NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA' rating on Sunrise, FL's (the city) approximately $110 million in outstanding utility system revenue bonds, series 2010A, 2010B, and 2010C.
The Rating Outlook is Stable.
The bonds are secured by a senior lien pledge of the net operating revenues of the city's combined water, sewer, and natural gas system (the system). The 2010 bonds are not covered by a debt service reserve.
KEY RATING DRIVERS
STRONG FINANCIAL MANAGEMENT: Financial metrics are very strong with annual margins, debt service coverage (DSC) and liquidity all exceeding their respective 'AA' category medians.
STABLE RETAIL SYSTEM: The system provides water, sewer, and natural gas service to a mainly residential and retail customer base consisting of the city and surrounding areas. The customer base is stable and benefits from its location in Broward County, which provides diverse employment options.
MANAGEABLE DEBT PROFILE: Leverage is a manageable $1,364 per connection, but a somewhat high 68% of net assets. Debt carrying costs are affordable at 15% of gross revenues in fiscal 2013, although amortization is slow. No new debt is currently planned for at least the next several years.
FLEXIBLE CAPITAL PLAN: The city is in the process of updating its comprehensive capital improvement plan (CIP), led principally by water system projects. While some debt may be needed to fund capital spending, expectations are for less bonding than previously anticipated.
SOMEWHAT ELEVATED WATER/SEWER RATES: The average monthly bill for water and sewer service is a somewhat high 2.1% of median household income (MHI), potentially limiting future rate raising flexibility. On the positive side, the city has raised rates by an annual inflation-adjustment the last several years.
AUTOMATIC PASS-THROUGH: The city purchases natural gas for retail delivery to approximately 10,000 retail customers. Gas rates are subject to commodity price volatility. However, the city's automatic pass through adjustment provides full cost recovery of purchased natural gas when prices rise, and this policy is seen as positive credit factor.
STRONG FINANCIAL PERFORMANCE, MANAGEABLE DEBT PRESSURES: Fitch does not expect the to-be-revised capital plan to significantly pressure system finances given the lower expectations for debt and the system's already strong financial position. The Stable Outlook reflects Fitch's expectation the city will continue to manage its capital and debt needs while maintaining a strong financial profile.
CITY RELIANCE ON HIGHER TRANSFERS: A trend of continued large scale transfers from the system to the city's general fund as experienced in fiscals 2013-2014 could adversely affect system financial performance or capital funding capabilities.
STABLE RETAIL SYSTEM LOCATED IN WEALTHY BROWARD COUNTY
The city owns and operates the system, which provides mainly retail service to approximately 213,000 residents located within city limits as well as to customers residing in Weston, Davie, Tamarac and the town of Southwest Ranches. The predominantly residential customer base has been relatively stable over the past several years, and given the service area's relatively built-out nature, customer growth is expected to be manageable. The city's unemployment rate has been steadily trending downward to 5.9% in March 2014, which is below the state and national figures. Income levels are slightly below average and bad debt as a percentage of revenues remains exceptionally low.
STRONG INFRASTRUCTURE CAPACITY
The water and wastewater systems are similarly sized with about 84,000 equivalent residential connections, while the gas system serves a noticeably smaller retail customer base of roughly 10,000 accounts. Raw water supply is derived from the Biscayne Aquifer pursuant to a 20-year water use permit (WUP) granted by the South Florida Water Management District (SFWMD) in 2008. Average daily water demand has been on the decline for several years, a result of conservation efforts and a weak economy.
In fiscal 2013, average demand of approximately 22 million gallons per day (mgd) was a comfortable 69% of the system's current permitted allocation. Nevertheless, the city is in the process of developing additional raw water sources from the Floridan Aquifer to meet potential demand increases and an expected decline in its existing permitted allocation. A new reverse osmosis water treatment plant to treat the deeper and more brackish supply will be constructed, and is included in the CIP. The wastewater system provides collection, treatment and disposal service with ample treatment capacity. The system's three wastewater treatment plants are permitted to treat a combined 33.75 mgd, while actual flows in 2013 totaled about 21.4 mgd.
STRONG FINANCIAL PERFORMANCE A CREDIT POSITIVE
Financial performance has generally been strong, despite holding water and sewer rates steady from fiscals 1998-2007. Historically, rapid customer growth trends provided significant connection fee revenue, which in turn enabled the city to accumulate sizeable reserves and offset the need for rate hikes. As a result, the system's cash position grew to a substantial $96 million in fiscal 2009 (inclusive of accumulated connection fees), allowing the city to utilize approximately $70 million of this balance to defease a portion of its outstanding parity debt in 2010.
