AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned a 'AA' rating to the following Melbourne, FL's (the city) revenue bonds:
--Approximately $15 million water and sewer revenue refunding bonds series 2016B.
The bonds are expected to sell via negotiation the week of June 6. Bond proceeds will be used to refund the outstanding series 2007A for interest savings and pay issuance costs.
In addition, Fitch has affirmed the ratings on the following outstanding revenue bonds of the city:
--Approximately $86.2 million (pre-refunding) outstanding water and sewer revenue bonds to 'AA'.
The Rating Outlook is Stable.
SECURITY
The bonds are payable by a first lien pledge of the net revenues of the city's combined water and sewer system (the system), including impact fees.
KEY RATING DRIVERS
STRONG FINANCIAL PERFORMANCE: The system's overall financial flexibility is demonstrated by strong and improving debt service coverage (DSC) and liquidity margins as well as a declining debt burden.
DECLINING CAPITAL SPENDING: System capital needs have tempered in recent years to focus on targeted renewal and repair (R&R) in lieu of unrealized growth and expansion. However, the system's age of plant is rising, reflecting a level of capital reinvestment that is not keeping pace with annual depreciation.
MODERATE DEBT LEVELS: Debt ratios are generally moderate but debt per capita and debt to net plant remain somewhat elevated. Both ratios are expected to decline due to small scale future borrowings and rapid amortization.
LIMITED RATE FLEXIBILITY: Customer charges have been raised steadily in recent years in order to enhance financial margins however at 1.9% of median household income (MHI) in 2015 they approximate Fitch's 2% affordability threshold. Management has indicated a willingness, given strong cash balances, to defer future rate increases in order to maintain rate affordability.
RATING SENSITIVITIES
MAINTENANCE OF SOUND FINANCIAL POSITION: The city of Melbourne, Florida's water and sewer system's ability to maintain strong financial results and a continued moderating debt profile while assuring sufficient capital re-investment to satisfy annual depreciation costs will be key to maintaining rating stability.
CREDIT PROFILE
Melbourne is located in southern Brevard County (sewer revenue bonds rated 'AA-' and unlimited tax general obligation bonds rated 'AA' by Fitch) on the Atlantic coast.
The system provides water service to approximately 150,000 people on a retail basis in and around the city as well as wholesale service to the city of West Melbourne. Raw water from Lake Washington and four Floridan aquifer production wells provides ample supply and the system has sufficient treatment capacity. The sewer system serves about 70,000 people, almost all of which are located within the city limits. The system's two wastewater treatment plants currently provide adequate treatment capacity.
MUCH IMPROVED FINANCIAL PERFORMANCE
The city's adoption of a multi-year rate increase in 2012 has resulted in consistently improved financial outcomes in comparison to the prior seven fiscal years. All-in DSC of senior lien bonds and state revolving fund (SRF) loan payments was a very low 1.1x in fiscal 2009 but has since improved markedly to a strong 3.2x in fiscal 2015 (3.1x excluding connection fees). These improvements are largely attributable to the system's consistent rate increases and a much improved revenue profile amid fairly flat annual expenditures. They are also a result of several bond re-financings that led to annual debt service savings; debt service carrying costs have declined from 21% in fiscal 2010 to 16% in 2015, well below Fitch's 'AA' sector median.
Cash levels have also shown sustained improvement over time. Fiscal 2015 unrestricted cash totals $50 million and includes designated funds of $26 million. This equates to a very strong 657 DCOH, well above Fitch's 'AA' sector median of 458 days and beyond Fitch's prior projections. This strong cash position is attributable to lower capital expenditures in fiscal 2015 than expected, surplus cash freed up from reserves from bond re-financings, and the availability of funds following the conclusion of a system-wide cash-funded meter replacement program. Cash is expected to remain strong through the forecast.
