Fitch Rates Orlando, FL's State Sales Tax Payments Bonds 'AA+'; Outlook Stable
--$26.6 million state sales tax payments refunding and improvement revenue bonds, series 2016.
The bonds are scheduled for sale on a negotiated basis on August 24. Proceeds will be used to refund remaining series 2008 sales tax payments bonds for upfront savings which will be used to fund capital improvements to the city's Amway Center.
In addition, Fitch has affirmed the ratings on the following city obligations:
--$26.6 million state sales tax revenue bonds, series 2008 at 'AA+';
--$184.8 million capital improvement revenue bonds at 'AA+';
--$236.3 million contract tourist development tax (TDT) payments revenue bonds, series 2014A (contract TDT bonds) at 'AA+';
--$170.5 million senior lien TDT revenue bonds (sixth-cent contract payments) series 2008A at 'BBB';
--$31.8 million second lien subordinate TDT revenue bonds (sixth-cent contract payments) series 2008B at 'BBB-';
--the city's Issuer Default Rating (IDR) at 'AAA'.
The Rating Outlook is Stable except for the Rating Outlook on the series 2008B TDT bonds, which is revised to Positive from Stable based on Fitch's assessment that increasing revenues in the outlook period will trigger an elevation of the bonds to on parity with the series 2008A debt.
The state sales tax payments bonds are payable from an annual $2 million statutory distribution to the city of sales taxes from the state's 6% sales tax for the purpose of maintaining a professional sports franchise.
The capital improvement bonds are backed by the city's covenant to budget and appropriate (CB&A) non-ad valorem (NAV) revenues sufficient to pay debt service. The NAV covenant will be cumulative to the extent not paid and will continue until such NAV revenues or other legally available funds are sufficient to make all such required payments under the bond resolution.
The contract TDT bonds are initially secured by a specified portion of the first four cents of Orange County TDT collections but are ultimately backed by, and rated based on, the city's CB&A sufficient NAV revenue to cure any deficiency in contract TDT revenues or dedicated reserves. .
The 2008A and 2008B TDT revenue bonds are limited obligations of the city secured by the discrete trust estate, including pledged funds, for each respective series of bonds. The majority of pledged funds consist of 50% of a one-cent tax levied county-wide on hotel stays. The hotel tax is collected by the county and remitted to the city according to an interlocal agreement. Pledged revenues also include a fixed installment payment payable from the remaining half of the one-cent tax, equal to $2.8 million per year available through 2018. Pledged funds are allocated to each trust estate of three series of bonds (Fitch does not rate the series 2008C bonds) according to a flow of funds with revenues distributed to each trust estate according to the seniority of the series. Additional security is provided by a dedicated liquidity reserve and debt service reserve fund for each series, with each established at 50% of respective maximum annual debt service (MADS) for a total combined reserve for each series of 100% of MADS.
KEY RATING DRIVERS
The 'AAA' IDR is supported by very strong economic and revenue prospects and solid expenditure flexibility which enables management to maintain the city's superior financial position through the economic cycle. The city's long-term liability burden is moderate, consisting mostly of debt, and a significant portion of the debt is composed of bonds secured by the TDT, which is mostly paid by non-residents.
SALES TAX BONDS LINKED TO STATE: The state sales tax payments bonds are rated at the lower of one notch below the state IDR (as pledged revenues come from the state but are not a GO of the state) and the city's IDR rating. The state of Florida's IDR is 'AAA' with a Stable Outlook, so one notch below the state IDR is currently the lower rating. (For more information on the state, see 'Fitch Rates Florida's $198MM GO Bonds 'AAA'; Outlook Stable', dated July 21, 2016.)
CB&A PLEDGE RATED ONE NOTCH BELOW CITY IDR: The ratings on the capital improvement (NAV) and contract TDT bonds are one notch below the city's IDR based on the city's CB&A pledge.
TDT BONDS RATED ON COVERAGE: The rating on the series 2008A TDT senior bonds reflects strong and consistent TDT growth and improved coverage, as well as the probability that the series 2008B TDT junior lien bonds will ascend to parity with the senior bonds over the next few years at a relatively modest coverage of 1.33x MADS. The Positive Outlook on the series 2008B bonds, currently rated one notch below the series 2008A bonds, also reflects this likelihood, which is driven by the expectation for continued growth. The TDT remains an economically sensitive and volatile revenue.
