NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA-' rating to the following Hollywood, FL (the city) revenue bonds:
--Approximately $47 million water and sewer refunding revenue bonds, series 2014.
The bonds are expected to sell via negotiation on Nov. 13. Bond proceeds will be used to current refund all of the outstanding series 2003 bonds for interest savings, fund a reserve account (at the discretion of the city), and pay issuance costs.
In addition, Fitch affirms the following revenue bonds:
--Approximately $120 million in outstanding water and sewer revenue bonds (prior to issuance) at 'AA-'.
The Rating Outlook is Stable.
The bonds are secured by a senior lien on net revenues of the city's water and sewer system (the system).
KEY RATING DRIVERS
IMPROVED FINANCIAL PERFORMANCE: Debt service coverage (DSC) and free cash flow (FCF) are strong relative to peer systems. Liquidity is also ample having more than doubled since 2009. A combination of unrestricted cash, rate stabilization, and renewal and replacement funds totaling $91 million equates to over 780 days of operations in fiscal 2013.
ABOVE-AVERAGE RATES: A cumulative 68% increase in rates since fiscal 2010 has improved the system's financial profile but has also pushed rates to above-average levels relative to peer systems and to median household income (MHI). Though rates currently represent 2.1% of MHI for 5,000 gallons of use, affordability concerns are somewhat offset by a recently adopted multi-year rate freeze.
MODERATE DEBT BURDEN: Debt ratios are manageable (and slowly improving) given the system's large proportion of revenues received from bulk users, ample liquidity and significant FCF. Debt ratios are somewhat elevated on a direct basis with debt per customer over $2,800 in 2013. However, Fitch considers the rapid amortization of existing debt, manageable carrying costs, and tens of thousands (estimated) of additional retail customers served through wholesale contracts in its analysis of the debt burden.
COMPREHENSIVE CIP, OUT-YEAR RISKS: The five-year capital improvement plan (CIP) will focus on water distribution and transmission, and overall system upkeep and maintenance and will be financed from pay-go sources and low-interest, short-term subordinate debt. While the debt burden is not expected to weaken over the short term, Fitch is concerned legislative mandates to limit the amount effluent discharged through ocean outfall may lead to substantial capital costs for the system that are beyond the current CIP period.
SOLID INFRASTRUCTURE CAPACITY: The system is generally in a good state of repair and water supply and treatment capacity is ample for the long term. Sewer treatment capacity is sufficient as the city is almost completely developed.
RATING STABILITY EXPECTED: The rating is sensitive to shifts in various credit fundamentals including the financial performance and capital and debt management of the system, and potential pressures to the city's overall credit quality. The Stable Outlook reflects Fitch's expectation that such changes are unlikely over the near term.
Hollywood, Florida (general obligation [GO] bonds rated 'A' by Fitch) is located in Broward County (GOs rated 'AAA') on the southeast coast of Florida and is a part of the Miami-Ft. Lauderdale metropolitan statistical area (MSA). The city is nearly fully developed and has a 2013 population estimate of 145,000.
RETAIL AND WHOLESALE SERVICE PROVIDED
The system provides direct retail service to 40,000 water connections and 21,000 sewer accounts in fiscal 2014. Retail customers are predominantly residential with no concentration concerns. The system also provides wholesale sewer service to the adjacent municipalities of Pembroke Pines, Hallandale Beach, Dania Beach, Broward County, and Miramar through substantially similar large user agreements.
Wholesale customers represented roughly 22% of the system's total fiscal 2013 revenues, a proportion that presents potential customer concentration risk. However, this risk is largely mitigated by stiff provisions contained in the contracts, including a mandatory one-year termination notice, the pre-payment of debt prior to termination, and a present value payment of any other charges that would have been paid by the large user over the ensuing five years.
RATE INCREASES IMPROVED FINANCIAL PERFORMANCE
The system has improved its financial position significantly over the past five years. Several years of substantial rate increases contributed to a 37% growth in system operating revenues from fiscals 2009-2013, resulting in greater DSC and free cash flows. Operating revenue growth coupled with de minimus growth in operating expenses (excluding depreciation) over the past five years has resulted in very strong operating margins of near 50%.
In fiscal 2013, operating cash flows represented nearly 2.0x current liabilities, and unrestricted cash and investments, including the cash the utility restricts for its renewal, replacement and improvement (RR&I) fund and rate stabilization, equated to over 780 days cash on hand. In fiscal 2013, senior DSC was very strong at 3.8x, and all-in coverage, which includes subordinate lien state revolving fund loans, improved to 2.6x. Coverage net of transfers to the city's general fund (for payments in lieu of taxes, or PILOTs and administrative service charges) was still very strong at 3.5x on the senior bonds, and 2.4x for all debt. PILOT payments are fairly standardized and calculated using the system's net assets multiplied by the millage rate. Fitch expects the formula for determining PILOT payments will remain consistent and predictable.
