Fitch Affirms East Central Reg'l Wastewater Treatment Facils Ops Bd, FL Sewer Revs at 'AA+'

NEW YORK--()--Fitch Ratings has affirmed the rating on the following revenue bonds issued by the East Central Regional Wastewater Treatment Facilities Operation Board, Florida (the ECR):

-- $92.8 million sewer system revenue bonds, series 2014, at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by net revenues of the ECR, which are derived primarily from wastewater flow charges (WFCs) received from the member entities - Palm Beach County (the county), the cities of West Palm Beach (WPB), Lake Worth and Riviera Beach, and the town of Palm Beach. Net revenues also include septage charges, penalties, and other income.

KEY RATING DRIVERS

MEMBER PAYMENT OBLIGATIONS: An interlocal agreement (IA) was established in 1992 to consolidate existing separate agreements with the ECR and provide a single unified set of policies and procedures to operate the plant. The tenets of the original IA are currently in effect through 2052 and include provisions that provide for a joint-and-several agreement among the members for the repayment of obligations to the ECR, including debt service on the bonds.

STRONGEST MEMBERS DRIVE RATING: The rating reflects the credit quality of the ECR's strongest member - Palm Beach County (utility bonds rated 'AAA'/Stable Outlook), but also takes into consideration limited operational risk.

ROBUST FINANCIAL MANAGEMENT: ECR policies result in strong cash reserves and solid ongoing debt service coverage (DSC), exceeding levels typical of other wholesale providers and thus enhancing bondholder protection.

MANAGEABLE DEBT AND CAPITAL NEEDS: A series of consecutive debt issuances has led to increased (relative to historical levels) but manageable debt metrics. The five-year capital improvement program (CIP) will support the conclusion of a large biosolids project and the system's substantial renewal and replacement (R&R) program.

STRONG OPERATING PROFILE, ESSENTIAL SERVICE: The ECR has ample treatment capacity and a solid track record of regulatory compliance. Each member is either entirely or nearly entirely dependent on the ECR for wastewater treatment, and the development of alternative sources would likely be cost prohibitive.

FAVORABLE MEMBER PROFILES: The service area is wholly contained within Palm Beach County and the underlying customer base exhibits strong economic and credit fundamentals.

RATING SENSITIVITIES

DETERIORATION IN LARGEST MEMBER CREDIT CHARACTERISTICS: Deterioration in the credit quality of Palm Beach County, or increased operating risk related to West Palm Beach as the operator, could result in downward movement in the East Central Regional Water Reclamation Facility rating.

FINANCIAL PROFILE DETERIORATION: Continued surplus net revenues and maintenance of robust reserves will be a key consideration in maintenance of the current rating.

CREDIT PROFILE

Created in 1992 as a separate governmental entity pursuant to the IA, the ECR provides collection, treatment, and disposal of wastewater flows on a wholesale basis to a large and diverse service area that includes just over 400,000 people. The ECR is located within the east and central portions of the county in southeastern Florida and its five member entities include the county, the cities of WPB, Riviera Beach (utility revenue bonds rated 'A+'/Stable Outlook) and Lake Worth as well as the town of Palm Beach. The IA expires in 2052.

The ECR is governed by a five-member board comprising a representative from each participating entity. Votes are weighted based on each entity's share of the system's treatment capacity. The city of WPB is the system operator and is responsible for tracking expenses and proposing annual budgets and revenue requirements to be approved by the board. The board meets monthly and is able to convene immediately should circumstances require.

SOUND PAYMENT PROVISIONS, IMPLIED UNLIMITED STEP-UP

Each member entity pays a proportionate share of the ECR's operations and maintenance (O&M) expenses, debt service, R&R and catastrophic reserve balances as well as any other amounts required under the bond resolution. WPB presents the board with the subsequent year's budget no later than 150 days prior to the close of the current fiscal year. The budget is based on two years' worth of historical operating expenses and wastewater flows as well as fiscal year-to-date and projected year-end expenses. The expense budget is used to determine WFCs, which are based on the total amount of the annual operating budget divided by the estimated flows for the budget year of each entity. WFC payments are O&M expenses of each entity, superior in priority to the member's own debt obligations.

While the IA does not contain explicit step-up language in the event of a customer default, it does require the board (via notification by the operator WPB) to amend the operating budget immediately (at any time of the year) to adjust WFC rates upward to meet expected shortfalls. Fitch views this as an implied unlimited step-up. Members are billed two months in advance, providing time for a potential cash flow shortfall to be detected and remedied via the use of the system's abundant cash balances and/or a step-up of other member payments prior to debt service payments.