Since then, robust operating margins (roughly 46% annually) have led to continued strong DSC and significant free cash flow. The system ended fiscal 2013 with approximately $63 million in unrestricted cash, which is equivalent to a very healthy 420 days cash. When the system's considerable renewal and replacement fund balances are included, liquidity is over 700 days cash.
DSC reached 3.2x and a still healthy 2.5x net of system transfers in fiscal 2013, having climbed steadily in each of the past three fiscal years. The system historically made annual transfers to the general fund (GF) equal to 2.5% of gross revenues. In fiscals 2013 and 2014, the city decided to make one-time transfers totaling $12.1 million (about $6 million each year), leading to a high rate of transfer of close to 10% of gross revenues in fiscal 2013; fiscal 2014 will equal a similar level. Currently, the system's high cash balances and strong annual margins allow it to comfortably absorb the temporarily high transfers.
Going forward, the city has indicated annual transfers will approximate 4.5% of gross revenues. This increase in transfers is not expected to significantly pressure the system over the foreseeable future, but a ramp up of further increases could weigh on the system over time given the system's already moderately high rates. Pro forma finances provided by the city indicate strong financial metrics will be maintained with DSC net of transfers at no less than 2.5x.
RATES ARE ELEVATED, RAISING LONGER-TERM AFFORDABILITY CONCERNS
Water and sewer rates were increased sharply in fiscal 2008 (10.5%) and again in fiscal 2010 (40%) after many years of rate stability. With the 2010 increase, the city also instituted automatic annual rate adjustments based on inflation, which Fitch views favorably as it provides baseline revenue growth that is outside of the political process. Over the past three years, inflation-adjusted rate increases totaled a cumulative 17%, raising the typical residential customer's bill to approximately $88 for combined service in fiscal 2014 assuming 7,000 gallons of use per month.
Rates are competitive relative to other nearby systems but a somewhat elevated 2.1% of MHI, above Fitch's 2% affordability threshold. The city anticipates rates will increase by 3%-5% annually going forward. However, potential for some debt-financing for capital needs coupled with increased annual GF transfers may necessitate additional rate hikes (beyond inflation increases). On the positive side, the city had previously planned to raise rates by approximately 8.5% annually on top of inflation adjustments in fiscals 2012-2014, which were ultimately deemed unnecessary as the system generated significant margins and stretched bond proceeds somewhat further than originally expected.
CAPITAL PLAN EXPECTED TO INCLUDE MORE PAY-GO SOURCES
The system's $240 million CIP for fiscals 2014-2018 is comprehensive, although slightly smaller than the prior CIP. The majority of the planned spending will benefit the water system, which includes development of new wells and a small 4 mgd water treatment plant. Approximately 30% of the CIP will be financed with existing bond proceeds (about $70 million).
The city is in the process of updating the system's CIP for fiscals 2015-2019 as part of the budget process and expects lower spending needs and larger pay-as-you go funding, including substantial renewal and replacement fund balances. In addition, sizable existing bond process will also limit future planned borrowings.
The prior CIP included $150 million in potential additional debt beginning in 2014. However, this forecast turned out to be conservative as no new debt was issued and the city does not expect to issue bonds until existing proceeds have been expended. The updated CIP was not available for this review, although city officials indicated expected capital needs will likely be smaller in size and in scope relative to the current plan. However, if the CIP is substantially similar to the fiscal 2014-2018 spending plan, projected free cash flow (net of operating costs, debt service and transfers) alone will be insufficient to cover future projected capital spending without either significant use of reserves, or issuance of some amount of additional debt.
The system's $230 million in total debt outstanding as of fiscal 2013 consists of fixed-rate series 1993, 1998, 1998A, and 2010A-C. Debt ratios are somewhat mixed; debt was a manageable $1,364 per connection excluding the 10,000 gas customers, but an above average 68% of net capital assets. Amortization of existing bonds is somewhat slow over the first 10 years with only 22% retired, but accelerates with 55% retired in 15 years and 78% retired in 20. The rating incorporates maintenance of a manageable debt profile.
SMALL NATURAL GAS SYSTEM
The city's natural gas system provides service to customers located in the city and, pursuant to franchise agreements, portions of Tamarac, Weston, and Lauderhill. The system contracts with Florida Gas Utility (FGU) for its gas supply. FGU serves as a joint action agency formed by interlocal agreement for the purpose of securing and managing natural gas supply for 23 member municipal gas systems. The outstanding franchise agreement with Tamarac (about 900 customers) has been renewed for an additional 15 years. Two other franchise agreements are current, with expiration dates occurring in 2016 and 2021, respectively. Gas system revenues comprise less than 10% of total system revenues.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'2014 Water and Sewer Medians' (December 2013);
--'2014 Outlook: Water and Sewer Sector' (December 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2014 Water and Sewer Medians
2014 Outlook: Water and Sewer Sector