Fitch Ratings takes the following rating action on Cape Coral, FL's (the city) revenue bonds as part of its continuous surveillance effort:
--Approximately $202 million water and sewer revenue bonds, affirmed at 'A+';
--$82.2 million water and sewer revenue bond anticipation notes (BANs), series 2009 affirmed at 'F1';
--Approximately $180.1 million in wastewater and irrigation water refunding assessment bonds and utility improvement assessment bonds, series 2005 (Southwest 2), 2006 (Southeast 1), 2007 (Southwest 4), and 2007 (Southwest 5 and Surfside), affirmed at 'BBB+'.
The Rating Outlook remains Negative on the outstanding water and sewer revenue bonds.
The Rating Outlook on all utility improvement assessment bonds is revised to Stable from Negative.
RATING RATIONALE:
Water and Sewer Revenue Bonds:
--The 'A+' reflects primarily the utility system's high water and sewer rates, significant system leveraging and diminished operating flexibility.
--Despite improved operating results in fiscal 2009, the system's cash position remains below average.
--The system's fragile service area continues to experience high foreclosure and unemployment rates as well as declining income levels.
--Water supply is ample, and overall treatment capacity is in excess of current system demand.
--Maintenance of the Negative Outlook reflects Fitch's concern regarding the ability and willingness of the city's elected officials to move forward with the implementation of a series of steep annual increases in water and sewer rates (through 2014) adopted in 2009.
BANs:
--The 'F1' short-term rating to the BANs incorporates the size of the issuance, which accounts for a notable 15% of total utility debt currently outstanding, as well as the potential for refinancing risk, particularly for lower rated issuers. Additional concern stems from the utility system's lack of sufficient liquidity to guard against the potential risk to refinance or extend the BANs.
Special Assessment Bonds:
--The 'BBB+' rating on the utility improvement assessment bonds reflects narrow coverage by special assessments levied on residential and commercial properties that benefited from expansion projects. A backup covenant to pay debt service from net revenues of the utility system in the event that assessments are insufficient adds to bondholder protection and has not been called upon to date.
--Despite a stressed housing market with a high rate of residential home foreclosures, tax collections have been sufficient.
--Special assessments are included as a line item on the property tax bill, and nonpayment results in a property lien on parity with those related to ad valorem tax delinquencies.
--The Outlook revision to Stable from Negative on the utility improvement assessment bonds reflects the improved, though still constrained, financial position of the city's utility system as well as consideration for the subordinate lien on utility system net revenues after payment of senior lien and state revolving loans.
KEY RATING DRIVERS:
--Although user charges are already high, the implementation of future rate increases sufficient to maintain solid debt service coverage margins and continued build-up of reserves remains critical to the system's long-term credit profile.
--Continued collection of special assessments sufficient to meet debt service, despite the city's stressed housing market, is essential.
SECURITY:
The city's revenue bonds and BANs are secured by a senior lien on net revenues of the city's water and sewer system. The utility improvement special assessment bonds are secured by assessments levied on residential and commercial properties that benefit from utility expansion projects as well as a subordinate lien (after payment of water and sewer revenue bonds and state revolving loans) on net water and sewer system revenues.
CREDIT SUMMARY:
The city's water and sewer system serves approximately 60,000 accounts located entirely within city limits. Water supply is drawn from the Lower Hawthorne Aquifer and is sufficient for the foreseeable future, and recent expansion projects at the system's treatment facilities will ensure adequate capacity. Following a sustained period of rapid customer growth that averaged about 8% annually over the last 10 years, the pace of new customers connecting to the system dropped off substantially over the last two years. A significant amount of debt was issued over the past five years to support both realized and future increases in customers, although the dramatic slowing in growth in recent years has left revenue growth insufficient to comfortably meet a rapidly rising debt burden. As a result, annual debt service coverage margins declined and substantial rate increases were adopted. In addition, weak operating results in fiscal years 2007 and 2008 and the use of reserves for capital projects in anticipation of future borrowing significantly reduced the system's liquidity position.
To improve operating margins, increase debt service coverage and restore the system's cash position, a series of large annual rate increases totaling 79% over five years were adopted in 2009 by the city council, beginning with a 30% rate increase that took effect in fiscal 2010. While the system realized favorable operating results in fiscal 2009 that somewhat restored liquidity and increased debt service coverage on all outstanding obligations to a strong 2.3 times (x), including impact fees which are legally pledged. Similar results going forward will necessitate implementation of the already adopted rate hikes.
With the current average monthly residential bill equal to 2.3% of the city's median household income, user charges exceed what Fitch considers to be affordable. Nonetheless, Fitch remains concerned regarding the utility's potential deviation from the series of adopted rate hikes and management's stated consideration of alternative plans to offer rate relief to customers while maintaining debt service coverage margins and funding capital needs going forward. Favorably, the reduced pace of customer growth has resulted in a smaller, more manageable multi-year capital improvement plan (CIP) of about $115 million through 2014 compared to the prior $564 million 2006-2010 CIP. Fitch believes the system is highly leveraged, as the amount of currently outstanding debt is equal to slightly more than $3,500 per customer and equals 65% of system assets.
Applicable Criteria available on Fitch's web site at 'www.fitchratings.com':
--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 6, 2008.
Additional information is available at www.fitchratings.com.
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Fitch Ratings, New York
Christopher Hessenthaler, 212-908-0773
Michael
Rinaldi, 212-908-0833
or
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Cindy Stoller,
212-908-0526
Email: cindy.stoller@fitchratings.com