RATING METHODOLOGY: TOP-DOWN PAYMENT APPROACH

Because of the joint-and-several nature of the ECR's revenues, Fitch's analysis considers the non-defaulting members' ability to absorb any potential (albeit remote) delinquencies by other ECR members from both one-time sources (available cash) and then on a recurring basis (annual revenues). According to the IA, the occurrence of a defaulting customer would result in an immediate recalculation of WFCs based on the proportionate contributing flows by non-defaulting customers, leading to a full recovery of the ECR's revenue requirements. Though no customer has ever defaulted on its member payments, several have been late due to administrative oversight and upon notice, paid in full with a late charge.

Fitch evaluates the ability of a single member or group of members to cover payment defaults from other members of the pool without impairing the non-defaulting members' own credit quality using a top-down approach. In the event of revenue shortfalls from member payments, Fitch believes that Palm Beach County alone (the largest entity with the highest credit quality) has more than sufficient cash resources to pay any immediate revenue shortfall. For example, had the four other ECR members defaulted on their fiscal 2015 WFC payments, the combined cost for the county to recoup these missed revenues would have only amounted to 6.6% of the county's available cash and 8% of its operating revenues that year.

While Fitch believes the county's credit profile is sufficient to absorb any step-up costs from defaulting members, we also believe there is a practical limitation to this step-up, particularly given WPB's role as billing agent and operator for ECR. Consequently, ECR's rating is influenced by operating risk of the facility and payment obligations of the members that are not explicitly unconditional. This operating risk, albeit small, ultimately limits ECR's rating.

STRONG SYSTEM FINANCIAL RESULTS

The system's financial metrics are strong. Typical of a wholesale provider, recurring revenues alone, which include each member's share of total system O&M and debt service costs, yield break-even coverage. However, financial flexibility is further enhanced by the system's ample cash balances. In fiscal 2015, (unaudited) available cash amounted to an estimated $22.2 million or about 648 days' cash on hand. Most of the cash is in the R&R fund, which is intended for capital improvements but is also available for debt service. Annual debt service comprised a moderate 28% of gross revenues in unaudited fiscal 2015 and is expected to average 24% over the next six fiscal years.

Cash balances through the fiscal 2016-2021 financial forecast are shown to remain robust given the system's stringent reserve fund replenishment policies and despite management's expectation to fund 55% of the CIP internally.

MANAGEABLE DEBT AND CAPITAL PROGRAM

The facility has historically maintained very strong debt metrics, as debt has been low and limited to state revolving fund loans. However, the recent series 2014 bond issuance and three private placement loans with JP Morgan/Chase since 2012 (amortizing loans on parity with senior lien debt), have increased debt ratios to be more commensurate with other utilities rated in Fitch's 'AA' median category. Debt-per-capita (based on the combined service area population) approximated $311 (favorable compared to the 'AA' median of $577). Bond amortization is slow, however, with only 58% of total debt projected to be paid off in 20 years. Debt represented a very high 125% of net plant according to unaudited 2015 numbers; however, this represents a lag in the realization of the value of the debt-funded asset and should be adjusted in subsequent audits.

The system's five-year, fiscal 2017-2021 CIP totals $63.1 million and includes largely R&R projects, as well as the continued construction of the biosolids processing facility, which is estimated to be 44% completed. Remaining proceeds from the 2014 bond issue and an $11.1 million loan from JP Morgan/Chase will fund 45% of the CIP.

SOLID LOCAL ECONOMY, STRONG MEMBERS

The county's economy is supported by its traditional underpinnings of agriculture, tourism, government, healthcare, and aerospace supplemented by growing bioscience and higher education sectors. Employment growth remains strong, with the unemployment rate averaging around the most recent Bureau of Labor Statistics level of 5.2% in July 2016. Permit applications continue to grow, signaling new development of office buildings and mixed-use projects in the downtown urban areas and large residential projects in the suburbs.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
https://www.fitchratings.com/site/re/869223

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013018

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https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Eva Rippeteau, +1-212-908-9105
Director
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Andrew DeStefano, +1-212-908-0284
Director
or
Committee Chairperson
Kathryn Masterson, +1-512-215-3730
Senior Director
or
Media Relations, New York
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com