NEW YORK--()--Fitch Ratings assigns an 'AAA' rating to the following City of Orlando, Florida (the city) revenue bonds:
--Approximately $39 million wastewater system refunding and improvement revenue bonds, series 2013.
Bond proceeds will be used to refund and defease the remaining maturities of the system's outstanding series 2002A and series 2006A bonds for interest savings and restructuring, finance the 2013 project, make a DSRF deposit, and pay issuance costs.
The bonds are scheduled for negotiated sale the week of Jan. 7, 2013.
The Rating Outlook is Stable.
The bonds are secured by a senior lien pledge of the wastewater system's net operating revenues (including connection fees), and a subordinate lien on the proceeds of the utilities services tax (UST).
KEY RATING DRIVERS
SECURITY CHANGE CREDIT NEUTRAL: The 2013 bonds will be issued under a new bond ordinance. The bonds will be secured by a double-barrel pledge that includes net system revenues and a subordinate lien on UST collections. The previous revenues pledge included a senior lien on UST revenues. Strong pro forma financial performance from system revenues and the inclusion of an anti-dilution test on the city's leverage of UST allays concerns over a change in security.
STRONG FINANCIAL MARGINS EXPECTED: The refunding and redemption of the previous bonds will significantly lower annual debt service resulting in significantly greater financial margins and debt service coverage (DSC) levels from operating revenues alone. Fitch expects the city to meet its pro forma projections showing very strong all-in DSC of at least 3.0x.
LIQUIDITY IS STRONG: The system ended fiscal 2012 (unaudited) with nearly $60 million in unrestricted cash and renewal and replacement funds, which is equivalent to 460 days cash on hand. The capital plan is manageable and expected to be funded with debt (including these bonds), which should allow cash to remain strong going forward.
RISING BUT MANAGEABLE DEBT: The debt burden will increase to $1,949 per customer after issuance, which is high but manageable given the system's measured capital needs and strong pro forma financial profile. Debt carrying costs will improve as a result of the refunding and redemption of the outstanding bonds.
RATES ARE HIGH: Rates have been increased by a total of 40% since fiscal 2010 in order to meet capital requirements and to maintain system solvency. Sewer rates are high at about $45 per month (assuming 7,000 gallons of water use), which is equivalent to 1.4% of median household income (MHI), and overall utility rates (including separate water service provided by Orlando Utilities Commission) will be above Fitch's affordability threshold of 2% of MHI. However, future rate increases are likely unnecessary with expected declines in annual debt service.
STABLE, TOURISM-BASED ECONOMY: The regional economy is diversified with employment in professional and business services, health care and education, and biotechnology, but remains subject to fluctuations in tourism and related services. Recent employment growth has lowered the unemployment rate to 7.9% in October 2012.
CREDIT NEUTRAL SECURITY CHANGE; PLEDGED RESOURCES REMAIN ABUNDANT
The 2013 bonds will be issued under a new Master Ordinance and the city will refund and redeem the previously issued bonds that carried a senior lien on the UST. Fitch acknowledges the city's decision to subordinate the UST to support other governmental capital funding somewhat weakens the overall pledge to bondholders. However, Fitch believes the changes are credit neutral as the rating largely reflects the sound operating profile, strong expected financial performance, and the addition of an anti-dilution test on future UST secured bonds.
State law authorizes any municipality to levy a UST (not to exceed 10% of the payments received by the seller of such services) on the purchase of electricity, metered/bottled natural gas, liquefied petroleum, fuel oil, and water service. The city collects the proceeds of the tax into a separate governmental fund and the cash is available to pay for system operations and maintenance costs, senior lien debt service, or replenishment of debt service reserves. Proceeds of the tax have been significant over the years and totaled roughly $28 million in fiscal 2012. Fitch notes that while the UST is pledged and available for utility needs it has not been used for such. The city relies on UST revenues to fund general government operations.
FINANCIAL PERFORMANCE TO IMPROVE
DSC from all pledged revenues, including the UST, has been very strong historically, averaging 4.0x or better on the senior lien bonds and 2.8x of all debt service over the past five years. When excluding the UST DSC was still good at about 2.1x in fiscal 2012 (unaudited), but was as low as 1.5x on the senior bonds in fiscal 2008 as recessionary pressures led to operating revenue declines.
Historical all-in coverage excluding the UST has been somewhat low, ranging between 1.3x and 1.7x over the past five years, and was just 1.6x for fiscal 2012. However, a decline in annual debt service from the refunding and redemption of the prior bonds will significantly improve financial performance.
