Fitch Upgrades Palm Bay, FL's IDR and Revs; Outlook Stable

NEW YORK--()--Fitch Ratings has upgraded the following ratings of the city of Palm Bay, Florida to 'AA' from 'AA-':

--Long-term Issuer Default Rating (IDR);

--$50.9 million taxable special obligation refunding bonds, series 2013;

--$5.3 million public service tax revenue bonds, series 2010.

The Rating Outlook is Stable.

SECURITY

The special obligation bonds are payable by a subordinate lien on public service tax (PST) and communications service tax (CST) revenues (collectively, the designated revenues). The city has also covenanted to budget and appropriate non-ad valorem revenue in the event the designated revenues are insufficient to pay debt service. This covenant is subject to the availability of non-ad valorem revenues after satisfying obligations with a specific lien on such revenue and the funding of essential government services.

The public services tax revenue bonds are secured by a senior lien on PST and CST revenues and a cash-funded debt service reserve fund (DSRF).

KEY RATING DRIVERS

The upgrade of the city of Palm Bay's IDR and related bond upgrades to 'AA' from 'AA-' reflect the application of Fitch's revised criteria for U.S. state and local governments, which was released on April 18, 2016. The application of the revised criteria focuses on the city's solid revenue framework and solid expenditure flexibility, moderate carrying costs and low long-term liability burden.

The rating upgrade to 'AA' from 'AA-' on the revenue bonds reflects the strong debt service coverage and exceptional resilience when viewed in the context of historical revenue declines and the Fitch Analytical Sensitivity Tool (FAST) output through a moderate economic downturn scenario. The rating on the bonds is capped at the level of the city's IDR because, in Fitch's opinion, the pledged revenues would not be insulated from the general operations of the city in the event of a bankruptcy filing.

Economic Resource Base

Palm Bay is located in central Florida in Brevard County near the Atlantic Coast. The city covers an area of over 100 square miles and is the largest incorporated municipality in the county by population, with a 2015 census estimate of 107,888.

Revenue Framework: 'aa' factor assessment

Revenue growth prospects are favorable, driven by development projects planned and underway. The city has substantial independent legal revenue-raising ability although millage rates are subject to a statutory limit.

Expenditure Framework: 'aa' factor assessment

The pace of spending is expected to generally align with or slightly exceed revenue growth trends, absent policy action. Fixed carrying costs associated with debt and retiree benefits are moderate at about 19% of spending.

Long-Term Liability Burden: 'aaa' factor assessment

The city's long-term liability burden, which includes debt and pensions, is a modest 5% of personal income. Liabilities are expected to remain low, with limited debt plans and adequate funding of pension benefits.

Operating Performance: 'aaa' factor assessment

Fitch expects the city to maintain significant financial resilience in the event of a moderate economic downturn. The city's adherence to its 10% reserve policy and its superior inherent budget flexibility provide for exceptionally strong gap closing ability.

RATING SENSITIVITIES

FINANCIAL FLEXIBILITY: The rating is sensitive to shifts that would lead to a significant decline in the city's financial flexibility and gap-closing ability.

CITY IDR: The revenue bond ratings are sensitive to changes in the city's general credit quality as expressed in the city's IDR.

MATERIAL SHIFT IN DESIGNATED REVENUE PERFORMANCE: The rating on the revenue bonds is also sensitive to changes in Fitch's expectations for designated revenue performance that materially affect the debt service coverage cushion.

CREDIT PROFILE

The local economy is centered on equipment and communications manufacturing, housing, healthcare and tourism. Palm Bay's economy continues to stabilize evidenced by the employment levels that have been on a gradual upswing since the Great Recession. The unemployment rate has improved but still exceeds the state and the U.S average. City home values endured steep declines during the recession and have notably recovered but are still below the 2006 peak. Assessed values have experienced similar declines during the recession (down over 50% from 2008 through 2013) and recovery in recent years, with additional growth fueled by the economic development projects planned and underway. The city is working with the Florida Department of Transportation for the construction of a new I-95 interchange in the southern area of the city, which is expected to spur significant development. Wealth indicators for the city remain below state and national averages. The Harris Corporation employs about 3,000 or a somewhat elevated 6% of the city's total employment base. The firm acquired Exelis Inc. in 2015 and decided to integrate the two segments headquarters in Palm Bay, demonstrating the firms' commitment to the area. The combined operations of the two firms will create one of the largest defense contractors in the nation.

Revenue Framework

Property tax revenue is the city's largest revenue source (comprising about 40% of general fund revenues in fiscal 2015), followed by intergovernmental revenues (17%), utility taxes (14%), license and fees (10%) and fuel taxes (6%).

General fund revenues grew at a 10 year CAGR of 3.4% through 2014, exceeding the rate of inflation but trailing the national GDP. However, historical revenue growth incorporates a series of millage rate increases to offset the impact of falling home values during the Great Recession and state property tax reform. Fitch believes revenue growth prospects are more moderate, expected to generally track the rate of inflation going forward due to development projects planned and underway.

The city has substantial independent legal revenue-raising ability with the fiscal 2015 general fund millage rate (8.6326 mills) below the statutory limit of 10 mills.

A recent voter-approved city charter amendment that limits city council's ability to impose millage rates may pressure the general fund budget. Beginning in fiscal 2018, the city council will be restricted from setting millage rates at a level that would result in total ad valorem revenue growth to exceed the prior year ad valorem revenue by more than three percent, unless approved by a supermajority vote or in an emergency or for critical needs. Fitch notes that, even with this change, rate increases within the statutory limit remain in the city's independent legal control.

