Fitch Ratings affirms the ratings on West Palm Beach, FL’s (the city) approximately $115 million in outstanding utility system revenue bonds at ‘AA-‘.
The Rating Outlook has been revised to Positive from Stable.
The bonds are payable from the net operating revenues of the city’s water, sewer and storm water utility systems (the system), including available impact fees.
KEY RATING DRIVERS
STRONG FINANCES DRIVE POSITIVE OUTLOOK: The system’s consistently strong financial performance and metrics drive the Outlook revision. Rate increases implemented to meet increased capital funding requirements beginning in 2008 have systematically improved debt service coverage (DSC), free cash flow (FCF) and liquidity since 2009.
LARGE CAPITAL PROGRAM EASING: The city has reached a favorable point in its capital cycle. Overall costs are lower as the city is nearly finished with mandated water treatment upgrades and future needs are geared toward routine renewal and replacement (R&R).
MANAGEABLE DEBT BURDEN: Debt is somewhat mixed with most metrics approximating the medians for ‘AA’ category. The stronger financial margins have allowed the system to fund recent capital needs with pay-as-you-go resources, forgoing the need for additional debt over the past few years and allowing the debt profile to remain manageable over time.
ELEVATED RATES: Residential rates are high but provide the city with the ability to cash-fund the majority of its future capital needs from existing charges. The city provided some rate relief in fiscal 2015 (and may again in fiscal 2016) by foregoing previously approved small automatic rate increases. Financial metrics are still expected to remain strong.
WELL-MANAGED SYSTEM: The city has sufficient long-term water supply and treatment capacity. Rates have been increased and regulatory-driven capital needs are nearly complete.
STABLE LOCAL ECONOMY: The city’s local economy is experiencing a solid recovery evidenced by rising employment, an improved housing market and significant development activity. The customer base is stable and mostly residential.
FINANCES, CAPITAL FUNDING AND DEBT: A continued trend of strong financial results and limited capital pressures could lead to a rating upgrade over the near-term. Greater clarity with regards to the city’s capital and financial expectations as well as wholesale cost expectations would be viewed favorably.
West Palm Beach (general obligation [GO] bonds rated ‘AA+’ by Fitch) is located along the Intracoastal Waterway along Florida’s Atlantic coast in Palm Beach County (GO rated ‘AAA’).
STABLE, MOSTLY RESIDENTIAL CUSTOMER BASE
The system covers roughly 60 square miles and serves an estimated population of about approximately 232,000. The system provides potable water, wastewater and storm water service to its mostly residential customer base of 32,000 water and roughly 28,000 sewer and storm water accounts. In addition to its own customers, retail water service is also provided via long-term franchise agreement to nearby towns of Palm Beach and South Palm Beach. The stable and diverse customer base also includes over 2,100 multi-family connections.
SUFFICIENT WATER SUPPLY AND TREATMENT CAPACITY
Water supply is sufficient to meet projected long term demand and consists of surface water from a large water catchment area and a series of wetlands in the western portion of the city. In addition the city can access various groundwater well fields from the Floridan Aquifer during low rainfall periods. Raw water withdrawal is regulated by the South Florida Water Management District through a water use permit that allows the city to draw up to an average annual 39 million gallons per day (mgd). The system currently uses about 75% of its permitted withdrawal and, like many utility systems throughout the southeast, is implementing more efficient water use through inclining block rate structures and developing re-use capabilities. The water use permit is valid through October 2026.
The city operates one water treatment plant (WTP) with a maximum daily treatment capacity of 47 mgd. The average daily water demand in 2014 of approximately 27 mgd is comfortably below both water rights and treatment capabilities.
Sewer flows are treated at the East Central Regional Water Reclamation Facility (ECR), which is a shared facility between the city, Palm Beach County, the town of Palm Beach, and the cities of Lake Worth and Riviera Beach. The city operates the facility on behalf of a separate governing board and costs are allocated to member agencies based on flows. The city’s capacity allocation in the plant is 20.5 mgd, which is almost twice the city’s average daily flow and about 30% of the ECR’s total flows. Customer growth is expected to be limited as the service area is reaching build-out.
STRONG FINANCES, LIMITED CAPITAL NEEDS
Financial operations are very strong with high margins and DSC, very strong liquidity and significant FCF. In fiscal 2013, DSC was a very robust 3.7x, improving steadily from fiscal 2008 due to the implementation of a fairly significant multi-year rate plan. Including the annual payments-in-lieu-of taxes (PILOTs) to the city’s general fund, coverage of all fixed obligations was 3.0x in fiscal 2013.
Financial results were even better in fiscal 2014, although results are not yet audited. The very high FCF (over 200% in each of the past three years) is especially noteworthy as it demonstrates the system’s ability to meet all of its fixed obligations, including PILOTs, and pay for routine system R&R from existing rates. In fact, the city was able to pay for the majority of its capital needs over the past several years with accumulated reserves, foregoing the need to issue additional debt as previously anticipated.