Pro forma financial results provided by the city's consulting engineer appear reasonable and show a very strong financial profile from operations, including operating cash flows and DSC, over at least the next five years. The system projects generating operating margins of around 40% annually, and excess annual cash flows (cash flows after debt service is paid) of just over $20 million, as a result of a decline in debt service.
Annual debt service on the senior bonds is anticipated to decline to just $2.6 million in fiscal 2013 (from over $15 million in 2012), which will significantly improve DSC from operating revenues (i.e., not including UST) to a very strong 10.6x on the senior bonds, and 3.6x on all debt in fiscal 2013. Coverage declines slightly during the remainder of the forecast but remains very strong at no less than 10.0x for the senior bonds, and 3.0x all-in.
LIQUIDITY TO REMAIN STRONG
The system's liquidity position is expected to remain strong. The system ended fiscal 2012 with nearly $60 million in unrestricted cash and investments and renewal and replacement funds, which comprise a very strong 460 days of cash on hand. Including accounts receivable, system resources are nearly 2.0x current liabilities. Liquidity is expected to remain strong going forward due to the very large projected excess annual cash flows.
STRONG SERVICE AREA CHARACTERISTICS, ECONOMY STILL TIED TO TOURISM
The city of Orlando's (implied GO rating of 'AAA') wastewater utility provides sewer collection and treatment services to a large retail customer base of 73,000 sewer and 3,000 reclaimed water accounts. The customer base is mostly residential and stable.
Orlando and the surrounding communities make up one of the world's leading tourist destinations and remains the economic anchor for central Florida. In addition to tourism, the regional economy includes healthcare and education, professional and business services, and biotechnology. The unemployment rate for the Orlando metropolitan area has steadily improved over the past two years as a result of employment gains demonstrated for most of 2011 and 2012.
ADEQUATE TREATMENT CAPACITY; MANAGEABLE CAPITAL NEEDS
The city owns and operates three wastewater treatment plants with a combined capacity of 72.5 million gallons per day (mgd). Average daily wastewater flows have ranged between 37 mgd and 39 mgd for the past three years, leaving ample treatment capacity to meet future growth. The system utilizes a combination of rapid infiltration basins, sale of reclaimed water to existing customers, and man-made wetlands to discharge effluent. All plant operating permits are current and the system is not facing any regulatory issues.
The system's $122 million five-year capital program will focus on system-wide improvements including major upgrades to two of its treatment facilities. The city plans to use a combination of impact fees, additional subordinate lien state revolving fund loans, and other internal sources to fund the program.
RISING BUT MANAGEABLE DEBT BURDEN
Debt ratios are currently moderate and are characterized by debt to net plant of 18% and debt per customer of $1,023 in fiscal 2012, both of which are near or below average for the rating. As previously expected, the issuance of the 2013 bonds coupled with additional SRF loans will increase the debt burden. Fitch projects the new debt will push debt ratios to levels that are above the projected debt ratios for similarly-rated systems. However, the debt profile should remain manageable with affordable carrying costs and very strong projected financial results.
SOUND LEGAL COVENANTS
The bonds are secured by the system's net operating revenues and the UST, even though the pledge is now subordinate to potential (future) UST-backed bonds. There are no current plans to issue senior lien UST bonds; although a 1.5x MADS anti-dilution test ensures a significant amount of UST remains available for the system if UST bonds are issued. Fitch does not place great emphasis on the UST as long as the system maintains a strong financial and operating profile.
The city covenants to fix, establish, revise, maintain and collect such fees, rates, rentals and other charges which will always provide pledged revenues (including the UST) sufficient to pay 125% of annual debt service, and 100% of amounts required to be deposited into the reserve fund, the renewal, replacement, and improvement fund, and debt service on other obligations (subordinate SRF loans).
To issue additional bonds, pledged revenues for any 12 consecutive months of the previous 30 months preceding the issuance of proposed bonds is not less than 125% maximum annual debt service (MADS). The ABT is somewhat liberalized by the allowance of revenue adjustments for estimated revenues from expected rate increases, customer growth, or extensions and improvements to the system. A cash-funded debt service reserve equal to the standard lesser of three-pronged test provides bondholders with additional security.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in the U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012);
--'2013 Water and Sewer Medians' (Dec. 5, 2012);
--'2013 Outlook: Water and Sewer' (Dec. 5, 2012).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2013 Water and Sewer Medians
2013 Outlook: Water and Sewer Sector