Economic Resource Base
The city encompasses approximately 110 square miles located within the approximate center of Florida. Situated next to Disney World and incorporating Universal Theme Park and numerous other attractions, the city is one of the top tourist destinations in the world. While tourism predominates, other developing areas include the tech sector, healthcare and advanced manufacturing. A small but growing bioscience industry provides further diversification.
Revenue Framework: 'aaa' factor assessment
General fund revenue growth increased rapidly over the past 10 fiscal years at a pace above the rate of U. S. GDP growth and inflation. With rapid increases in population, revenues are projected to continue this brisk expansion going forward. Furthermore, the city retains considerable discretionary ability to generate additional revenues.
Expenditure Framework: 'aa' factor assessment
Expenditures are expected to rise rapidly as population growth drives increased service needs. However, Fitch expects spending growth to be accommodated within the city's quickly expanding revenue base. Management spending flexibility is solid despite comparatively high fixed carrying costs and management retains considerable resilience in its relations with employee labor organizations.
Long-Term Liability Burden: 'aa' factor assessment
The city's long-term liability burden, consisting of debt and a modest net pension liability, is moderate at 19% of personal income. Debt constitutes over 80% of the burden with about 45% of direct debt consisting of bonds payable from the TDT. Fitch notes that TDT debt is mostly paid by non-residents, a resource base not directly captured in the personal income-based statistic; as such, this metric somewhat overstates the burden of debt. Moreover, given the city's limited issuance plans and slow amortization of direct debt, the level of long-term liabilities is not expected to change significantly over the medium term and is expected to benefit from ongoing economic growth.
Operating Performance: 'aaa' factor assessment
Management is expected to utilize its significant revenue and spending flexibility to maintain reserves at a level that provides exceptional financial resilience. This was demonstrated in fiscal 2015 when city officials raised its millage rate and implemented spending cuts to balance operations after two fiscal years of planned deficits.
DETERIORATION OF FINANCIAL RESERVES: Significant operating deficits reducing general fund balance below the level that Fitch considers consistent with a 'aaa' financial resilience assessment would be a negative rating consideration.
TDT BONDS: Upward revision of the rating on the series 2008B bonds is likely over the next few years as coverage levels reach a threshold where the bonds ascend to senior lien with the series 2008A bonds. A reversal of recent positive trends could lead to coverage at levels inconsistent with even the current low ratings.
The local economy continues to expand and diversify with employment levels experiencing steady growth since 2011. TAV experienced robust gains of 7.5% in fiscal 2015 and 14.2% in fiscal 2016. The fiscal 2016 tax base growth represented the third consecutive increase after four years of decline. Median May 2016 home values are up 11% over the prior year according to the Zillow Group, signaling future tax base growth.
The leisure and hospitality sector continues to be a major component of the local economy, making up about 21% of total area employment. Disney is the dominant player, employing about 74,000 or over 10% of the Orange County workforce. Universal Orlando reports 19,000 employees while SeaWorld of Orlando's employment has approximately 6,000. Both Disney and Universal are making substantial investments in their parks including new Star Wars themed attractions at Disney and a new hotel and water park at Universal. Beside growing theme park attendance and TDT collections, expanding occupancy and hotel room rates are indicative of the strong recovery within this sector.
Economic diversification has occurred, most notably within the education and health services sectors. A growing biotechnology and life sciences cluster is centered in Lake Nona Medical City, a master-planned mixed community within Orlando. Significant additional residential and commercial development throughout the city points towards ongoing near-term growth.
The city's revenue base is relatively diverse, funded with a combination of property taxes, sales-based taxes, service charges and utility fund contributions. Property taxes are the largest revenue source but compose only about 35% of general fund revenues. Other major revenue sources are charges for various city services and contributions from the Orlando Utilities Commission (OUC; revenue bonds rated 'AA'/Stable Outlook). OUC operates the city's electric and water utility. The contributions consist of a dividend payment, a franchise equivalent fee and OUC's share of utility tax collections. In fiscal 2015, these payments totaled $110 million or 28% of total revenues. Half-cent sales taxes distributions from the state and transfers from the utilities service tax fund are additional revenue sources.
