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Rating Update:

MOODY'S AFFIRMS Baa1 RATING ON PUERTO RICO AQUEDUCT AND SEWER AUTHORITY'S SENIOR LIEN REVENUE BONDS

09 Nov 2010

OUTLOOK ON PRASA'S $1.38 BILLION RATED SENIOR LIEN REVENUE BONDS REVISED TO NEGATIVE

Water/Sewer
PR

Opinion

NEW YORK, Nov 9, 2010 -- Moody's Investors Service has affirmed the Baa1 rating assigned to the Puerto Rico Aqueduct and Sewer Authority's (PRASA) senior lien Revenue Bonds. The outlook has been revised to negative from stable.

RATING RATIONALE

The Baa1 rating incorporates PRASA's monopoly position as a provider of essential water and sewer services and the experienced senior management team's plans to improve the operational efficiency and effectiveness of the system. It also incorporates the financial weaknesses of the authority, which has received subsidies and loans from the commonwealth and the Government Development Bank (GDB), and the difficulty PRASA has had reducing the amount of water lost through leaks or for which no payment is received, currently at 63% of total water produced. The rating also reflects the size and complexity of the system, below-average wealth levels in the commonwealth, poor demographic trends and a weak labor market. The negative outlook reflects PRASA's continued reliance on GDB and the commonwealth (rated A3/Negative) for financial support, as well as the operational challenges the authority faces to reduce the significant amount of water lost through the system.

CREDIT STRENGTHS

*Monopoly provider of an essential service in the Commonwealth of Puerto Rico

*Experienced senior management team

*Implementation of large rate increases in 2005-2006 improved system financial margins

*Adequate forecasted debt service coverage ratios

*Ability to adjust rates 4.5% per year (up to a combined 25%) without additional board action

*In compliance with environmental agreements with U.S. EPA and DOH

CREDIT CHALLENGES

*Large and complex system

*Lack of rate adjustments in recent years, resulting in weak finances

*Large amount of undetermined water losses

*Reliance on funds from Government Development Bank (GDB) and commonwealth in recent years to cover operations

*Future regulatory requirements could be costly

SYSTEM OVERVIEW, MANAGEMENT

PRASA is the sole source of essential water and wastewater utility services in Puerto Rico. It covers 97% of the population; 57% of the population has a combined water/sewer account, while 42% has a water account only. PRASA has 5,000 employees, 128 water treatment plants (down from 129 in 2008) treating 640 million gallons/day, 60 wastewater treatment plants (down from 62 in 2008), 1,567 pump stations, 1,266 tanks, and 8 dams. The authority plans to reduce the number of plants and automate others.

PRASA was created in 1945 by the commonwealth, and since then has had a strong link to the commonwealth, including regular subsidies from the central government and the Government Development Bank (GDB). It is controlled by a 9-member Board of Directors appointed by the governor. Five of the directors are private citizens, 4 are ex-officio (including the Executive Director of PREPA, the President of the Planning Board, and representatives from the Association of Mayors and Federation of Mayors). PRASA is run by Executive President Jose Ortiz, who has been with PRASA for many years, and 6 executive directors.

In the past it has been politically difficult for PRASA to raise rates. The authority raised rates in 2005, which was the first time since 1986. Now, PRASA can raise rates up to 4.5% per year (25% cumulative) without any public hearings. To raise rates more than 4.5%, or after the 25% cap is reached, the authority must go through a rate process which could take 60-90 days and requires public hearings.

OUTSTANDING DEBT

PRASA has over $3.6 billion outstanding. However, $344 million of debt is related to the Superaqueduct, and is paid by commonwealth appropriations if PRASA does not have sufficient funds; it is not a PRASA obligation. In addition, about $1.6 billion is paid by PRASA's net revenues, after paying all expenses and debt service on senior and senior subordinate bonds, but is guaranteed by the commonwealth and paid by the commonwealth if the authority's net revenues are not sufficient.

INTEREST RATE DERIVATIVES

PRASA has no outstanding variable rate debt or swaps.

LEGAL SECURITY

The Revenue Bonds are secured by a senior lien on net system revenues (after paying operating expenses). There is a rate covenant which states that rates must be set sufficient to pay current expenses and annual debt service on all indebtedness, including Commonwealth Guaranteed and Supported obligations: Net Revenues must be set to equal or exceed 120% of annual debt service on senior bonds and 110% of annual debt service on senior and senior subordinate bonds.

The additional bonds test is such that revenues in 12 consecutive months out of the past 18 months must be 1.2 times maximum annual debt service (MADS) for all senior bonds. Revenues in 12 consecutive months out of the past 18 months must be 1.1 times MADS for all senior and senior subordinate bonds.

As specified in a supplemental agreement authorizing the bonds, there is a reserve requirement at the lesser of MADS, 10% of bond proceeds, and 125% of average annual debt service. The 2008 Senior Bonds Series A&B have Debt Service Reserve Funds. Both reserves are funded with cash deposited since the bond issuances in the Trustee accounts.

