NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the following bonds for the city of Orlando:
--$170.5 million senior lien tourist development tax (TDT) revenue bonds (sixth-cent contract payments) series 2008A to 'BBB' from 'BBB-';
--$31.8 million second lien subordinate TDT revenue bonds (sixth-cent contract payments) series 2008B to 'BBB-' from 'BB'.
The Rating Outlook for the series 2008A bonds is Stable. The Rating Outlook for the series 2008B bonds is Positive.
The 2008A and 2008B revenue bonds are limited obligations of the city secured by the discrete trust estate, including pledged funds, for each respective series of bonds. The majority of pledged funds consist of 50% of a one-cent tax levied county-wide on hotel stays. The hotel tax is collected by the county and remitted to the city according to an interlocal agreement.
Pledged revenues also include a fixed installment payment payable from the remaining half of the one-cent tax, equal to $2.8 million available through 2018. Pledged funds are allocated to each trust estate of the three series of bonds (Fitch does not rate the series 2008C bonds) according to a flow of funds with revenues distributed to each trust estate according to the seniority of the series. Additional security is provided by a dedicated liquidity reserve and debt service reserve fund for each series, with each established at 50% of respective maximum annual debt service (MADS) for a total combined reserve for each series of 100% of MADS.
KEY RATING DRIVERS
SERIES A RATING UPGRADE: The upgrade action of series 2008A reflects strong and consistent TDT growth, which now exceeds six years, boosting debt service coverage.
SERIES B COVERAGE: The upgrade on the series 2008B is based on improved coverage, which has sharpened the possibility that the lien on the series 2008B bonds will ascend to senior status on parity with the series 2008A bonds within the next few years.
SERIES B COVERAGE DILUTION UNLIKELY: Indenture provisions allow the series C bonds to ascend to parity with the series 2008B bonds on weak 1.1x coverage of combined MADS. However, ascension of the series B bonds to senior status is expected within the next few years at current growth rates, at which point series C ascension requires a much more robust coverage requirement of 1.33x MADS.
VOLATILE REVENUE SOURCE: The TDT remains an economically sensitive and volatile revenue.
PREMIER TOURIST DESTINATION: The city is home to Disney World, a world-class tourist attraction. The strength of the amusement park and other area attractions including Universal Studios has enabled the leisure industry to rebound relatively quickly from downturns.
RESERVE CUSHION: Each series of bonds was issued with a liquidity reserve (LR) equal to 1/2 (MADS) and a debt service reserve account (DSRA) equal to 1/2 MADS, with the intention that the cushion could provide sufficient cash flow to compensate for periods of weak revenue performance. While the LR for each series was previously tapped and subsequently replenished, there has never been a draw on either DSRA.
SUSTAINED TOURIST DEVELOPMENT GROWTH: Continued TDT growth which further bolsters debt service coverage could lead to positive rating action for the senior lien bonds.
LIMIT ON THE SERIES 2008B RATING: Upward revision of the rating on the series 2008B bonds is likely over the next few years as coverage levels reach a threshold where the bonds ascend to senior lien with the series 2008A bonds.
DECLINE IN TDT REVENUE: A reversal of recent positive trends could lead to coverage at levels inconsistent with even the current low ratings.
CONSISTENT TDT GROWTH RAISES COVERAGE
The strong and sustained recovery of TDT revenues is now in its seventh year with the pace of TDT growth accelerating. Since February 2010, TDT collections have increased every month on a year-over-year basis, with just three exceptions. Between fiscal years 2010 and 2015, TDT revenues expanded by 48%, and are currently at their historical peak. Following a 12.8% growth spurt in fiscal 2015, fiscal 2016 year-to-date collections through December 2015 are up 8.8%, signaling solid prospects for continued near-term growth. Growth in pledged revenues has boosted debt service coverage for both the series A and B bonds.
RATINGS BASED ON NOVEMBER PRINCIPAL AND INTEREST COVERAGE
The flow of funds directs the first interest payment in each bond year to be paid across all series, while for the second principal and interest payment, senior debt service is paid prior to the second and third liens. As a consequence, debt service requirements are substantially higher for November payment dates. The bonds were structured this way as revenue collections have historically been more robust during the summer months. Both on a historical and projected basis coverage has been narrower for the November dates, and Fitch rates to these lower ratios.
SERIES A BOND COVERAGE
TDT revenues from May through October of 2015 along with TDT revenues in excess of debt service provided 1.62x debt service coverage for the series 2008A payment on Nov. 1, 2015. Over the past five years, TDT revenues received from November through April have been more than sufficient to cover the May interest-only debt service on all three liens with the excess used to supplement the following November's debt service payment. This excess totaled $2.4 million in 2015, increasing the amount available to pay November debt service by 21%, as compared to $11.2 million in receipts alone. Fiscal 2015 coverage of the November debt service requirement of 1.62x represents a significant improvement over 2014 coverage of 1.39x. When taking into account TDT revenues and principal and interest requirements for full-year 2015, series 2008A debt service coverage increases to 1.65x.
Under the Fitch base case scenario of 3.2% annual growth, equal to one half of the average annual TDT growth since fiscal 2000, TDT revenues would provide full-year debt service coverage of at least 1.74x. Even in a severe stress scenario that mirrors the largest historical revenue declines of 2001 and 2002, followed by baseline growth, coverage of series 2008A debt service in any six-month period would not fall below 1.17x.