Pro forma financials provided by the city show a continuing trend of strong margins and DSC. Assumptions include operating revenue growth of 1.8% (average annual) in 2015-2019, primarily reflecting projected operating cost increases for bulk users which are reimbursed as revenues to the city. Even if operating revenues are held flat through the forecast, senior DSC is ample at no less than 3.6x (3.2x net of transfers), and coverage of all debt service is above 2.0x (1.8x net).
COMPREHENSIVE CAPITAL PROGRAM, ADDITIONAL DEBT EXPECTED
The system's five-year CIP (fiscals 2015-2019, not including unspent budgeted funds rolled over from fiscal 2014) totals $171 million and is very comprehensive. The CIP includes the replacement and lining of water and sewer mains, re-use system expansion, water and sewer treatment plant upgrades, and water supply well construction among various other projects. Fitch notes the capital plan is fluid and projects can be deferred as needed. The city anticipates funding the CIP mainly with pay-as-you-go resources and some additional debt (mainly low-interest SRF loans) totaling roughly $75 million.
The system's debt burden is somewhat elevated but has been on a steady decline over the past four years. In fiscal 2013, total debt outstanding of approximately $175 million led to debt that was 71% of net fixed assets and $2,886 per direct retail customer. The additional anticipated debt to fund the current CIP is projected to raise the debt burden slightly, although Fitch notes the system's large wholesale customer mix somewhat skews the debt ratios.
For instance, the city estimates approximately 100,000 additional connections are served through bulk service. Even if half of this amount (40,000 sewer and 9,000 water connections) were included in the calculations, debt would be closer to $1,600 per customer and near the median for 'AA' category water and sewer utilities. In addition, Fitch considers the rapid repayment of existing debt and the manageable debt carrying costs (debt service is 21% of gross revenues) as offsetting factors to the debt profile.
RATING CONSTRAINED BY WEAK LEGALS, CITY GO RATING
Legal covenants are weak; the rate covenant and additional bonds test require a 110% net revenue coverage requirement, and the flow of funds is open. In addition, pursuant to Section 802 of the original bond ordinance, an admission by the city in writing of its inability to pay its debts, generally, can lead to an event of default on the water and sewer bonds, subjecting the bonds to possible acceleration (cross-default). While the intent of this specific provision may be to limit the event of default to situations akin to insolvency, Fitch believes a liberal interpretation can be made to include failure by the city to pay any of its outstanding debt. While no specific cap is applied to the system's rating, the rating on the bonds is constrained by the city's general credit quality - Fitch rates the city's GO bonds 'A' with a Stable Outlook. For more information on the city's GO rating, see the press release 'Fitch Affirms Hollywood, FL's GOs at 'A'; Outlook Revised to Stable', dated Aug. 1, 2013.
ABSORPTION OF MANDATED OCEAN OUTFALL ELIMINATION PROJECTS
In response to legislation passed in 2008 (and amended in 2013) system capital needs looming beyond the current CIP consist of mandates to eliminate wastewater discharges through ocean outfalls into the Atlantic Ocean by 2025. While the system currently produces 4 mgd of reclaimed water (for irrigation and public space use) and utilizes deep well injection to dispose most of its effluent, roughly 15 mgd of effluent is discharged through ocean outfall.
The city has performed a pilot study to determine the level of treatment that would be necessary to allow it to meet the legislation via construction of aquifer recharge wells to pump treated effluent into the Floridan Aquifer. Other options include expansion of the system's reclaimed water capabilities. Either way, advanced treatment processes, including biological nutrient removal, would likely be necessary. The city's preliminary cost estimates for ocean outfall elimination projects are between $150 million and $310 million, depending on which course of action the city takes, and will likely include additional debt.
The projects are not expected to commence prior to the end of the current five-year CIP (fiscal 2019), and the city notes alternative options are still being explored. Fitch is concerned the out-year projects could pressure the system's strong financial profile and lead to higher rates and additional debt. On the positive side, Fitch notes that based on sewer flows to the city, roughly 50% of the costs for these projects would be paid by the bulk customers.
MODERATELY HIGH RATES; FLEXIBILITY TO IMPROVE
The system has implemented fairly rigorous rate increases since fiscal 2010, yielding significant cash reserves in order to fund the majority of its capital program. The final rate increase of an approved multi-year rate plan was for 7.5% and was implemented at the start of fiscal 2014. The average residential customer consumes roughly 5,000 gallons per month (gpm) due to a fairly strict tiered rate structure that discourages excess consumption. Assuming 5,000 gallons, the average customer pays roughly $80 per month for combined service in fiscal 2014, which represents 2.1% of median household income (MHI).
Fitch becomes concerned about rate affordability when charges relative to regional peer systems are on the high end (which they currently are) and when rates reach 2% of MHI for combined charges. However, the city recommended and received city commission approval for rate relief in 2014; rates will not be increased again until at least 2020. The rate freeze should allow rates to become more competitive over time, which Fitch views favorably as rate raising flexibility is likely needed to fund future ocean outfall elimination projects.
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:
2014 Outlook: Water and Sewer Sector
2014 Water and Sewer Medians
U.S. Water and Sewer Revenue Bond Rating Criteria
Revenue-Supported Rating Criteria