General fund revenue growth over the past 10 years exceeded both inflation and GDP. The general fund's historic revenue performance reflects the implementation of tax reform by the state beginning in fiscal 2008 offset by increases in revenue due to periodic fund consolidations. Population growth exceeds both the state and national rates, which Fitch believes will spur ongoing growth in revenues above GDP and inflation.
Despite a one-mill property tax increase in fiscal 2015 after six years of stable tax rates, the city still has a very strong legal ability to generate additional revenues, as the current property tax rate of 6.65 mills is well below the statutory 10-mill cap. Fitch estimates that the city could generate approximately $64 million in additional revenues if it chose to utilize the remaining property tax margin or about 16% of the fiscal 2016 general fund budget.
State sales tax payments consist of distributions from the Florida Department of Revenue to eligible state and local governments to assist in the payment for professional sports franchise facilities. The city receives set monthly payments that aggregate to $2 million annually. Distributions are derived from proceeds of the 6% state sales tax, and the order of distributions is determined by state statute. The distribution to the city commenced in February 2008 and continues for 30 years through January 2038, coinciding with final maturity of the state sales tax payments bonds.
The current position of sports franchise distributions in the flow of funds from state sales taxes leaves substantial sales tax revenues available to cover all of the state's sports franchise obligations. The rating on the state sales tax payments bonds incorporates the remote risk that the state could alter the statute to adversely affect sport franchise distributions.
State sales tax payments provide sum sufficient debt service coverage of the bonds. This level of coverage is typical of debt secured by this revenue source, and the sum sufficient coverage prevents any further leveraging of the security.
The city provides a full array of services including police and fire protection, parks and recreation, public works, economic development, etc. Public safety represents the largest spending item accounting for $236 million or 62% of general fund expenditures. Public safety costs were relatively stable between fiscals 2009 through 2011 but have increased at a compound annual growth rate of 5.5% since.
Sustained population growth will generate ongoing spending pressures; however, Fitch expects these costs to be accommodated within the city's projected rapid revenue growth.
Management's ability to cut spending is solid despite somewhat elevated carrying costs of debt service, pensions and OPEB contributions. The city did implement spending reductions in fiscals 2009 and 2010 through position reductions, consolidations and wage freezes. Since then, spending growth has been steady but limited.
Carrying costs equal 22% of spending with the bulk of the costs divided between debt service and pension contributions. These costs are not expected to vary much relative to spending for at least the foreseeable future. The city retains considerable flexibility with labor including over headcount and maximum three-year labor contracts, many with annual openers.
Long-Term Liability Burden
The city's long-term liability burden equals about 19% of personal income, 83% in the form of debt. Given limited debt plans and slow principal amortization, the long-term liability is not expected to change significantly over the medium term.
Nearly 45% of direct debt consists of bonds secured by TDTs (hotel taxes) mostly paid by non-residents. Capital needs are manageable and debt plans are limited. The city is considering issuing $45 million of TDT-secured bonds for transportation improvement within the next few years.
The city maintains three separate single-employer defined benefit pension plans (police officers, firefighters and general employees). The general employees defined benefit plan was replaced with a defined contribution plan for employees hired after 1998. The city consistently funds 100% of the actuarially required contribution each year. Funding ratios for the plans as of fiscal 2015 are 77%, 71% and 75% for the general employees, firefighters and police officers' plans, respectively, adjusted for a 7% discount rate.
Under a moderate downturn scenario, Fitch would expect city management to use its considerable revenue and expenditure flexibility to maintain available reserves at or above the minimum target level of 15% to 20% of general fund spending. This was amply demonstrated in fiscal 2015 when the city raised its property tax rate by one mill (or 17.7%) while implementing 4.5% across-the-board cost reductions in order to balance operations after two years of planned deficits.
Management is not expected to build up reserves substantially above current robust levels. Typical of past practice, Fitch expects the city to continue to adjust balances periodically to reflect spending priorities but have budgetary flexibility to maintain available reserves between its 15% minimum and 25% maximum target.
