant receipts.

In addition to the increase in one-time revenues in fiscal 2015 [as well as prior years], financial results have benefitted over the past several years from higher operating revenues on rate increases and lower debt service payments than previously projected. Fiscal 2014 DSC was a strong 2.3x (net) on the certificates and a solid 1.7x all-in with a partial payment of certificate debt service (due to capitalized interest) and approximately $7.5 million in subordinate state loans.

PROJECTIONS STILL INDICATE LOWER MARGINS

Debt service is expected to rise over the next several years, approximately $23 million on the senior certificates in 2020 and to $30 million on an all-in basis. Preliminary results for fiscal 2016 projects DSC on the certificates of 1.8x and coverage of all debt at 1.2x, which is similar to prior expectations.

Fiscal 2016 results indicate lower connection fees than actually collected in both fiscal 2014 and fiscal 2015, and results do not include any non-operating revenues (including grants). However, connection fee receipts are conservatively budgeted. For fiscal 2014 - 2016, actual connection fee receipts totaled $18.6 million (through September 2015), which is more than 3.0x greater than the cumulative amounts previously assumed.

Projected results for fiscal 2017 were also provided by management. The updated projections resemble previous projections provided to Fitch and include many of the same reasonable assumptions regarding rate increases, customer growth, flows, and anticipated future debt.

STRONG LIQUIDITY PROVIDES FLEXIBILITY, RISING RATES A CONCERN

The authority's liquidity position is strong, aided by a combination of capitalized rate stabilization and renewal and replacement balances funded from certificate proceeds and solid cash flow margins over the past several years. As of fiscal 2015, which ended Jan. 31, 2015, the authority had $54 million in unrestricted cash and investments and another $11 million in renewal and replacement funds, equivalent to over 1,200 days cash on hand. Fitch projects liquidity will decline from current levels but remain strong given the manageable capital needs facing the system.

Rates are set locally by the authority's board and are approved during the annual budget process. Rates have been consistently increased and are more than 50% higher in fiscal 2016 than fiscal 2007. However, a decline in water consumption offset some of the earlier rate increases, leaving operating revenues relatively stable through fiscal 2011. To help remedy the weaker revenues, management has and will continue to focus the rate increases on the fixed charges, allowing the system to be less dependent upon economic and demand cycles.

The rise in rates, while necessary to meet the increasing operating and debt service costs, has pushed the monthly residential sewer bill to $69 in fiscal 2016, which is considered high at 1.4% of county-wide median household income (MHI). Additional rate increases are anticipated to meet the scheduled debt service increases, further pressuring the rate base. Fitch will continue to monitor the authority's ability and willingness to press forward with rate increases.

HIGH DEBT BURDEN A CREDIT WEAKNESS

The authority's debt burden remains a credit weakness. Outstanding debt, which is principally comprised of the senior lien lease certificates and includes around $70 million in outstanding subordinate lien New Jersey Environmental Infrastructure Trust (NJEIT) state revolving fund loans totals approximately $430 million. A small variable rate portion consisting of the 2012C certificates comprises a manageable 10% of total debt outstanding. The 2012C certificates are unhedged variable rate demand obligations backed by a direct pay letter of credit facility from TD Bank, N.A. (Issuer Default Rating 'AA-'/'F1+').

Debt was an elevated 111% of net plant and more than $2,000 per capita in fiscal 2015. Both of these key ratios are well above average compared to similarly-rated systems. In addition, debt carrying charges are a high 41% of fiscal 2015 gross revenues. Debt amortizes slowly, with just 29% of outstanding principal retired over the next 10 years, ensuring the authority's debt burden will remain high for the foreseeable future. Favorably though, capital needs are manageable totaling $74 million through 2021 and expected to be mostly pay-go funded.