The system's five-year financial forecast predicts continued DSC improvement. Currently scheduled rate increases (if enacted) will produce revenue growth while expenditure levels, consistent with historical results, are shown to remain flat. All-in DSC net of connection fees is anticipated to remain at or above 3.0x through the fiscal 2020 forecast period. The system's strong financial margins indicate that DSC results will likely stay strong even if management defers future rate increases and revenues stay flat. A potential fiscal 2019 $25 million new money bond issue would increase annual debt service costs in 2020, but DSC is projected to decline only marginally. Fitch believes management's forecasts and the related assumptions are sound and generally conservative in nature as audited financial results have exceeded projections in recent fiscal years.
RATE INCREASES DROVE IMPROVED FINANCES
Historic rate increases have led to somewhat high customer charges relative to MHI. Based on the typical customer consumption of about 4,000 gallons of water per month, the typical bill costs around $66, or about 1.9% of MHI. Fitch's affordability threshold is 2.0% for combined water and sewer charges.
As rates have steadily increased since 2012, cash reserves have also increased prompting management to defer the system's 5.5% October 1, 2015 rate increase by one year. Management states that it will likely defer the upcoming October 2016 increase as well. The remaining 5.5% rate increase approved by the 2012 multi-year study is scheduled to occur in October 2017 and may also be deferred should cash levels remain robust. The system's somewhat elevated charges may pose a challenge to future rate-setting flexibility.
REDUCED CAPITAL PROGRAM
The system's fiscal 2016 - 2020 capital improvement plan (CIP) of $73 million is down from the city's prior five-year spending assumption. Management conducted a review of its capital priorities in order to estimate its CIP with more realistic R&R and growth needs than previously thought. Minimal customer growth and increased water conservation has pushed capacity expansion priorities out and significant investment in water supply and treatment capacity is not expected for at least 15 years. Moreover, management explains that certain investments included in the current CIP, including the modification of pumps and membranes at the reverse osmosis plant to increase energy-efficiency, as well as the R&R of key aging infrastructure components, have been thoroughly vetted as the most cost-effective and worthwhile improvements to maintain reliable service and treatment availability.
Fitch views management's efforts to right-size its capital needs as credit positive, however continues to note an elevated and increasing age of plant (accumulated depreciation divided by the annual rate of depreciation) and a recent decline in annual capital expenditures relative to annual depreciation. The system's average age of plant was 19 years in fiscals 2014 and 2015--on the rise from prior years. This metric is notably higher than 14 years for similarly rated credits, and given spending over the CIP is less than the expected annual depreciation costs the age of plant will likely to continue to be elevated.
DECLINING DEBT PROFILE
The system's debt profile includes senior lien revenue bonds and subordinate-lien SRF loans. Debt levels remain moderately high, as fiscal 2015 debt equated to 78% of the system's net plant and on a per capita basis amounted to $759 ('AA' medians are 47% and $577, respectively). These metrics have moderated over time and given the city's rapid amortization of 46% and 96% retired in 10 and 20 years, respectively, are expected to continue to improve. Bond covenants are characterized as weaker than average due to the 1.0x rate covenant and additional bonds test.
Prior CIPs were primarily debt-financed. But given the system's robust accumulation of available cash, management has shifted focus and is now largely cash-financing its reduced scope of capital improvements. A $25 million bond issue is currently forecast to fund several discrete projects in the fiscal 2019-2020 timeframe (34% of the five-year plan) but this may be deferred given the system's large and growing cash balance. Should management require greater capital spending than currently planned to fund the system's annual rate of depreciation, ample available cash reserves should ably accommodate this need and financial margins should likely remain comfortably within the 'AA' median range.
IMPROVED LOCAL ECONOMY
The city's employment sector is centered on high technology, medical and service industries, agriculture and tourism. The city's Orlando Melbourne International Airport houses one of the largest concentrations of high technology jobs, with aerospace and information technology firms continuing to invest in manufacturing space. City unemployment for March 2016 was a low 5.2%, still slightly above the states 4.7% but on par with the national average. Wealth levels have historically been and remain low at 86% and 76% of the state and national levels, respectively.
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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1005017
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005017
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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