The TDT bonds are primarily payable from 50% of the proceeds of 1% of the 6% tax on hotel stays levied and collected by the county and deposited with the trustee on a monthly basis. A fixed additional sum equal to $2.8 million per year (installment payment) is also deposited with the trustee through fiscal 2018 after which it is no longer available to pay debt service.
Pledged funds are allocated to each trust estate of three series of bonds (Fitch does not rate the series 2008C bonds) according to a flow of funds with revenues distributed to each trust estate according to the seniority of the series. Additional security is provided by a dedicated liquidity reserve and debt service reserve fund for each series, with each established at 50% of respective MADS for a total combined reserve for each series of 100% of MADS. The indenture prohibits additional debt except for refunding purposes. However, legal provisions do provide for the series B bonds to ascend to parity with the senior series 2008A bonds when TDT revenues less the installment payments cover MADS on the combined series 2008A and series 2008B bonds by at least 1.33x. Similarly, series 2008C bonds can ascend to parity with the series 2008B bonds when TDT revenues less installment payments reach 1.10x coverage of MADS on all three liens.
The historical volatility of the revenue stream underscores the economically sensitive nature of the TDT and its dependence on the local tourist sector. Historical TDT revenues experienced robust growth, increasing at an average annual rate of 12.7% from 1979 to 2000. During the past decade, however, the TDT suffered several declines, falling 12.6% in fiscal 2002 and, subsequent to a robust recovery, 15.4% in fiscal 2009. Beginning in fiscal 2010 TDT revenues have rapidly expanded and are now well above their pre-recession peak.
The large drop in TDT revenues in fiscal 2009 pressured debt service coverage on all three series of bonds resulting in across-the-board draws on the liquidity reserve funds and a draw in the debt service reserve fund for the series 2008C bonds (the respective debt service reserve funds for the series 2008A and series 2008B bonds have never been tapped). The draws on the series 2008A and 2008B liquidity reserve funds have subsequently been replenished and TDT revenues fully cover their respective debt service requirements. TDT revenues have reached a level where they are sufficient to partly replenish the series 2008C debt service reserve fund.
To evaluate the sensitivity of the TDT revenue stream to cyclical decline Fitch considers both the revenue sensitivity results (using the same 1% decline in national GDP scenario that supports assessments in the IDR framework) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. Based on the 15-year trend of TDT revenues, Fitch's analytical sensitivity tool (FAST) generates a 7% TDT revenue scenario decline. The largest actual cumulative decline in historical revenues was the 15.4% drop in fiscal 2009.
At current debt service coverage for the series 2008A bonds of 1.5x (excluding the installment payments, which drop off after fiscal 2018) TDT revenues would have to decline by 33% to reach 1.0x MADS coverage, a coverage cushion that is somewhat high for the current rating level. Although additional bonds outside of refundings are not permitted, the provisions which require ascension of subordinate debt to parity with more senior bonds at threshold coverage levels potentially dilute coverage. At the 1.33x coverage threshold at which point the series 2008B bonds ascend to parity with the 2008A bonds, the structure could tolerate a 25% drop in revenues or 3.5x the scenario results and 1.6x the largest TDT decline. Fitch considers this cushion more consistent with a 'bbb' level of coverage cushion.
Fiscal 2015 TDT revenues cover combined series 2008A and series 2008B MADS by 1.2x. At the historical average growth rate of 3.2% annually, Fitch estimates that the 1.33x MADS threshold coverage for ascension of the series 2008B bonds to parity with the series 2008A bonds would be achieved by fiscal 2018. Fitch believes that this is likely.
Fitch does not expect ascension of the series 2008C bonds to parity with the other debt in the foreseeable future as TDT revenues less installment payments are currently insufficient to cover interest-only series 2008C debt service, let alone targeted principal obligations associated with the series 2008C bonds which are also included under MADS. Once the series 2008B bonds ascend to senior status, ascension of the series 2008C bonds requires 1.33x coverage of MADS.
Issuing Entity Exposure
Section 902(2)(B) of the Bankruptcy Code defines as a special revenue special excise taxes on particular activities (such as liquor and hotel taxes); Fitch does not believe specific legal advice is generally required to evaluate the application of these provisions and rate the special revenue debt distinct from and potentially higher than the IDR of the related municipality. This is not relevant in this case, given the very high city IDR and low rating on the TDT security.