NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'A+' rating to the following Port St. Lucie, FL (the city) revenue bonds:
--Approximately $36.4 million utility system refunding revenue bonds, series 2014.
The bonds are expected to sell via negotiation on Oct. 1. Series 2014 bond proceeds will be used to current refund all or a portion of the outstanding series 2003 and 2004 bonds as well as advance refund all or a portion of the outstanding series 2006 bonds for interest savings. Savings are expected to be taken annually, although the majority will be taken in fiscal years 2015 and 2016.
In addition, Fitch downgrades to 'A+' from 'AA-' the ratings on the following utility system bonds:
--Approximately $146.2 million (pre-refunding) utility system revenue bonds, series 2001, 2003, 2004, 2004A and 2006.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a senior lien pledge of the net revenues from the operation of the city's water and sewer system (the system) and available connection fees.
KEY RATING DRIVERS
WEAK DEBT COVERAGE, LIMITED FLEXIBILITY: The rating downgrade to 'A+' from 'AA-' reflects the significant use of cash over the past few years, which coupled with already weak cash flow reduces the system's financial flexibility. While a portion of the recent capital spending will fortify the city's long-term water resource needs, it leaves the system with much lower cash balances.
LIQUIDITY UNLIKELY TO RISE SIGNIFICANTLY: Liquidity is still adequate at 291 days of operations (estimated for fiscal 2014), but Fitch believes these levels no longer offset the weak margins. As of fiscal 2014 cash balances are roughly one-third what they were just two years ago and unlikely to rise over the near-term absent more significant rate increases and/or accelerated customer growth.
HIGH DEBT LEVELS: Substantial capital investment has left the system with strong capacity but a high debt burden. Carrying charges are over 50% of gross revenues. Slow amortization will keep the debt burden higher than for similarly-rated water and sewer utility systems for the foreseeable future.
SOUND OPERATIONS AND LIMITED CAPITAL NEEDS: The system has sufficient capacity and the capital plan focuses on system upkeep and renewal projects with no new debt expected over the next five years.
SMALL ANNUAL RATE INCREASES EXPECTED: Rates compare favorably to those of neighboring utilities, although the combined residential bill in fiscal 2013 has reached Fitch's affordability benchmark of 2% of median household income (MHI). Only modest future increases are projected.
RATING SENSITIVITIES
FURTHER WEAKENING OF FINANCIAL METRICS: Fitch would view a further drain on liquidity negatively given the high fixed costs and limited margins to handle unforeseen capital spending and/or operational issues. Limited projected rate increases are not expected to improve margins or restore liquidity to previously strong levels.
CREDIT PROFILE
Port St. Lucie is a primarily residential community of 175,000 located along Florida's Atlantic coast approximately 100 miles north of Miami, FL in St. Lucie County (the county). The service area is comprised of approximately 134 square miles, including the entire city limits and some unincorporated areas of the county. Strong double-digit annual customer growth trends have subsided since the start of the recession, but growth remains positive. Leading utility customers are diverse and led by Tropicana Products, Inc. accounting for 1.8% of system revenues in fiscal 2014.
LOWER LIQUIDITY LEVELS NO LONGER MITIGATE WEAK SYSTEM CASH FLOWS
Financial performance has weakened since 2007 following a significant decline in construction activity coupled with only limited increases in operating revenues. The net result was a decline in both cash flows and annual debt service coverage (DSC), which dropped to just 1.1x by fiscal 2010. Results improved slightly in fiscal years 2012 and 2013 with DSC totaling 1.3x in both years despite a rise in annual debt service. However, improved results were still well below the medians for systems rated in the 'AA' category.
According to management, a rise in operating and maintenance costs due primarily to one-time energy conservation measures in fiscal 2013 led to a drop in DSC to 1.1x. When including approximately $8.5 million in accumulated (and pledged) connection fee fund balances, DSC improves slightly to 1.2x. Further, the system generated just $2 million in cash flow after paying operating expenses and debt service in fiscal 2013, which is well shy of the system's roughly $5 million in renewal and replacement capital needs. DSC of all debt for fiscal 2014 is expected to be slightly lower than fiscal 2013 at 1.03x.
