AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the following Hollywood, FL (the city) revenue bonds:
--$45.9 million water and sewer improvement revenue bonds, series 2010B (Build America Bonds-Direct Payment) at 'AA-';
--$37.5 million water and sewer refunding revenue bonds, series 2014 at 'AA-'.
The Rating Outlook is Stable.
The bonds are secured by a senior lien on net revenues of the city's water and sewer system (the system).
KEY RATING DRIVERS
STRONG FINANCIAL PERFORMANCE: Debt service coverage (DSC) and free cash flow (FCF) are strong relative to peer systems. Liquidity is also ample having more than doubled since 2009. A combination of unrestricted cash and rate stabilization funds totaling $75.6 million equates to over 650 days of operations in fiscal 2015.
ABOVE-AVERAGE RATES: A cumulative 68% increase in rates since fiscal 2010 has improved the system's financial profile but has also pushed rates to above-average levels relative to peer systems and to median household income (MHI). A 2013 rate study that showed sufficient revenues for the forecast period at the 2013 rate levels prompted implementation of a rate freeze that is in effect through 2019, limiting revenue flexibility of the system.
MODERATE DEBT BURDEN: Debt ratios are manageable (and slowly improving) given the system's large proportion of revenues received from bulk users, ample liquidity and significant FCF. Debt ratios are somewhat elevated on a direct basis with debt per customer over $2,800 in 2015. However, Fitch considers the rapid amortization of existing debt, manageable carrying costs, and tens of thousands (estimated) of additional retail customers served through wholesale contracts in its analysis of the debt burden.
COMPREHENSIVE CIP, OUT-YEAR RISKS: The five-year capital improvement plan (CIP) will focus on inflow and infiltration (I&I), water main, and reuse projects and will be financed from pay-go sources and low-interest, short-term subordinate debt. Debt ratios are anticipated to rise, and projects to address ocean outfall elimination may lead to higher capital costs for the system that are beyond the current CIP period.
SOLID INFRASTRUCTURE CAPACITY: The system is generally in a good state of repair and water supply and treatment capacity is ample for the long term. Sewer treatment capacity is sufficient as the city is almost completely developed.
FINANCIAL MARGIN DECLINES: Sustained declines Hollywood, FL's water and sewer system financial performance could place downward pressure on the rating. The Stable Outlook reflects Fitch's expectation that this will not occur in the short-term, even with the rate freeze in effect. Potential capital spending related to ocean outfall legislation may be needed in the longer-term but is outside the outlook period.
Hollywood, FL (general obligation [GO] bonds rated 'A'/Positive Outlook) is located in Broward County on the southeast coast of Florida and is a part of the Miami-Ft. Lauderdale metropolitan statistical area (MSA). The city is nearly fully developed and has a 2015 population estimate of 150,000.
RETAIL AND WHOLESALE SERVICE PROVIDED
The system provides direct retail service to 40,000 water connections and 21,000 sewer accounts in fiscal 2015. Retail customers are predominantly residential with no concentration concerns. The system also provides wholesale sewer service to the adjacent municipalities of Pembroke Pines, Hallandale Beach, Dania Beach, Broward County, and Miramar through substantially similar large user agreements.
Wholesale customers represented roughly 22% of the system's total fiscal 2015 revenues, a proportion that presents potential customer concentration risk. However, this risk is largely mitigated by stiff provisions contained in the contracts, including a mandatory one-year termination notice, the pre-payment of debt prior to termination, and a present value payment of any other charges that would have been paid by the large user over the ensuing five years.
RATE INCREASES IMPROVED FINANCIAL PERFORMANCE
The system has improved its financial position significantly over the past five years. Several years of substantial rate increases contributed to a 30% growth in system operating revenues from fiscals 2011-2015, resulting in greater DSC and FCFs. Operating revenue growth coupled with de minimus growth in operating expenses (excluding depreciation) over the past five years has resulted in very strong operating margins of over 50% in the last four fiscal years.
