NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the following city of Cape Coral, Florida (the city) outstanding water and sewer revenue bonds at 'A':
--$442.66 million water and sewer revenue bonds.
Also, Fitch affirms the following special assessment bonds at 'BBB+':
--$16.8 million utility improvement assessment bonds (Southwest 2 Area) series 2005;
--$17 million utility improvement assessment bonds (Southeast 1 Area), series 2006;
--$45 million utility improvement assessment bonds (Southwest 4 area), series 2007;
--$32.3 million utility improvement assessment bonds (Southwest 5 and Surfside areas), series 2007;
--$17.7 million wastewater & irrigation water refunding assessment bonds (Southwest 1, Pine Island Road & Southwest 3 Areas), series 2005.
The Rating Outlook is Stable.
The city anticipates selling approximately $150 million in water and sewer system revenue refunding bonds within the next 30-60 days.
The water and sewer revenue bonds are secured by a senior lien on combined net revenues of the city's water and sewer system (the system), including impact fees.
The assessment bonds are secured by special assessments levied and collected in the affected area, and by a covenant to pay debt service from system net revenues after payment of system senior and subordinate (state loans) obligations. The bonds are also secured by a surety-funded debt service reserve fund.
KEY RATING DRIVERS - WATER AND SEWER REVENUE BONDS
HIGH DEBT BURDEN: The system is highly leveraged with debt levels well above the 'A' categorical median levels. The system's debt burden will remain elevated due to additional state revolving fund (SRF) loans associated with the system's utilities expansion project (UEP).
SOUND LIQUIDITY/BELOW-AVERAGE COVERAGE: System liquidity aligns closely to the 'A' rating category at over 300 days of cash on hand in fiscal 2014. All-in debt service coverage (DSC), taking into account special assessment related revenues and debt, of 1.6x is somewhat below average compared to 'A' medians but adequate for the rating level.
EXPANDING AND FLUCTUATING CIP: The capital improvement plan (CIP) has increased significantly since Fitch's last review, driven by regulatory needs, the UEP, and a backlog of projects previously deferred during the housing crisis. Also, assumptions surrounding the CIP have fluctuated from year-to-year, sometimes dramatically. The city expects the CIP to be largely funded from impact fee revenues and some SRF loans.
ECONOMIC RECOVERY PROGRESSING: The city faced challenges as a result of the housing crisis which resulted in high unemployment and a high number of foreclosures. Aspects of the economy continue to show signs of improvement with unemployment slightly lower than the national average and foreclosures down.
RATING SENSITIVITIES - WATER AND SEWER REVENUE BONDS
DETERIORATION OF FINANCE PERFORMANCE: Given the system's very high debt profile, resumption of the UEP and shift in reliance to more volatile impact fee revenue; maintenance of sound finance performance will be a key rating consideration.
KEY RATING DRIVERS - SPECIAL ASSESSMENT REVENUE BONDS
BACK-UP PLEDGE: The city's covenant to use net system revenues on a subordinate basis to make up any shortfall in debt service payments on outstanding assessment bonds is a key factor in determining the rating. Assessments alone do not in all cases fully cover debt service.
LIMITED COVERAGE ON SPECIAL ASSESSMENT BONDS: Special assessments are levied in small geographic areas and are structured to provide narrow annual DSC on outstanding bonds, leaving little margin for non-collection. Historical collections have been satisfactory in most years. However, certain areas have had to utilize accumulated excess assessment revenues and back-up utility revenues to meet annual debt service (ADS) obligations.
TAX LIEN PROVIDES INCENTIVE: Special assessments are included as a line item on the property tax bill with nonpayment resulting in a property tax lien on parity with those related to ad valorem tax delinquencies.
RATING SENSITIVITIES - SPECIAL ASSESSMENT REVENUE BONDS
UTILITY CREDIT QUALITY: The rating on the special assessment bonds relies heavily on the system's ability to cover shortfalls in special assessments. A change in system credit quality would likely impact the rating on the special assessment bonds.
Cape Coral (implied general obligations rated 'AA-', Stable Outlook by Fitch) is located on the southwest coast of Florida in Lee County 10 miles south of Fort Myers and 125 miles south of Tampa. The city enjoys over 400 miles of waterways providing access to the Intercoastal Waterway and Gulf of Mexico making it a popular vacation and retiree community. The city's population swells to over 186,000 during peak tourist seasons from its normal 165,000.
The city's water and sewer system serves over 56,000 accounts located entirely within city limits. Pursuant to a 20-year consumptive use permit issued by the South Florida Water Management District, water supply is drawn from the Upper Floridan Aquifer and is sufficient for the foreseeable future. Treatment capacity for both water and wastewater is well in excess of annual demand.
RAPID GROWTH RESULTS IN HIGH DEBT
Following a sustained period of rapid customer growth that averaged about 8% annually over the prior decade, the pace of new customers connecting to the system dropped off substantially during the recession prompting the city to halt its UEP. A significant amount of debt was issued during the high-growth period to support both the actual and projected increases in system users, although the diminished rate of growth in new customer accounts did not keep pace with the system's rapidly growing debt burden. As a result, the system's financial performance weakened significantly in fiscals 2007 and 2008.
