OREANDA-NEWS. Fitch Ratings has assigned a 'BBB+' rating to the following revenue bonds issued by the city of Philadelphia on behalf of the Philadelphia Gas Works (PGW):

--Approximately $220,550,000 Gas Works Revenue Refunding Bonds, Fourteenth Series (1998 General Ordinance).

The bonds are scheduled to price via negotiation August 20. The bonds will refund a portion of outstanding parity bonds (Seventh Series, Ninth Series and Eighth Series A-E) for interest cost savings, fund termination payments related to corresponding swap agreements and pay issuance costs.

In addition, Fitch affirms the following rating:

--$915,175,000 million gas works revenue refunding bonds, various series (senior 1998 general ordinance) at 'BBB+'.

The Rating Outlook is Stable.

SECURITY

The 1998 general ordinance bonds are secured by net revenues of the gas works utility.

KEY RATING DRIVERS

LARGE GAS DISTRIBUTION SYSTEM: PGW is the largest municipally-owned gas distribution utility in the nation serving slightly more than 500,000 accounts located entirely within the City of Philadelphia (general obligation bonds rated 'A-'/Stable Outlook). The system provides natural gas on a retail basis to a considerably diverse and largely residential customer base exhibiting no concentration among users.

SUSTAINED IMPROVEMENT IN FINANCIAL PERFORMANCE: A sustained improvement in financial metrics and a continued reduction in debt levels resulted in a rating upgrade in 2015. Contributing factors include prior rate relief, greater cost recovery through various surcharges, historically low natural gas prices and PGW's ability to current fund its capital needs and maintain healthier collection rates. Fitch expects these trends will continue based on the latest financial forecast.

STABLE FINANCIAL METRICS: Fitch calculated debt service coverage has averaged a solid 1.52x over the prior five years while coverage of full obligations, which reflects the annual transfer made to the city's general fund, has also remained at a healthy level, averaging 1.37x since 2010. Liquidity continued at an acceptable level in fiscal 2015, equal to 74 days of cash on hand.

RATE REGULATED: PGW's ability to establish its rates is subject to oversight by Pennsylvania Utility Commission (PUC), potentially limiting needed rate increases and overall financial flexibility. Positively, the utility's relationship with the PUC has remained constructive and supportive in recent years.

WEAK BUT STABLE DEMOGRAPHICS: The city's economy continues to strengthen and is well anchored by several large health care and higher education institutions. However, wealth indicators for the service area remain are generally weak, contributing to chronically below average collection rates and sizeable write-offs, and compounding PGW's high rates.

RATING SENSITIVITIES

LIMITED FINANCIAL FLEXIBILITY: Despite the overall improvement in Philadelphia Gas Works' credit quality in recent years, Fitch expects the utility's exceptionally high rates, the service area's low income levels and a regulatory environment that includes state and local oversight will continue to limit financial flexibility. A return to weaker collection rates, diminished cash flow and an inability to gain needed rate relief and recover costs would exert downward pressure on the ratings.

FORECAST RESULTS REALIZED: PGW's ability to generate financial results included in its latest financial forecast, which hinge on gaining rate relief and further sustaining its trend of improved revenue collection could ultimately warrant positive rating consideration.

CREDIT PROFILE

IMPROVED CREDIT QUAILITY

PGW's financial performance since gaining rate relief beginning in fiscal 2010 has exhibited a generally more favorable trend with metrics supportive of the 'BBB+' rating. Fitch calculated debt service coverage of both senior and subordinate lien obligations has averaged 1.52x over that span, compared to 1.1x between fiscal 2006 and 2009. Coverage of full obligations, which reflects the annual transfer made to the city's general fund, has also remained at a healthy level, averaging 1.37x since 2010.

Liquidity is somewhat low but still adequate for the rating category. Unrestricted cash and investments peaked at 74 days in fiscal 2015 and have remained at no less than 55 days since 2010, despite management's prudent decision to use cash flow to defease or accelerate bond principal by approximately $50 million in recent years.

MANAGEABLE CAPITAL PROGRAM

PGW's capital improvement program (CIP) through fiscal 2021 appears manageable with spending levels moderately higher compared with historical programs. Planned spending spanning fiscal years 2017-2021 totals $587.2 million, the vast majority of which will be to reduce the inventory of cast iron mains. PGW remains committed to an ongoing cast iron main replacement program that has accelerated in recent years following the implementation and subsequent increase of a distribution system improvement charge.

Capital program funding sources will be almost evenly split between excess cash flow and debt issuances planned for midway through fiscal 2017 and the second half of fiscal 2020. Leverage ratios have fluctuated over the years but have generally exhibited gradual improvement with the current funding of capital projects leading to a steady decline in total debt outstanding. The ratios of equity to capitalization and debt to funds available for debt service (FADS) progressed to 22% and 7.1x, respectively, at the close of fiscal 2015 compared to 17.8% and 8.8x, respectively, in 2010.

Fitch expects a moderate increase in total debt outstanding by 2020 based on the additional borrowings plans; however, the related change in leverage ratios should be tolerable at the current rating category. Additional debt associated with a tentatively planned expansion of existing liquefied natural gas (LNG) facilities would likely pressure debt metrics further. However, the potential for higher LNG sales as a result of the expansion could enhance cash flow and sufficiently mitigate any rating concerns.

SOCIOECONIOMIC CHARACTERISTICS COMPOUND HIGH RATES

PGW's exceptionally high rates, the city's challenging demographics and the state's regulation of retails rates continue to constrain PGW's operating flexibility. Residential rates are more than 50%higher than all other gas distribution systems operating within the state in part due to historically weak collections and extensive utility-sponsored discount programs that benefit low-income customers. The city's nearly 27% poverty rate is nearly twice the national rate, and median household income (MHI) approximates just 70% of the state and national averages. Consequently, PGW's accounts receivable balances and annual write-offs are routinely high relative to most utilities. Fitch notes, however, that after remaining consistently below 90% prior to 2004, revenue collection has averaged a more acceptable 96% over the prior 10 years.

HEIGHTENED REGULATORY ENVIRONMENT

PGW operates within a heightened regulatory environment with the gas commission, city council and the PUC maintaining oversight of the utility's operations and the PUC retaining rate setting authority.. While the regulatory bodies have been increasingly more supportive over the last several years, Fitch believes the multiple layers of oversight will continue to limit the utility's financial flexibility,

Fitch notes the PUC's ratemaking methodology is designed to ensure PGW recovers its costs, meets its rate covenant of 1.5x coverage on senior and subordinate lien obligations, and continues to fund a required $18 million annual utility payment to the city.