The master trust indenture specifies that 90 days of operating and maintenance costs must be available in liquidity. At this time, PRASA has a $150 million revolving line of credit provided by GDB for this purpose. There was an outstanding balance of $150 million on this line as of June 30, 2009. As of the date of this report, there is no outstanding balance on this facility.

COVERAGE

Net revenues available for debt service in 2009 were $126 million. This provided coverage of 3.4 times on the outstanding senior revenue bonds (debt service was $37 million). It also provides 1.3 times coverage of maximum annual debt service (MADS) on the revenue bonds (which is $95 million). PRASA expects 2010 net revenues to be approximately $202 million, which would provide 2.9 times coverage of the $69 million due in debt service, and 2.1 times coverage of MADS.

RECENT CHANGES AND ACCOMPLISHMENTS

PRASA's current rate of "non-revenue water" (water lost through leaks or through stolen (non-metered) pipes) is 63%. This compares to 62% in 2008. PRASA's Revenue Increase Program, which was expected to bring in $48 million in fiscal year 2010, brought in $67 million, an improvement over projections of 40%. The program worked on service disconnections, enhanced collections, meter replacement, etc. PRASA has plans in place to partner with the private sector to enhance revenues through improving customer services operations, improving technology, and improving the authority's customer database.

The authority has made efforts in recent years to cut spending and improve its finances. PRASA collected $70 million from past years accounts receivables from the central government, PRIFA, and others. Government payments are now all up to date. The authority has reduced the number of employees by 840 since fiscal year end 2008, which the authority expects saves more than $30 million per year.

Operationally, PRASA has improved services. The number of people without service is down from 14,000 in 2005 to 6,000 today. Clients with intermittent service are reportedly down from 70,000 to 5,000. The authority is also in full compliance with environmental agreements signed with the Environmental Protection Agency (EPA) and the Department of Health (DOH).

FINANCES

Finances in 2008 and 2009 were weaker than we expected when we looked at the credit in 2008. We expected that PRASA would institute annual rate increases, which hasn't happened. Instead, PRASA has continued to get by with GDB assistance and commonwealth appropriations. Fiscal 2008 and 2009 audited financials show revenues were weaker than projected at the beginning of 2008. On the other hand, there has been some success in reducing O&M costs. Net revenues have been sufficient to pay debt service on senior revenue bonds and on the commonwealth guaranteed bonds.

Preliminary results from fiscal 2010 show lower revenues but also lower expenses than expected. While the operational initiatives brought in more money than expected, this was more than offset by lower service collections and no rate adjustment. In addition, the commonwealth General Fund appropriated $27 million for the operations of the Superaqueduct. Expenses were lower than expected, largely due to cuts in payroll and benefits. Debt service was also lower, due to a smaller line of credit from local banks.

LOCAL ECONOMY AND CUSTOMER BASE

Until the mid-2000s, Puerto Rico's growth direction tended to mirror that of the U.S. In 2006, however, Puerto Rico entered recession when the rest of the U.S. was still in full expansion mode. Since then, the commonwealth has remained in recession. This presents a challenge to PRASA, as raising rates is politically less feasible in a recessionary environment.

CAPITAL IMPROVEMENT PLAN AND REGULATORY COMPLIANCE

The revised CIP defers certain projects to reduce debt service without any impact on operations. The CIP complies with all environmental regulations requirements. The requirements are consolidated in 3 agreements with the Department of Health (Water Consent Agreement), EPA (Wastewater Consent Decree), and EPA (Sludge Treatment System Agreement).

The CIP for 2010 was $424 million, of which 68% was mandatory due to the above requirements or safety requirements. The CIP for 2011 is $361 million, of which 52% is mandatory. Out of that, $260 million will be provided by a line of credit from GDB, and $111 million will be provided by federal grants (principally ARRA funds). The CIP for 2012 is $382 million, of which 43% is mandatory.

Outlook

The outlook is negative based on the authority's continued weak finances and operations, the continued reliance on GDB and the commonwealth for financial support, and the significant challenges the authority will face to reduce the amount of lost water.

WHAT COULD CHANGE THE RATING-UP

"Sustained financial self-sufficiency, without assistance from commonwealth

"Improvement in system operations and efficiency

"Demonstrated willingness to implement rate adjustments to maintain financial margins

"Upgrade in commonwealth's G.O. rating

WHAT COULD CHANGE THE RATING-DOWN

"Failure to implement needed rate adjustments in a timely manner

"Decline in coverage

"Downgrade in commonwealth's G.O. rating

"Failure to address lost water

The principal methodology used in this rating was Analytical Framework For Water And Sewer System Ratings published in August 1999.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings and public information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Emily Raimes
Analyst
Public Finance Group
Moody's Investors Service

Edith Behr
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
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New York, NY 10007
USA

MOODY'S AFFIRMS Baa1 RATING ON PUERTO RICO AQUEDUCT AND SEWER AUTHORITY'S SENIOR LIEN REVENUE BONDS
No Related Data.
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