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Rating Update:

MOODY'S DOWNGRADES THE RATINGS ON DU PAGE WATER COMMISSION'S OUTSTANDING GO AND REVENUE DEBT TO A1 AND A2 FROM Aa1 AND Aa2, RESPECTIVELY

03 Jan 2011

OUTLOOK IS NEGATIVE

Water/Sewer
IL

Opinion

NEW YORK, Jan 3, 2011 -- Moody's Investors Service has downgraded the ratings to A1 from Aa1 on Du Page Water Commissions' $12 million of outstanding general obligation debt and to A2 from Aa2 on $71.9 million of outstanding water revenue debt. The outlook on both ratings remains negative.

RATING RATIONALE

The downward rating actions are primarily due to the depletion of reserves, failure to keep rates in-line with expenditures, the need to borrow for operations and weak governance not congruent with the previously high rating categories. The A1 and A2 ratings reflect the commission's broad, diverse and affluent tax base/service area, and manageable debt profile as well as the essentiality of the service provided.

STRENGTHS:

-- Strong economic base

-- Diverse economy with affluent wealth levels

-- Less economic / revenue volatility than most counties

-- Low debt with rapid amortization

CHALLENGES:

-- Revenue shortfalls/spending pressures leading to narrow operating fund liquidity

-- Need to short term borrow to meet this year's expenses

-- Uneven management

DIVERSE LOCAL ECONOMY EXPECTED TO WEATHER DOWNTURN

Located 20 miles west of Chicago (GO rated Aa3), DuPage County benefits from its proximity to Chicago, but over time has developed a significant and distinct economy of its own. The economic strength of the area is reflected in unemployment rates which have historically tracked below the state and nation, with major employers and taxpayers well diversified - telecommunications and electronics, health care, research, retail and food service all well represented. Spurred by large amounts of land available for development and the presence of a number of major transportation arteries, strong residential, commercial and industrial development patterns emerged over the past two decades- contributing strong population growth during the 1980's, and slowing into the 1990's. With a maturing tax base, population growth is expected to continue, albeit at a more modest pace, with a final build out population of around 1 million. The inherent strength of the region is the diversity of its tax base: middle class through estate level residential, a large amount of office space, particularly along the I-88 corridor, and notable amount of complementary retail.

Several large governmental research facilities (Argonne National Laboratory and the Fermi Lab) are nearby, creating a hub affect to attract a highly educated workforce to the area. Lucent Technologies (senior unsecured B1 with negative outlook) remains one of the County's largest employers, though employment levels are considerably reduced from the peak of 12,000 only a few years ago. Additional layoffs occurred in previous years at Tellabs as well, though the company's global headquarters remains in Naperville (general obligation rated Aaa). BP, previously one of the county's top employees recently moved roughly 1,000 of its 3,200 employees to downtown Chicago. Favorably, Edward Hospital (rated A2 with a positive outlook), the county's largest employer at 4,100, continues to perform well. In general, the dour national economic condition is being felt locally. Housing activity is down, and the county's traditionally sturdy employment levels are showing a decided softening, but its unemployment rate remain below both state and national averages. The county's October rate of 7.2% was well above its 5.1% experienced during the same time two years ago, but down from 8.7% October 2009. Unemployment compared favorably to the state and national October 2010 rates of 9.2% and 9.0% respectively.

LOW RATES, REBATES AND INCREASING COSTS DEPLETE HIGH RESERVE LEVELS

While the general obligation bonds are secured by the commission's unlimited ad valorem pledge, the commission has chosen to abate the property taxes since 1986, in favor of using sales tax to cover debt service. Additionally, sales tax revenues have been utilized to support a portion of debt service on the water revenue bonds as a conscious decision by the commission to keep water rates low. The sales tax rate is set at 0.25% by state statute. Before a 21% rate increase in May 2010, the commission was buying water from the City of Chicago at a rate of $2.01 per 1,000 gallons and sells it to its customers for $1.48 per 1,000 gallons. Compounding the problem at the time the recession hit leading to steep sales tax declines (9.3% in fiscal 2009), the commission was required to pay Du Page County $75 million over a five year period ($15 million annually) which ended in July 2007. The commission also paid underlying member utilities a total of $40 million in rebates on May 1, 2007. This give-back, unfortunately, coincided with the City of Chicago raising its rates by 15% in 2008 and 2009 with another 14% hike in 2010, which were not immediately passed along by the commission to its users. The commission represents $38.8 million in sales to Chicago making it its largest customer at 8.7% of total revenues and has 40 year contract that expires in 2023. Sizable rate increases are being discussed currently to stabilize the commission's financial picture.

Up until the last few years, the commission enjoyed robust balances, which brought upon pressure from the county and cities for the commission to redistribute $75 million and $40 million to each, respectively. In recent years, governance practices appear lax as fund balance monitoring seems to have been neglected. The commission's target emergency balance of $20 million was not met in fiscal 2009. The actual balance was $2.4 million on April 30, 2008 (fiscal year-end). That reserve had been completely depleted. The line item Designated for Rate Stabilization Fund declined from $42.8 million in fiscal 2005 to zero in fiscal 2008. Unrestricted reserves experienced a reduction of $51.2 million in fiscal 2008 and another $21.2 million in fiscal 2009.