In fiscal 2015, operating cash flows represented nearly 2.0x current liabilities, and unrestricted cash and investments, including the cash the utility restricts for its rate stabilization fund, equated to over 650 days cash on hand. In fiscal 2015, senior DSC was very strong at 5.7x, and all-in coverage, which includes subordinate lien state revolving fund loans and capital leases, improved to 3.6x. Coverage net of transfers to the city's general fund (for payments in lieu of taxes, or PILOTs and administrative service charges) was still very strong at 3.5x on the senior bonds, and 3.4x for all debt. PILOT payments are fairly standardized and calculated using the system's net assets multiplied by the millage rate. Fitch expects the formula for determining PILOT payments will remain consistent and predictable.
Pro forma financials provided by the city show a continuing trend of strong margins and DSC, with all-in DSC ranging between 2.0x and 2.4x over the forecast period. Assumptions are reasonable and include average annual operating revenue growth of 1%, and average annual operating expense growth of about 5% over the fiscal 2016 to 2020 period.
MODERATELY HIGH RATES; FLEXIBILITY TO RATE FREEZE ENACTED
The system has implemented fairly rigorous rate increases since fiscal 2010. The final rate increase of an approved multi-year rate plan was for 7.5% and was implemented at the start of fiscal 2014. The average residential customer consumes roughly 5,000 gallons per month (gpm) due to a fairly strict tiered rate structure that discourages excess consumption. Assuming 5,000 gallons, the average customer pays roughly $81 per month for combined service in fiscal 2016, which represents 2.1% of median household income (MHI).
Fitch becomes concerned about rate affordability when charges relative to regional peer systems are on the high end (which they currently are) and when rates reach 2% of MHI for combined charges. However, the city recommended and received city commission approval for rate relief in 2014; rates will not be increased again until at least 2020. The rate freeze should allow rates to become more competitive over time, but reflects an elevated degree of rate sensitivity in the service area and lack of rate flexibility.
COMPREHENSIVE CAPITAL PROGRAM, ADDITIONAL DEBT EXPECTED
The system's fiscal 2016 to 2021 six-year CIP totals $170.5 million and is very comprehensive. The CIP includes the reduction of I&I projects, the replacement and lining of water and sewer mains, and re-use system expansion among various other projects. Fitch notes the capital plan is fluid and projects can be deferred as needed. The city anticipates funding the CIP mainly with pay-as-you-go resources (69%) and some additional debt (mainly low-interest SRF loans) totaling roughly $53 million.
The system's debt burden is somewhat elevated but has been on a steady decline over the past five years. In fiscal 2015, total debt outstanding of approximately $175 million led to debt that was 63% of net fixed assets and $2,844 per direct retail customer. The additional anticipated debt to fund the current CIP is projected to raise the debt burden to $3,058 in five years, although Fitch notes the system's large wholesale customer mix somewhat skews the debt ratios.
For instance, the city estimates approximately 100,000 additional connections are served through bulk service. Even if half of this amount (40,000 sewer and 9,000 water connections) were included in the calculations, debt would be closer to $1,582 per customer and near the median for 'AA' category water and sewer utilities. In addition, Fitch considers the rapid repayment of existing debt and the manageable debt carrying costs (debt service is 18% of gross revenues) as offsetting factors to the debt profile.
ABSORPTION OF MANDATED OCEAN OUTFALL ELIMINATION PROJECTS
In response to legislation passed in 2008 (and amended in 2013) system capital needs beyond the current CIP consist of mandates to eliminate wastewater discharges through ocean outfalls into the Atlantic Ocean by 2025. While the system currently produces 4 mgd of reclaimed water (for irrigation and public space use) and utilizes deep well injection to dispose most of its effluent, roughly 15 mgd of effluent is discharged through ocean outfall.
The city's cost estimates for ocean outfall elimination projects are between $70 million and $100 million. Projects looking at doing contract re-use with other municipalities. Design is not expected to commence until around fiscal 2019. Out-year projects could pressure the system's strong financial profile and lead to higher rates and additional debt.
WEAK LEGALS COVENANTS
Legal covenants are weak; the rate covenant and additional bonds test require a 110% net revenue coverage requirement, and the flow of funds is open. In addition, an admission by the city in writing of its inability to pay its debts, generally, can lead to an event of default on the water and sewer bonds, subjecting the bonds to possible acceleration.
Additional information is available at 'www.fitchratings.com'.
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
Dodd-Frank Rating Information Disclosure Form
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