Affordability and Utility Revenue Bond Rating Criteria

Ted Chapman Senior Director

Standard & Poor’s Ratings Services

(214) 871-1401

Theodore.Chapman@standardandpoors.com Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.

Today’s Agenda

•  Summary of the Proposed Criteria •  What’s New •  What’s Staying the Same •  Market Position and Management Assessments

Summary

Holders of Municipal Debt

Households 42%

Mutual Funds 16%

Insurance Companies 12%

Banks and Credit Unions

10%

Everything Else 15%

Closed-End Funds and ETFs 3%

State & Local Gov't and GSEs

1%

Corporate and Small Businesses

1%

Source: Bond Buyer

•  We want to make sure that the framework that supports the methodology and assumptions in our criteria for assigning ratings is clear and transparent

•  The criteria continues to reflect a current and accurate picture of the risks associated with the sector, today and into the future

•  In our opinion, the industry risk is very low

5

Why?

What’s New?

Proposed Municipal

Water Utility criteria

Existing Municipal

Pools criteria

The Matrix

FinancialRiskProfile 1 2 3 4 5 6

EnterpriseRiskProfile

ExtremelyStrong VeryStrong Strong Adequate Vulnerable HighlyVulnerable1

Extremely aaa aa+ aa- a bbb+/bbb bb+/bbStrong

2 Very aa+ aa/aa- a+ a- bbb/bbb- bb/bb-Strong

3 aa- a+ a bbb+/bbb bbb-/bb+ bb-

Strong 4 a a/a- a-/bbb+ bbb/bbb- bb b+

Adequate 5 bbb+ bbb/bbb- bbb-/bb+ bb bb- b

Vulnerable 6

Highly bbb- bb bb- b+ b b-Vulnerable

The RATING Matrix

Bill Affordability •  Assesses the burden of the utility bill against median household

effective buying income •  Because median income represents an “average” customer, true

affordability assessment would be incomplete

•  The proposed criteria therefore also incorporates the local poverty rate of the utility’s service area

11

Market Position

All-In Coverage is the Best Assessment of True Financial Capacity and Use of All Utility Revenues

Operating Revenues

Operating Expenses

Debt Service

General Fund and Other Transfers Out

Self-Support of Tax-Backed Debt

Other

12

All-In Coverage Defined

(Revenues – Expenses – Net Transfers Out) + Fixed Costs

All Revenue Bond Debt Service + Fixed Costs + Self Supporting Debt

13

What’s Staying the Same?

•  Economic fundamentals • Customer base, demographics, major employers, unemployment

rate, trends in local economy • Remains the most heavily weighted factor

•  Liquidity and reserves • Not just days cash, but also how much actual cash (in dollars)

•  Total debt • How is it allocated by lien? • How quickly does it roll off? • Has management been what we would view as aggressive in the

type of debt instruments used, so much so that contingent risks have been introduced?

15

Rating Factors

Market Position

The Delicate Balance

90

100

110

120

130

140

150

160

170

180

Sour

ce: U

.S. B

urea

u of

Lab

or S

tatis

tics

Con

sum

er P

rice

Inde

x fo

r All

Urb

an C

onsu

mer

s (C

PI-U

) ad

just

ed to

bas

e ye

ar 2

000

= 10

0

Selected Inflation Rates Since 2000

CPI, All Items

Real Disposable Income

All Utilities + Public Transportation

Water, Sewer & Trash

Electricity

Public Transportation

Cable TV and Satellite Service

Annualized Utility Bill as a Percent of Median Household Effective Buying Income (i.e. take-

home pay) Less than

2.25% 2.25% to

4.50% 4.50% or More

Percent of the County’s

Population Living in Poverty

10% or less 1 2 3

10% to 20% 2 3 4

20% to 30% 3 4 5

30% or more 4 5 6

Market Position Assessment (1-6, lowest score is most favorable)

Operational Management Assessment

The OMA

40%

20%

40% Asset Adequacy & Identification of Operational Risks

Organizational Effectiveness, Management Expertise & Drought Mgmt Planning

Rate Setting Practices

Asset Adequacy

•  Raw Water Supply •  Quantity

•  Quality

•  Regulatory Compliance •  Treatment Capacity •  T&D, Collection System •  NRW •  Climate Risk •  Other Vulnerabilities

•  Organizational Effectiveness •  How proactive does management seem in its communication and public education? •  How open is the process?

•  Ex. Town halls, social media •  Do the political officials have reasonable discretion and autonomy? Does staff? •  Votes on rates, budgets, debt, etc.?

•  Management Expertise •  Who is answering your questions? •  Do they know what they don’t know? •  Greying of the workforce and succession planning? •  Ask how they balance the triple bottom line

22

Organizational Effectiveness, Management Expertise and Drought Management Planning

Financial

Social

Environmental

•  Drought Contingencies •  Water conservation is an unusual business model

•  Voluntary •  Mandatory •  Mainly targets outdoor watering: time of day, day(s) of the week

•  Generally, a drought management plan either supplements the water conservation program, or supersedes it

•  Most drought plans focus only on the resource management, not on the revenue requirements

•  Some states or regional / wholesale providers require retail systems to have drought plans that we would probably view as “strong”. For the local utility to achieve that, they must have their own ordinance or policy that at least mimics if not exceeds the state’s or wholesaler’s or else it is a “good”

•  Ex. the state of Georgia has very robust drought management planning with well-delineated contingencies depending on the severity of the drought. If we were to view this as “strong” then the city of Atlanta would at least be “good” by default. If Atlanta had equivalent or even stronger policies of its own, it could be viewed as a “strong”

23

Organizational Effectiveness, Management Expertise and Drought Management Planning

Evidence-Based Anecdote

Strong When rate increases have been needed, the decision-making body has been supportive and timely; even to the extent that multi-year pre-approved rate increases are common if not standard. What we view as financially prudent decisions are made rather than decisions that are politically expedient that could possibly be to the detriment of the utility’s near-term financial health. Periodic rate studies (internal or external) are common.

Good Rate considerations are done on a year-to-year planning horizon rather than over a long-term time frame, but generally are apolitically approved if and when necessary.

Standard The rate covenant and/or additional bonds test are the de facto guide as to when rate adjustments are necessary, but that is still enough for the political decision-makers to agree to a rate increase.

Vulnerable Rate increases are often in reaction to a weakened financial position, including a technical default or some other legal covenant violation, even if the recent debt service payments were made on time and in full. There is clear evidence of recent political decisions to defer or downsize needed rate increases.

24

Rate Setting Practices

Questions?

26

For More Information

Geoff Buswick, Managing Director and Lead Analytical Manager Boston, 1 (617) 530-8311; geoffrey.buswick@standardandpoors.com

James Breeding, Senior Director and Analytical Manager

Dallas, 1 (214) 871-1407; james.breeding@standardandpoors.com

Scott Garrigan, Director and SRF Sector Leader

Chicago, 1 (312) 233-7014; scott.garrigan@standardandpoors.com

Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

STANDARD & POOR’S, S&P, GLOBAL CREDIT PORTAL and RATINGSDIRECT are registered trademarks of Standard & Poor’s Financial Services LLC.