In order to meet operational expenses the Commission borrowed $30 million and additional $40 million medium-term five year notes. The $30 million Certificate of Debt is with West Suburban bank and the $40 million Certificate of Debt is with Northern Trust. The final maturities are December 21, 2015 and May 1, 2011, respectively. Management hopes to extend the May 1, 2011 maturity with Northern Trust to May 1, 2015.

In terms of debt service coverage, after three strong years at over two times coverage, 2.4 times in fiscal 2006 and 2007, for the senior lien bonds, the coverage dropped down to 1.6 times in fiscal 2008 and to 0.89 times in fiscal 2009. Total debt service coverage had been more than adequate at 1.24 times in fiscal 2006 and 2007, yet declined to 0.83 times in fiscal 2008 and down to 0.46 times in fiscal 2009. The April 30, 2010 audit field work is nearly complete and audited results are expected to be released before the end of February 2011. Projected coverage for fiscal 2010 is improved yet below sum sufficient. Unaudited preliminary figures dated November 2010 show year-to-date water sales only 0.7% higher than the first seven months of fiscal 2009, however sales taxes are up 9.4% over same period. At this point, officials are conservatively projecting a $900,000 operating surplus by the end of the fiscal year.

Favorably, the commission's pension liability is 80.6% funded as of December 31, 2009 and while OPEB is not funded, it only amounts to $99,000. An additional strength to the credit profile is the limited amount of debt which will mature shortly; general obligation bonds in March 2011 and revenue in March 2016.

ADEQUATE LEGAL PROVISIONS

The water revenue bonds are payable from net revenues of the system; revenues to be derived from payments of charter customers pursuant to water purchase and sale contract. The obligation to pay the commission is a take-or-pay obligation of customers' respective water and sewer systems. However, customers are not prohibited from using other funds to make contract payments.

The flow of funds is a closed loop; first to Water Fund, then (1) O&M; (2) interest; (3) principal; (4) debt service reserve; (5) O&M reserve equal to one-sixth of operating costs, with deposits to begin the second month after operations start; (6) depreciation account; (7) general account, to be used for any lawful system purpose, including reducing charges to, or payments from, customers.

The rate covenant is adequate as the commission must maintain "reasonable" fees, charges, and rates sufficient to pay O&M debt service, to fund depreciation account, and meet all other bond covenants. In establishing fees and charges, the commission (pursuant to its budget covenant) may take into account funds on hand in the general account to meet its revenue requirements.

The reserve requirement provisions for making up debt service reserve deficiency are relatively weak as the reserve can be built up over five-year period. However, presently, the debt service reserved is fully insured by AMBAC. Adequate additional indebtedness specifications require the commission to receive counsel opinion indicating that valid and binding water supply contract obligating contract customers to make payments on same basis as those for existing bonds and in amounts sufficient to make all required payments to Water Fund.

Authorized investments vary according to fund, with interest, principal, and debt service reserve accounts requiring more conservative investments. The range of permitted investments includes direct and guaranteed obligations of the U.S., those of certain federal agencies, time deposits, short-term corporate obligations, and state treasurer's pool, among others.

Other security provisions include payments due from charter customers are calculated according to a formula; payments generally based on each customer's pro rata share of water allocation prior to system operation or when there is no water delivery, and on customer's relative usage when water delivery is occurring. If a customer defaults in payment, other customers would provide for the defaulting customer's payment; the amount of "step-up" is unlimited.

A Board of Commissioners governs the commission, which consists of 12 commissioners and a Chairman. The DuPage County Board Chairman with the approval of the DuPage County Board appoints the Chairman and six of the Commissioners. Six Commissioners are elected by the mayors/presidents of the municipalities within a County Board District. The new board is expected to be seated by mid-January in time for the next Commission meeting. A few of the current Commissioners will be re-appointed, but the vast majority will be serving their initial terms.

Outlook

The assignment of the negative outlooks reflects the commission's declining reserve levels and the strong need to increase rates. The commission's governance poor oversight further pressures the rating. We will continue to monitor the commission's ability and willingness to raise rates in a timely manner.

WHAT COULD MOVE THE RATING UP (OR REMOVAL OF NEGATIVE OUTLOOK):

* Restoration of unrestricted reserves to adequate levels

* Retaining the debt service coverage levels of the system

WHAT COULD MOVE THE RATING DOWN:

* Continued weakening of the systems unrestricted reserves position

* Further decline in debt service coverage

Key Statistics:

Number of accounts: 27 city/village customers; serving over 9000,000 people

Average Daily Pumpage: 87.1 MGD

Highest Daily Pumpage: 145.1 MGD

Lowest Daily Pumpage: 65.4 MGD

Debt service coverage (senior lien), 2009: 0.89 times

Payout (principal and interest), 6 years: 100%

Fiscal 2009 balance (April 30): $2.2 million

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, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics 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

Edward Damutz
Analyst
Public Finance Group
Moody's Investors Service

Iliana Beltran
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

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MOODY'S DOWNGRADES THE RATINGS ON DU PAGE WATER COMMISSION'S OUTSTANDING GO AND REVENUE DEBT TO A1 AND A2 FROM Aa1 AND Aa2, RESPECTIVELY
No Related Data.
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