OREANDA-NEWS. Fitch Ratings assigns an 'AA+' rating to the following city of Sugar Land, TX (the city) bonds:

--Approximately $31.1 million waterworks and sewer system revenue and refunding bonds, series 2016.

The bonds will be sold via negotiation as early as the week of March 14. Bond proceeds will be used to refund outstanding bonds for interest savings, to fund capital projects and to pay issuance costs.

In addition, Fitch affirms its 'AA+' rating to the following outstanding city waterworks and sewer system bonds (pre-refunding):

--$47.3 million revenue bonds, series 2008, 2009, 2012 and 2013;
--$45.7 million revenue and refunding bonds, series 2009, 2012A and 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are secured and payable from a first lien on and pledge of the net revenues of the city's waterworks and sewer system (the system).

KEY RATING DRIVERS

HISTORICALLY STRONG OPERATIONS: Historical financial performance has been strong, characterized by high all-in debt service coverage (DSC) that consistently exceeded 2x from fiscal 2010 to 2014. However, lower than budgeted revenues due to extreme wet weather combined with rising operating costs yielded significantly lower all-in coverage in fiscal 2015 at 1.5x. Liquidity remained robust at 579 days cash on hand at the end of fiscal 2015.

GROWING DEBT BURDEN: The system's debt per customer is high compared to that of Fitch's 'AA' category rating medians. Additional capital needs that will require debt funding over the next five years are projected to continue to pressure already high debt levels.

AFFORABLE RATES: Current rates are very low relative to median household income (MHI), providing ample rate flexibility for future rate increases.

GOOD PLANNING EFFORTS: The system is highlighted by comprehensive long-range financial and capital planning. In addition, the city consolidated efforts with other area providers to ensure timely compliance with groundwater reduction plans.

SOLID SERVICE AREA: The service area, which is located outside of Houston, exhibits good growth patterns, very robust income metrics, and unemployment that is consistently lower than the state and U.S. Although the plunge in oil prices is expected to affect the pace of economic growth in the Houston metropolitan statistical area (MSA) over the near term, its diverse regional economy will help to offset losses attributable to the oil sector.

RATING SENSITIVITIES

DETERIORATION OF FINANCIAL PROFILE: Sugar Land's waterworks and sewer system rating could be pressured by a continued weakened financial profile, characterized by all-in debt service coverage and liquidity levels inconsistent with the current high rating. The Stable Rating Outlook reflects the system's ample rate flexibility and management's historical willingness to increase rates to maintain strong financial metrics.

CREDIT PROFILE

Sugar Land is a suburban community located about 20 miles southwest of Houston in Fort Bend County. The system provides service to an estimated population of approximately 87,500 through 29,117 water and 27,371 wastewater connections. The majority of customers are residential and there are no customer concentration concerns.

STRONG FINANCIAL METRICS

Historical financial performance has been very strong, consistently outperforming system forecasts with combined annual DSC at or above 2x through fiscal 2014. However, fiscal 2015 results were lower than projected due to wet weather as well as rising operating costs. Also, in fiscal 2015, the city began accounting for general fund overhead allocations as an operating expense as opposed to transfers, reducing DSC somewhat. Lastly, a wastewater reuse plant was placed into operation during the fiscal year. The resulting all-in DSC, which includes the city's $96.3 million waterworks and sewer system revenue bonds and $91.5 million in system supported certificates of obligation was at 1.52x, below system forecast and well below Fitch's 'AA' category all-in coverage median of 2x.

For fiscal years 2016-2020, management forecasts weaker all-in DSC ranging from a low point at 1.3x (in year five) to a high 1.6x in the earlier years. These calculations include future planned debt and a modest rate increase in 2018 that was deferred from prior plans due to deferral of a wastewater treatment plant expansion. Historical rate increases enabled the system to maintain above-average operating margins and robust liquidity to support the high rating. Fitch notes that the system has ample rate flexibility to adjust rates to maintain historically strong coverage. Realization of forecasted results, which are well below similarly-rated utilities, would be expected to lead to downward pressure on the rating.

