NEW YORK--()--Fitch Ratings upgrades the rating on the following Leesburg, FL (the city) revenue bonds:
--Approximately $42 million utility system revenue bonds, series 2004, series 2007A, and series 2007B to 'AA-' from 'A+'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
STRONG LIQUIDITY DRIVES UPGRADE: The rating upgrade reflects the system's track record of solid financial margins and the restoration of strong liquidity levels over the past several years. Unrestricted cash and investments have increased by almost 100% since fiscal 2008, and are vastly improved from the very low liquidity levels demonstrated in fiscal 2004 - 2006.
DEBT COVERAGE REMAINS STRONG: Financial margins are near 40% and debt service coverage (DSC) has averaged 2.5 times (x) over the past four years net of transfers. Free cash flow is ample, providing significant pay-go capital funding resources.
MODEST CAPITAL PLAN: Significant previous capital investment has left the system with plenty of treatment capacity and modest capital needs. The system plans to spend just $15 million through 2017 for system upkeep and maintenance. The city has accumulated roughly $5.8 million in funds for renewal and replacement, with the rest of the capital program easily covered by the system's strong annual cash flows.
AVERAGE DEBT BURDEN: The debt burden is manageable, and near 'AA' category medians. Pay-out is slow, but the city does not expect to issue additional bonds over the near term which should allow the trend of modest declines in the debt burden to continue.
REASONABLE, BUT RISING RATES: Rate increases have been consistent and modest, and traditionally linked to an inflation index. Charges for combined water and sewer service total about $48, which is competitive and affordable at 1.6% of median household income (MHI). Residential natural gas rates are also competitive both in relation to other municipal systems and to regulated natural gas companies within the state.
COMMODITY COST RISK MITIGATED: The gas component of the monthly utility bill includes a purchased gas 'pass-through' which is automatically adjusted to pass along commodity cost increases to customers on a monthly basis and does not require approval by the city commission.
LIMITED ECONOMY SUBJECT TO VOLATILITY: The local economy is generally focused on agriculture, real estate, and health care. Suffering dramatic loss of jobs and plummeting housing prices during the recession, economic conditions are only recently showing evidence of stability although unemployment remains elevated and demographic indicators are still low.
STRONG FINANCIAL MANAGEMENT EXPECTED: The rating is sensitive to shifts in fundamental credit characteristics, and in particular, Fitch's expectation the system will continue to demonstrate strong financial margins and solid liquidity.
Leesburg (implied GOs rated 'AA-'; Stable Outlook by Fitch) is located in Lake County in central Florida, approximately 40 miles northwest of Orlando. The city owns and operates a combined utility system consisting of natural gas delivery, water treatment and distribution, and wastewater collection, treatment, and disposal to residents of the city and areas nearby in unincorporated Lake County.
Each utility is accounted for as a separate self-supporting enterprise fund of the city, but are nonetheless consolidated for bonding purposes. The water and wastewater utilities are the largest revenue contributors, accounting for 30% and 42% of fiscal 2013 budgeted operating revenues, respectively. The gas system accounts for the remainder.
STRONG FINANCIAL MANAGEMENT AND IMPROVED LIQUIDITY DRIVE UPGRADE
The system's cash reserves have steadily improved and are considered to be strong with a combined $21 million in unrestricted cash and renewal and replacement fund reserves as of fiscal 2012 (unaudited). The combined cash balances are a healthy 542 days of cash on hand, compared to 163 days cash on hand in fiscal 2007. The accumulation of fairly sizable cash balances over the past five fiscal years is attributed to a slowdown in capital expenses, improved operating margins, and lower annual transfers out.
The transfers are calculated by multiplying 7.75% (7.25% for the wastewater system) against charges for services, excluding certain revenues, but such transfers are capped at 10%. The city has increased the transfer for fiscal 2013 up to the maximum but expects this to be temporary and has indicated it would like to reduce the transfers over time as the economy improves. Fitch believes the city is not likely to change course over at least the next several years, given continued pressure on taxable assessed values and property tax revenue, the largest funding source for the general fund.
Operating margins have increased to a solid 39% in fiscal 2012, from just 29% a few years earlier. Strong annual cash flows (the system has generated no less than $6 million annually over each of the past six years) have put the system on strong financial footing. The positive trends in financial performance and much-improved liquidity is a positive credit development, and a primary driver of this rating action.
Coverage has historically been strong with recent declines due mainly to an increase in debt service. Nevertheless, DSC remains strong in fiscal 2012 at roughly 2.9x, and a still strong 2.2x net of system transfers. Free cash flow (measured as net revenues available for debt service minus transfers) was a solid 131% of depreciation in 2012, and averaged 145% annually over the previous four years. Annual debt service is a very manageable 14% of gross revenues.
AFFORDABLE RATES AND LOCAL RATE-SETTING PROVIDES FLEXIBILITY
The city has independent rate setting authority. Assuming 7,500 gallons of use, rates are a reasonable $48 for combined water and sewer service, and compare very favorably to MHI (1.6%), and rates charged by neighboring systems.
Consistent and modest rate increases are viewed favorably with increases traditionally linked to an inflation index. Management has shown the flexibility to augment the increases when necessary, and has implemented an additional 1% rate increase for 2013 to accommodate a temporary increase in the GF transfer. Additional inflation-adjusted increases are expected to provide for baseline revenue growth and allow the system to maintain its strong margins.
DEBT BURDEN EXPECTED TO DECLINE, CAPITAL NEEDS ARE LIMITED
Debt is manageable and consists of the existing series 2004, 2007A, and 2007B bonds, as well as a series 2010 note totaling $51 million in total debt outstanding as of fiscal 2012. The 2010 note was issued to refinance the system's 2006 bond anticipation note, carries a fixed rate, and matures in 2026. The city plans to fully refund the series 2004 bonds for roughly $2 million in net present value savings over the next few months.
The debt burden has been on the decline and is currently equivalent to about 50% of net plant and $1,000 per customer, which approximate the medians for similarly rated systems.
Capacity in the system is strong, and the city estimates current water supplies will meet demand through 2030. As a result, capital needs are modest focusing on renewal and replacement of system assets. The city expects to spend between $1.5 million and $3 million annually from internally generated funds through 2017 for all three systems. With no new dent planned, the debt burden should continue to steadily decline.
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 Sector'(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