Historically Fitch's concern over low coverage was offset by the availability of sizable accumulated cash balances. Total unrestricted cash for the system was close to $64 million at the end of fiscal 2012, which was equivalent to more than 800 days of operations. Even after adjusting issuer-reported cash to exclude $14 million in debt service reserves and customer deposits, the remaining approximately $50 million in truly unrestricted reserves was a strong 670 days of operations.
Financial flexibility has since declined measurably to 466 days cash in fiscal 2013 and is estimated by the city to be just 291 days cash in fiscal 2014. The declining cash balances were due to capital spending for the system. However, Fitch believes the spending has significantly limited the system's ability to meet unforeseen capital requirements or changes in revenues and/or expenses, and the lower liquidity no longer provides sufficient offset to the weak margins at the 'AA-' rating level.
ELEVATED DEBT BURDEN TO SLOWLY DECLINE
The system was expanded and upgraded mainly as a result of the housing boom that preceded the national housing-led recession in 2008. This has led to a high, slowly amortizing debt burden totaling roughly $440 million as of fiscal-end 2013. While heavy investment in the system has led to a large amount of debt, it has also provided significant long-term capacity and minimal intermediate capital needs.
At $3,328 per customer and 67% of net capital assets in fiscal 2013, debt is nearly two times greater than the median for the 'AA' category and around 25% higher than even the 'A' category medians. However, with no additional bonding plans over the next five years Fitch expects the debt burden to slowly moderate. The city anticipates spending roughly $25 million on routine repair and replacement projects through fiscal 2019. Fitch projects debt per customer will decline to a more reasonable but still elevated $2,740 per customer by fiscal 2019.
RATES TO INCREASE, SURPASS FITCH AFFORDABILITY THRESHOLD
Rates have been increased modestly in recent years, which has kept user charges competitive overall with neighboring utilities. However, Fitch is somewhat concerned over the system's minimal free cash flow from operations, as net cash from operating activities represented only 10% of current liabilities in fiscal 2013, and a somewhat worrisome 6% deficit of annual depreciation. Over the past five years, free cash has averaged just 13% of annual depreciation, which is well below the median for 'A' category and below what Fitch considers prudent.
Rates have been increased by approximately 3% annually since at least fiscal 2009. The city expects to recommend to the council another 3% water rate increase for fiscal 2015, but to hold rates steady for the sewer system. Additional annual 3% rate increases were recommended through fiscal 2018 by the city's rate consultant. The average residential customer consumes roughly 5,000 gallons per month due to a fairly strict tiered rate structure that discourages excess consumption. The average residential customer paid approximately $84 for 5,000 gallons in fiscal 2014, which is 2% of MHI.
Fitch expects the city will continue to raise rates to meet at least minimum requirements for operations and debt service, but perhaps no more than this as the rate covenant only requires sum-sufficient DSC. The system's legal covenants in general are weak. The financial ratios for the rate covenant and additional bonds test are low, and the rate covenant calculation includes accumulated pledged impact fees (connection fees).
STABLE OPERATING PROFILE & AMPLE CAPACITY
The city's raw water supply comes from both the Floridan and the Surficial aquifers. Through a long-term consumptive use permit, the city is allowed a maximum withdrawal of 51.5 million gallons per day (mgd). The system's two water treatment facilities provide 42.2 mgd of maximum treatment capacity, which is well in excess of average daily water treated at the plants of 13.2 mgd in fiscal 2013.
The sewer system consists of two treatment facilities and over 1,000 miles of collection and transmission mains. Total treatment capacity was increased to 18 mgd in July 2011. The average daily flows for the sewer system are approximately 8.0 mgd, leaving more than 50% capacity in the treatment facilities. The larger of the two facilities can be expanded by an additional 12 mgd to meet future customer growth. Treated wastewater effluent is supplied to the city's reclaimed water system or discharged into deep injection wells. There is no surface water discharge, and the system is not facing any regulatory issues.
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
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
2014 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358
2014 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=880214
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