SURFACE WATER CONVERSION

The city approved a Groundwater Reduction Plan (GRP) that outlines the city's strategies for meeting mandated conversion to non-groundwater sources pursuant to Fort Bend Subsidence District regulations. The GRP involved participation by smaller water providers in the area to consolidate water plans and collectively meet ground water withdrawal limits.

The city commenced its surface water conversion project, which involved the construction of transmission lines, groundwater plant improvements and construction of a 9 million gallons per day (MGD) surface water treatment plant (with capability for future expansion) adjacent to Oyster Creek and Gannoway Lake. Construction of the surface water treatment plant was completed on time in November 2013 at a cost of $105.9 million, all of which was debt funded.

Currently, the city supplies surface water for about 41% of total water demands. The GRP mandates for 2025 is to increase surface and alternative water to 60%. This will be achieved through increased use of Oyster Creek surface water, wastewater re-use, and expanding the surface water plant to 25 MGD.

DESPITE INCREASES, RATES REMAIN VERY AFFORDABLE

Water and sewer rates are approved by the city council as part of the budget process. Water rates have two components: a utility charge and a surface water conversion fee. The average city customer pays $59.30 for combined service charges (assuming average water and sewer usage of 7,500 and 6,000 gallons, respectively) or a very affordable 0.7% of MHI. An additional rate adjustment of approximately 2.5% is planned for fiscal 2018. Given the high area wealth levels, charges are expected to remain well below Fitch's affordability threshold of 2% of MHI for the near to intermediate term.

The system also collects GRP fees from participating entities in the consolidated GRP. These fees are based on groundwater withdrawals and, like the surface water fees for city customers, have also steadily increased to the current $1.75 per 1,000 gallons. In fiscal 2015, the surface water fees and GRP fees generated $13.2 million to support the surface water conversion efforts.

HIGH DEBT BURDEN

Debt levels grew rapidly as a result of the surface water conversion project. System debt ratios are very high with outstanding debt per customer at approximately $3,324, compared to the 'AA' category median of $2,050. With future debt planned to finance the maintenance-related capital improvement program (CIP) and the wastewater treatment expansion, levels are expected to increase by approximately 13% in five years. Debt amortization at 43% and 83% in 10 and 20 years, respectively, aligns closely to the 'AA' category median.

The city's 2016-2020 CIP totals an estimated $88 million, with projects split between water system (17%), surface water conversion (20%) and wastewater (63%). Funding for 81% of the CIP is planned from future debt issuance, while the remaining projects will be funded with available resources. About one-third of the CIP is for a wastewater treatment plant expansion that has been deferred several years due to lower than previously expected flows. The remaining projects focus on system repair and maintenance. The current bond issue will fund the 2016 projects and refund outstanding revenue bonds for debt service savings.

TREATMENT PLANT EXPANSION ON HORIZON

Wastewater treatment is provided by the Sugar Land Regional Sewerage System Plant and the South Wastewater Treatment Plant. Both plants are operated by the Brazos River Authority (BRA). With a combined capacity of 16 MGD and sewer flows averaging 8 MGD annually over the past five years, there is more than sufficient capacity remaining to handle near term city growth. City growth estimates indicate that additional system capacity will be needed in the next five to 10 years, therefore planning and construction of wastewater treatment expansion is included in the CIP at a cost of approximately $31 million. The planned expansion could be delayed if flows do not materialize.

ROBUST SERVICE AREA ECONOMY

Sugar Land is located in the broad Houston MSA and residents have direct access to Houston's central business district via a major highway. The post-recession recovery of Houston's regional economy outpaced that of many other large U.S. cities. As a robust energy sector, the Port of Houston and healthcare all contributed to healthy population and employment gains. However, the downturn in the oil market has significantly decelerated Houston's economy. The MSA unemployment rate of 4.6% for December 2015 was up from 4% in the same period last year and is now slightly higher than the state (4.2%) but below the 4.8% U.S. rate.

Locally, Sugar Land's employment contracted 1.6% year-over-year (yoy) through December 2015. Nonetheless the local jobless rate of 3.3% as of December 2015 is low and below the MSA, state, and U.S. averages. Reflective of its highly educated workforce, wealth and income levels are high, with MHI equal to 2x that of the nation.