For combined series 2008A and subordinate series 2008B debt service, debt service coverage of the November 2015 principal and interest requirements improved to 1.34x. This compares favorably with prior year coverage of 1.2x. March through August TDT revenues increased by 11.3% over the comparable period in 2014. Under the Fitch base case scenario, the minimum TDT coverage of full-year debt service for both series combined would be 1.45x. With recent TDT growth, repayment of series A and B debt service can tolerate increasing amounts of stress. Under a scenario of the two worst years of TDT decline with no subsequent growth, both the series A and B bonds would be paid with only a modest draw on reserves.
SERIES B BOND COVERAGE APPROACHES SENIOR LIEN THRESHOLD
TDT coverage of combined series 2008A and 2008B debt service has grown to the point that it is approaching the threshold where the series 2008B lien on TDT revenues ascends to senior lien on parity with the series 2008A bonds. Indenture provisions provide for accession to senior lien when TDT revenues less the installment payment cover MADS on combined series 2008A and 2008B bonds by at least 1.33x. Fiscal 2015 coverage less the installment payment is at 1.19x. However, at baseline growth, the 1.33x threshold would be achieved by fiscal 2017, placing the series 2008B bonds on parity with the senior bonds.
The indenture also provides for the series 2008C bond lien to ascend to 2nd lien on parity with the series 2008B bonds when TDT revenues less installment payments reach 1.10x coverage on MADS of all three liens, raising concerns regarding series 2008B coverage dilution. However, it is expected that series 2008B will ascend to senior lien well before the series 2008C bonds meet the 1.10x coverage test. At that point, ascension of the series 2008C bonds to senior parity with the 2008A and 2008B series requires more robust 1.33x coverage of MADs, tempering concerns regarding dilution.
HISTORICALLY VOLATILE REVENUE STREAM
The volatility of the revenue stream underscores the economically sensitive nature of the TDT and its dependence upon the local tourist sector. Historical TDT revenues experienced robust growth, increasing at an average annual rate of 12.7% from 1979 to 2000. During the past decade, however, the TDT suffered several declines, falling 12.6% in fiscal 2002 and, subsequent to a robust recovery, 15.4% in fiscal 2009.
Some revenue stability is provided by the annual installment payment equal to $2.8 million to be received monthly through Nov. 15, 2018. In fiscal 2015, the installment payments represented close to 14% of pledged revenues.
CASH RESERVES OFFSET TDT VOLATILITY
The liquidity reserves for each series were established to compensate for expected fluctuations in TDT collections. Reserves for both the series 2008A and 2008B bonds have been tapped but fully replenished; unused bond proceeds replenished the series 2008B liquidity reserve. The DSRA has never been utilized for either series of bonds.
ADEQUATE BONDHOLDER PROTECTIONS
Legal provisions include a cross-default provision. Upon default of the series 2008C bonds, the flow of funds directs payment of principal and interest to the holders of the series 2008A bonds and subsequently to the owners of the 2008B bonds, prior to any payments to third lien bondholders.
Fitch believes if TDT revenues experience a sharp decline, a cross-default is possible although unlikely during the life of the bonds. Current pledged revenues remaining after payment of the prior lien bonds narrowly cover series 2008C debt service requirements. Following a series of drawdowns, the series 2008C liquidity reserve is currently depleted. Despite some recent replenishment of the $4.4 million series 2008C DSRA, current funding is still $674,000 below the requirement. Even a moderate sustained downturn in TDT collections could lead to a series 2008C default.
The indenture prohibits additional debt, except for refundings. Additional bonds for refunding purposes may be issued if, during any consecutive 12 of the previous 25 months, contract revenues equaled at least 1.33x MADS on all senior debt and 1.10x MADS on all senior and second-lien bonds. The calculation excludes installment payment revenues.
CENTRAL FLORIDA ECONOMY CONTINUES TO EXPAND
The leisure and hospitality sector continues to be a major component of the local economy, making up about 21% of total area employment. Disney is the dominant player, employing about 74,000 or over 10% of the total county workforce. Universal Orlando reports 19,000 employees while SeaWorld of Orlando's employment is approximately 6,000. Both Disney and Universal are making substantial investments in their parks, including new Star Wars themed attractions at Disney and a new hotel and water park at Universal. Beside growing theme park attendance and TDT collections, expanding occupancy and hotel room rates are indicative of the strong recovery within this sector.
The local economy continues to expand and diversify. Employment levels have increased steadily since 2011 and were up 1.7% in December 2015 on a year-over-year basis. The city's December 2015 unemployment rate of 3.9% was lower than the state and national rates of 5.0%.
The city's taxable assessed value experienced robust gains of 7.5% in fiscal 2015 and 14.2% in fiscal 2016. The fiscal 2016 tax base growth represented the third consecutive increase after four years of decline. Median January 2016 home values are up nearly 12% over the prior year according to the Zillow Group, signaling future tax base growth.
EVOLVING BIOTECH AND LIFE SCIENCE HUB
Economic diversification has occurred most notably within the education and health services sectors. A growing biotechnology and life sciences cluster is centered in Lake Nona Medical City, a master-planned mixed community within Orlando. Lake Nona is anchored by the University of Central Florida's (UCF) Health Sciences Campus, which is home to its College of Medicine and the Burnett College of Biomedical Sciences, the M.D. Anderson Cancer Center and the Sanford-Burnham Medical Research Institute. Other Lake Nona medical facilities are the recently opened Nemours Children's and a new Veteran's Administration hospital. Significant additional residential and commercial development throughout the city points towards ongoing near-term growth.
Additional information is available at 'www.fitchratings.com'.
Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and
Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings, dated Feb. 2, 2016). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.
In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope, Lumesis, IHS, and Zillow Group.
Exposure Draft: Incorporating Enhanced Recovery Prospects into US Local Tax-Supported Ratings (pub. 02 Feb 2016)
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form