In 2012 the city council authorized the resumption of the UEP program and the city estimates it will bring on an additional 3,000 properties by 2016, another 8,400 properties by 2017 and 6,800 properties by 2019. The city is financing the UEP with the use of SRF loans. As of fiscal 2014, outstanding SRF loans totaled over $35 million and are subordinate to the water and sewer revenues bonds. The city has also drawn an additional $33 million in loans since the end of fiscal 2014. Including the special assessment debt, debt per capita for fiscal 2014 of $3,100 is 7.8x higher than the 'A' category median of $741. Slow amortization of existing debt (66% of the system's debt is retired within 20 years) coupled with additional SRF debt ensures that debt levels will remain high for the foreseeable future.
FLUCTUATING CAPITAL PLANS AND IMPACT FEE REVENUES
In the last decade the city's CIPs have varied widely, generally correlating to the expansion and contraction of the housing market. The 2015-2019 CIP now totals over $147 million and is driven by regulatory needs, UEP and system maintenance previously deferred due to the Great Recession. The current CIP is significantly larger than the $81 million fiscal 2013-2017 plan presented at Fitch's last review, but notably smaller than the fiscal 2006-2010 plan of over $560 million.
RATE HIKES STABILIZE FINANCIAL METRICS
Also varying widely is the system impact fee revenues. Prior to the economic downturn, impact fees in fiscal years 2006 and 2007 accounted for a very high 65% and 56% of operating revenues, respectively. During the downturn, impact fee revenues fell swiftly, and without offsetting rate increases, financial performance also fell. The city reacted beginning with a 30% rate hike in fiscal 2010 and council adopted a series of annual rate increases in order to restore operating margins, increase DSC and rebuild the system's cash position. By 2011 coverage levels had improved to over 1.5x on an all-in DSC basis and unrestricted cash as well as restricted cash for repair and replacement totaled a strong 438 days of cash on hand (DCOH). Since fiscal 2011, all-in DSC levels (taking into special assessment revenues and debt) have remained stable with a three year average of 1.5x while DCOH has remained at over 300 days.
The system performs annual rate studies to ensure revenue sufficiency. The most recent study performed in fiscal 2014 points to total DSC hovering at 1.3x-1.4x on senior lien debt from recurring revenues through 2024. With the inclusion of impact fees, DSC jumps to a much higher 1.7x-2.4x over the same forecast period. The study anticipates no additional rate increases through at least fiscal 2024, instead relying on the more volatile impact fees, which are projected to grow to 38% of operating revenues by fiscal 2019.
SIGNS OF ECONOMIC RECOVERY
The city's economic picture is showing favorable signs. Since peaking at a very high 12.4% in 2011, the city's unemployment rate is down to 5.4% as of February 2015. This is down almost 1% over the prior year and compares favorably to the state (5.5%) and national (5.8%) averages. Gains in the employment base (averaging 3.6% annually since 2012) relative to the labor force (1.8% annually since 2012) have driven this recovery. Wealth levels, while declining over the last five years, are still higher than the state and just below the nation. Local employment opportunities are focused in the retail trade, leisure & hospitality, and government sectors.
LIMITED COVERAGE FROM SPECIAL ASSESSMENT LEVIES
The city levies assessments annually in each area in an amount sufficient to cover ADS. The levy also includes an amount equal to one full percentage point above the interest rate on the relevant series of bonds (the maximum discount allowed for early payment of the tax bill) and the estimated cost of collections. While structured to achieve approximately 1.1x DSC, tax collections have been below 100%, providing even less cushion.
Historical collections have typically been sufficient to meet ADS. However, certain areas have had to utilize accumulated excess assessment revenues when collections have fallen short. Special assessments are included as a line item on the property tax bill with non-payment resulting in a property lien on parity with those related to ad valorem tax delinquencies. It is city policy to redeem area bonds from prepaid assessments which the city plans to continue to do.
Annual collections plus accumulated excess assessment revenue from prior years for tax years 2008-2013 have been sufficient to meet ADS obligations in six out of the eight assessment areas, based on data provided by the city. In fiscals 2013 and 2011, an advance of $21,146 and $26,195, respectively, of surplus net revenues from the system was used to support timely debt service payments for the city's Surfside area bonds due to slightly weak tax collections.
In fiscal 2014 the city failed to bill for the full amount of the debt service requirement for all special assessment areas resulting in a shortfall that was covered with the use of excess assessment funds, not system revenues. Management noted that the shortfall in billing would be made up in the next assessment year. Also in fiscal 2012 an advance of $211,560 of surplus system revenues was used to support debt service for the city's Southwest 4 area bonds. Coverage from assessments alone was only 0.96x. Management indicated that failed county tax certificate sales during fiscal 2012 accounted for the decline in assessment revenues being received.
The city has SRF loan obligations which are secured by special assessments from new project areas and a backup pledge of surplus net system revenues. Payments on these loans do not begin until Dec. 15, 2016 and are senior to the back-up pledge for the special assessment debt, but subordinate to the senior lien bonds.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and Burton & Associates (rate consultant).
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'2015 Water and Sewer Medians' (December 2014);
--'2015 Sector Outlook: Water and Sewer' (December 2014).
Applicable Criteria and Related Research:
2015 Outlook: Water and Sewer Sector
2015 Water and Sewer Medians
U.S. Water and Sewer Revenue Bond Rating Criteria
Revenue-Supported Rating Criteria