Overall, for the U.S. public waterworks and sewer utility sector, 2018 shouldn't bring too much in the way of surprises. S&P Global Ratings expects the traditionally low-risk sector will continue to face few credit risks. The Republican tax plan largely will not affect the sector. Furthermore, we don't expect major new environmental regulations, especially at the federal level, and the U.S. economy is likely to continue its slow-but-steady expansion.
But low risk does not imply no risk. One of the biggest risks the sector faces is the financial, human, and technical resource gap between smaller and rural utilities versus urban and larger ones. We expect that gap will continue widening. But overall, we expect ratings in the sector to remain stable and high.
Risks And Opportunities
- The Tax Reform and Jobs Act ultimately ended up preserving private activity bonds (PABs); the 2018 cap actually increased. However, water and sewer utilities do not use PABs nearly as much as housing authorities, airports, and not-for-profit entities. Therefore, we believe that eliminating PABs would have created only very modest issues for the sector anyway. However, other factors, like the elimination of tax-exempt advance refunding transactions and the Federal Open Market Committee's stated intent for three hikes in the federal funds rate in 2018, could still make borrowing costs higher for all and will almost surely lead to a steep decline in total bond issuance in 2018.
- The gap between larger utilities (defined by the U.S. Environmental Protection Agency [EPA] as serving a population of over 10,000; see chart 1) and smaller ones is increasingly profound. Utilities defined by the EPA as very small (serving a population of less than 500), small (501 to 3,300), and medium (3,301 to 10,000) serve less than 20% of the U.S. population but report more than 80% of deficiencies. We anticipate that 2018 will continue the trend of large (10,001 to 100,000) and very large (more than 100,000) utilities finding a way -- somehow -- to generate crucial capital dollars while smaller systems, most of which serve low-density rural areas, get left further behind.
- Per the Water Research Foundation's estimates, as many as half of all water sector employees will be of retirement age or will have retired by the end of this decade. We expect succession planning and mentoring could move from risk to crisis, again with disproportionately tough effects on small and rural systems with more limited ability to offer competitive pay. State and local governments are struggling to continue honoring obligations promised to retirees with costs that continue to consume larger percentages of operating budgets (see "Local Government Pension And Other Postemployment Benefits Analysis: A Closer Look," published Nov. 8, 2017, on RatingsDirect). We expect this issue to continue.
- For many utilities, capital expenditure dollars are limited and projects must be prioritized. For some, the focus is on what they can afford rather than what they need, which, in our view, introduces the risk of deferred maintenance. The American Water Works Association's state of the industry report in 2017 listed capital expenditures and financing as the top two challenges facing the sector based on a survey of its members. Using the EPA's Drinking Water Dashboard and other available statistics, small and very small systems have most of the identified problems. Conversely, large and very large systems -- those most likely to continue to use tax-exempt borrowing or qualify for state loan programs -- accounted for 7.4% of total reported issues in 2016 (see table 1), the most recent year for which data are available.
- The fiscal 2017 federal budget included appropriations for the first loans under the Water Infrastructure Finance and Innovation Act (WIFIA). The EPA announced in July 2017 that, of the more than 40 applicants, it had selected 12 projects in nine different states for up to $2.3 billion in loans. This is small compared to the sector's total estimated needs, but it is still the first new federal program for water utilities in years. The fiscal 2018 budget reflects the administration's intent to greatly reduce EPA's total budget, including the Superfund program and enforcement divisions. However, WIFIA and the drinking and clean water state revolving fund (SRF) appropriations are largely unaffected. There are also several bills that focus on creating federal appropriations for drinking and clean water and stormwater. These have up to five years' worth of funding and which include attention to small and rural systems, as well as bills that would pave the way for more integrated planning to allow municipalities to continue to comply with the federal Clean Water Act.
- We anticipate that any infrastructure stimulus package proposed by President Donald Trump's administration will focus mainly on the surface and air transportation sectors. Discussion of drinking and clean water infrastructure will most likely encourage alternatives to address needs, including private-sector investments and local solutions. Still, tempering this is the delicate condition of state budgets, although we expect states will still find a way to participate. We have negative outlooks on nine states. Some expenditures, like Medicaid, pension, and postemployment benefit obligations, are outstripping growth in revenues. Should a new federal grant require a state match, given the relatively low debt loads across the state sector and increasing awareness of the need for more infrastructure investments, many states might consider leveraging the federal grant with bond proceeds.
- As in 2017, we do not expect major new environmental regulations in 2018, only updates on those implemented or under development. These include the Lead and Copper Rule and further scaling back of the Waters of the U.S. program, as well as enhanced public notification and disclosure related to utilities' combined sewer overflows into the Great Lakes. In November 2016, the EPA updated its contaminant candidate list, which is "a list of contaminants that are not subject to any proposed or promulgated national primary drinking water regulations, but are known or anticipated to occur in public water systems." Being on the list means these chemicals or microbes have been prioritized, and at least the top five will be subject to further study and possible regulation. The list itself does not create any new regulations. Although headlines or Congress could spearhead prioritization of any new regulation or an update to an existing rule, any new rulemaking must be based on the best available science and control technology. Ultimately, however, we view the political environment as creating a very low risk for new regulations, especially given the president's directive to repeal two existing regulations for every new one.
- S&P Global Ratings' economic research states that even in a downside scenario, U.S. gross domestic product (GDP) should still grow in 2018, at 1.6%. Our baseline forecast is 2.8% growth, continued full employment, and 1.3 million new housing starts. We view the odds of a recession as relatively low, absent the unintended consequences of new macroeconomic policies or geopolitical events. For more information, see "Economic Research: A Tax Package For The New Year: Its Impact On U.S. GDP Growth", published Jan. 8, 2018.
Table 1 - Municipal utility violations
Systems With One Or More Safe Drinking Water Act Violations During 2016
|% total violations||Average population served|
Note: All reported violations, regardless of severity, from monitoring and reporting to acute health risk violations. Source: Environmental Protection Agency Safe Drinking Water Information System.