Expenditure Framework

Palm Bay provides a broad range of services that include public safety, general government, transportation, and parks and recreation. City spending is mainly driven by public safety, which accounts for 62% of total general fund spending.

Fitch expects the pace of spending to generally match or slightly exceed revenue growth to meet the needs of an expanding population, absent policy action.

Employee wages and benefits are the main expenditure driver. Wages and benefits are collectively bargained. City employees are largely represented by four unions; the city recently renewed one of its contracts for a three-year term and is in negotiations with another. The city's remaining two contracts (fire and fraternal order of police unions) were ratified in late 2015 for a three-year term. Under state law, if an impasse is declared, both parties are required to engage in a non-binding mediation process after which the city may impose contract terms for one year. In order to manage costs during the Great Recession, the city implemented a two-day furlough, froze salaries, privatized certain services, and reduced positions. The city has since added new positions and applied wage increases; however, staffing levels remain below pre-recession levels and may present some practical constraints on future expenditure flexibility in an economic downturn.

Long-Term Liability Burden

The city's long-term liability burden is modest at about 4.5% of personal income and is expected to remain low, given the city's manageable capital needs and limited debt plans. The city's total direct debt, which amortizes at slow pace with approximately 30% of principal to be repaid within 10 years, approximates 60% of the long-term liability burden.

The city's 2017 - 2021 capital improvement plan totals $69 million, with about $48 million to be dedicated towards the city's self-supporting stormwater system and $19 million identified for the city's road program. The city plans to finance a portion of its road projects through a combination of state, federal and debt proceeds. Debt issuance plans are currently estimated at $11 million, although may be revised lower depending on available state and federal grant funding. The remaining capital needs are expected to be financed through impact fees, grants, and other cash sources. Additionally, a recent (November 2016) voter approved city charter amendment will provide additional funding for road and drainage improvements. The new charter amendment permits city council to impose special assessments in 2017 for the construction, repair, and maintenance of roadways, stormwater and wastewater management facilities, and water supply and distribution systems.

The city's overall pension burden is affordable with a net pension liability of approximately $47 million, or about 1 % of personal income (using a Fitch adjusted 7% investment return). The city's pension contributions reflect payments to the city sponsored general employee, police and fire plans and the Florida Retirement System. The city funds its post-employment benefits (OPEB) on a pay-as-you-go basis with the bulk of payments reflecting an implicit rate subsidy. The fiscal 2015 OPEB liability was equal to less than 1% of personal income.

Operating Performance

The city's superior inherent budget flexibility provides it with the ability to maintain reserves at a level consistent with a 'aaa' financial resilience assessment. Fitch believes the city would undertake the necessary actions to adhere to its 10% reserve policy and manage through future economic cycles.

The city managed the budget through the Great Recession with a combination of millage rate increases and various expenditure reductions. While the unrestricted general fund balance dipped to approximately 9% in fiscal 2010, it quickly recovered in the ensuing years with balances ranging from 10% to 18%. General fund reserves balances declined by $1.8 million in fiscal 2015 (to 13.5%) due to the establishment of the road maintenance capital improvement fund for the restoration of city infrastructure. Per city management, fiscal 2016 results are forecast to be consistent with the prior year and in compliance with its 10% reserve policy. The adopted general fund budget for fiscal 2017 represents a 5% increase over the prior adopted budget and incorporates no use of reserves and a lower millage rate (8.45 mills).

Dedicated Tax Bonds

Pledged revenues for the PST (senior lien) and special obligation bonds demonstrate robust coverage and exceptional financial resilience. Fiscal 2015 pledged revenue of $10.9 million covered senior lien MADS of $471,503 by approximately 23x and combined PST and special obligation bond debt service by 2x on an all-in basis. The city covenants to not incur additional senior lien obligations on the PST or the CST, effectively closing the lien to additional leverage. The additional bonds test for the subordinate lien bonds require a 1.5x coverage of all-in MADS.

The essential nature of the pledged revenue bases (electric, communication, water, and gas services) has resulted in relatively stable revenue collections and resilience during the Great Recession. Based on the pledged revenue history, Fitch's Analytical Sensitivity Tool (FAST) generates a 2.5% decline in a moderate economic downturn scenario. The largest consecutive decline was equal to a comparatively modest 6% from fiscal 2010 to 2012. Fitch expects revenues to continue to grow at least in line with inflation over the long term.

Given current solid coverage levels and assuming no additional leverage, the structure for the PST and special obligation bonds could tolerate a 54% decline in revenues before MADS coverage reaches 1.0x. This level of tolerance is very strong, equivalent to approximately 22x the FAST result and 9x the largest consecutive decline. When assuming leverage to the 1.5x ABT, the coverage results yield a similarly high level of resilience. The structure could withstand a 33% decline in revenues before MADS coverage would decline to 1.0x, which is equal to 13x the FAST result and nearly 6x the largest actual revenue decline. Fitch expects coverage levels to remain fairly stable and the risk of additional leverage is fairly remote as surplus revenues are used to support city operations.

Issuing Entity Exposure

Fitch does not believe that the pledged revenues would be considered special revenues in a bankruptcy of the city under Chapter 9 of the U.S. Bankruptcy Code. As such, the rating on the revenue bonds is capped by the city IDR.

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

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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Contacts

Fitch Ratings
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Grace Wong, +1-212-908-0652
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Grace Wong, +1-212-908-0652
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com