Pro forma results were not provided. However, Fitch expects results will remain strong despite expectations for no rate increases in fiscals 2015 and 2016 as well as anticipated increases in operations and maintenance (O&M) costs associated with debt issued by the ECR beginning in fiscal 2016. The increased costs attributable to the system total approximately $2 million, for a total payment of about $7 million annually for regular operating costs and debt service on its proportion of ECR debt. These costs are already included in the city’s rates.
Liquidity is also healthy. Unrestricted cash increased nearly 5.0x from fiscal 2009 to 2013, reaching a very strong 549 days cash on hand (DCOH), and 482 days when adjusted for a potential swap termination payment. When including R&R fund balances, DCOH was over 600 in 2013. Liquidity is even higher in fiscal 2014.
Liquidity is expected to decline due to the expected use of approximately $30 million in R&R reserves to fund the remaining WTP upgrades. Even with the expected use of reserves for capital projects over the next several years, Fitch projects cash will be strong as the system continues to generate free cash above $30 million annually.
RATES ARE HIGH, FUTURE INCREASES TO BE LIMITED
Rates are somewhat high as the system fully implemented a five-year rate resolution passed in 2008. Residential rates for combined water and sewer service are approximately $86 each month for 7,500 gallons of use in fiscal 2014, which is above average compared to other regional utilities and equates to 2.3% of median household income (MHI).
The rate resolution also included automatic rate adjusters beginning in year six. The city decided to postpone the first automatic adjustment in fiscal 2014 by a few months and eliminate it entirely in fiscal 2015 to provide rate relief. The city may take a similar stance on rates in fiscal 2016 given the strength of the system’s financial position. Future rate adjustments are expected to be manageable and tied to an inflation index. A separate monthly storm water fee of approximately $10 is also levied for each equivalent residential unit.
CAPITAL NEEDS EASE AFTER LARGE CAPITAL PROGRAM NEARS COMPLETION
The city spent $180 million on system capital improvements from fiscals 2007 – 2014, equating to average annual capital expenditures of $22 million or 2.0x the annual depreciation over that time. The system’s most significant projects in recent years were mandated by a consent order with the Palm Beach County Health Department to improve potable water quality issues and included substantial upgrades to the city’s WTP. While previous capital forecasts assumed an additional $150 million in bonds to fund the capital plan, the city instead funded all of its capital requirements entirely from internal sources.
The city expects to spend an additional $31 million (cash already set-aside) to finish the WTP projects over the next two years. Going forward, the city anticipates it will focus on system upkeep and R&R with approximately $11 million generated from annual FCF. In addition, management is undergoing a needs assessment for storm projects that could result in an additional $20 million in capital costs for the storm system, which could be debt-financed. No additional debt is expected at this time.
MANAGEABLE DEBT BURDEN
Debt metrics point to a manageable debt position, but are somewhat mixed. With $229 million in total debt outstanding as of fiscal 2014, debt was 51% of net plant and about $2,600 per customer. The per customer debt ratio is slightly higher than the ‘AA’ category median ($1,934) but debt to plant is right at the median ratio.
Debt carrying costs are a very manageable 12% of gross revenues (ECR debt is an O&M expense), and annual debt service is level at approximately $15 million annually. However, amortization of existing debt is slow (68% retired in 20 years) and the system maintains a high proportion of its debt (40%) in variable rate mode. The variable rate bonds (series 2008C) are covered by a fixed payor swap, with the most recent mark-to-market valuation of the swap being a negative $18 million. The bonds are also covered by a recently renewed liquidity facility from J.P. Morgan Chase. The proportionally high amount of variable rate debt is somewhat offset by high counterparty ratings, no provision for collateral posting by the city and limited termination triggers.
STEADY ECONOMIC RECOVERY, MIXED WEALTH LEVELS
The city incorporates a population of about 100,000 which increased at solid average annual rate of 1.8% over the past decade. Leading employers include the Palm Beach County School Board, the county and state government and several large healthcare providers. Top county-wide economic drivers include expanding healthcare and education sectors supplemented by tourism and other service industries.
City employment has shown consistent strong growth since 2010 with annual gains ranging from 2.4% to 3.7%. As a result, employment levels are approaching their pre-recession high while unemployment rates have plummeted 50% since 2010. January 2015 jobs were up a strong 8.5% year over year, nudging the unemployment rate down to 4.7%, below the state and national averages.
City wealth indices are mixed despite its location within affluent Palm Beach County. Per capita income levels exceed those of the state and nation while median household income sits well below both benchmarks. The large number of retirees residing within the city may partially explain this discrepancy. The city’s poverty rate of 19.4% is 26% over the national average.
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 and Related Research:
–‘Revenue-Supported Rating Criteria’ (July 2014);
–‘U.S. Water and Sewer Revenue Bond Rating Criteria’ (July 2013);
–‘2015 Water and Sewer Medians’ (December 2014);
–‘2015 Outlook: Water and Sewer Sector’ (December 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria