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Wednesday, March 30, 2011

Palm Coast, FL Utility System Revenue Bonds Downgraded

Dual-headquartered in New York and London, and with 50 offices worldwide, Fitch Ratings is a global rating agency (similar to S&P or Moody's). Fitch Ratings downgraded the following Palm Coast, FL utility system revenue bonds, and stating that "the Rating Outlook is Stable:"
Approx. $132 million,
series 2003 and 2007,
downgraded to A+ from AA-.
The downgrade indicates that the bonds are no longer considered "High Grade - High Quality" but one step down, "Upper Medium Grade."

  • The downgrade on the city of Palm Coast, FL's utility system (the system) revenue bonds to 'A+' from 'AA-' reflects system's very low debt service coverage margins in fiscal 2010 and expectations for below-average financial metrics and liquidity for the near to intermediate term.
  • Despite these financial challenges, the system maintains good overall capacity and has a manageable capital plan that is somewhat fluid as portions of the plan are related to future customer growth; although if growth occurs, additional debt is expected.
  • The system remains highly leveraged, largely a result of its debt-financed acquisition in 2003.
  • The economy remains limited, and continues to show persistently high rates of unemployment.
  • The mostly residential customer base is stable despite the still soft economy and housing market.
  • Rates are currently affordable.
  • Legal provisions are below average and include a rate covenant requiring just 110% coverage of debt service from net revenues, or 105% coverage from net revenues plus 120% coverage including connection fees. The additional bonds test has similar requirements.

  • The system's ability to balance its rate affordability with its high debt costs and capital needs.
  • Further declines in system liquidity may lead to lower overall financial flexibility and could cause additional downward rating pressure.

  • The bonds are secured by a pledge of the net revenues of the system plus pledged connection fees.

Palm Coast (the city) is located along the Atlantic coast in northeastern Florida's Flagler County, approximately 40 miles north of Daytona Beach and 25 miles south of St. Augustine. The city has an estimated population of 75,000, which accounts for approximately 79% of the total county population in 2010. During the past decade, the city was part of one of the nation's fastest growing metropolitan areas with a population that more than doubled since the time of its incorporation in December 1999. However, since the start of the recession, growth has abated, and the downturn in the local economy and housing market has been especially noteworthy. Palm Coast's unemployment rate is still high at 15.4% as of January 2011 (the latest BLS data available).

The system provides services to a mostly residential customer base of 36,000 water, and 35,000 sewer accounts as of 2010. The service area encompasses the city and a portion of unincorporated Flagler County. Water is pumped from the Surficial and Floridan aquifers and treated at one of three city-owned treatment plants. The water treatment plants have a combined 12 million gallons per day (mgd) of treatment capacity, which is more than sufficient to meet the system's average daily demand in 2010 of 7.3 mgd. The consumptive use permit, issued by the St. Johns Water Management District, expires in 2015; however, the city is in the process of requesting an increase in the current allocation to 11 mgd, and believes the modified permit will soon be available. While the current water supply is expected to be sufficient to meet intermediate demand, the system is developing additional well sites for future supply, and is studying the potential for participation in a regional desalination facility.

The wastewater utility is a collection, treatment, and disposal system. The sole wastewater treatment plant (WWTP), with a current capacity of 6.8 mgd, treats the system's average daily flow of 5 mgd for 100% re-use for golf-course and other irrigation. The plant can be expanded to accommodate up to 9.1 mgd. Because the primary method of effluent disposal is for re-use and irrigation purposes, the city does not anticipate significant capital or other costs related to the pending mandates to lower nutrient levels for effluent discharged into local surface water bodies. The current WWTP permit expires in 2012. Management will begin preparing the renewal application within the next couple of months, and does not anticipate any delays and/or additional requirements for the extension of the permit. Construction of a second wastewater treatment facility is currently on hold until demand increases and the additional capacity is needed. The new plant, once completed, will increase capacity by another 2 mgd.

System financial performance has fluctuated. After the city raised rates in 2007 (for fiscal 2009) by 12.5%, operating revenues increased by 13.5% from the previous year. However, the system's financial profile has weakened since that time as growth in operating and debt service expenses have outpaced the growth in revenues in 2010. Annual debt service coverage for the bonds in fiscal 2008 was good at 1.75 times (x), and still satisfactory in fiscal 2009 at 1.56x including connection fees. When excluding such fees, coverage was roughly 1.4x in both years. When including subordinate lien loans, all-in debt service coverage was slim but acceptable at 1.2x and 1.1x in 2008 and 2009, respectively. For fiscal 2010, the city council approved annual CPI-adjusted rate increases, which Fitch views positively; however, rates actually declined slightly as a result of a decline in the CPI. For fiscal 2010, a rise in annual debt service (by roughly $1 million), a slight rise in O&M expense, and stagnant revenues led to much narrower debt service coverage of 1.3x on the senior bonds (including available connection fees), and just 1.05x on an all-in basis for the year. Significant improvement in the current financial profile may need to be accompanied by large rate increases. While the city has implemented a large rate increase in the recent past, it has yet to indicate it will adopt rate increases above the automatic CPI-adjusted levels over the next few years. In addition, while rates are currently affordable and generally competitive with those of neighboring systems, rate flexibility is tempered by the still sluggish local economic conditions, only average income and wealth levels, and a high number of retiree-aged residents.

Pro forma financial projections provided by the city show the system demonstrating better financial results than recorded in fiscal 2010. Revenue assumptions include inflation-adjusted rate increases (of 3% annually) through 2015 and additional customer growth of roughly 2% annually, which Fitch believes to be somewhat optimistic. The forecast also includes conservative assumptions for rising debt service costs and O&M expenses (projected at 6% annually); a rise in debt service beginning in 2013 related to additional borrowing for the construction of the second WWTP (and related mains and lines) appears unlikely to begin for at least several more years. With these assumptions, net revenues (impact fees are not included) are expected to improve senior debt service coverage to 1.6x by 2012, and to 1.9x through the rest of the forecast. Coverage on an all-in basis is expected to be a minimum of 1.2x which is considered satisfactory. At fiscal end 2010, the system had $5.8 million in unrestricted cash and investments, equivalent to 125 days of operations. After replacing the surety policies for the debt service reserve funds with cash in fiscal 2011 with a combination of cash and prior bond proceeds, liquidity is projected to be even lower by the end of the fiscal year.

The system's debt profile is above average, which is partially offset by a very low average age of plant. Debt per customer is over $2,200, which is roughly similar to the median level of $2,300 for systems rated in the 'A' category. Debt to net plant assets is also high at 100%. Debt amortization is average, which will leave these ratios elevated for some time. The average customer bill of $59 for combined service assuming 5,000 gallons of use is presently affordable at roughly 1.5% of median household income.

In addition to the sources of information identified in the 'U.S. Revenue-Supported Rating Criteria', dated 8 Oct. 2010, this action was additionally informed by information from the Bureau of Labor Statistics, IHS Global Insight, and LoanPerformance, Inc.

Source: Based on Fitch Press Release from Business Wire | March 30, 2011

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