OREANDA-NEWS. Fitch Ratings affirms the following Hialeah, FL (the city) revenue bonds issued through the Florida Municipal Loan Council (FMLC):

--\$47.6 million water and sewer revenue bonds, series 2011D at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds are limited obligations of the FMLC payable solely from loan repayments equal to debt service made by the city. Pursuant to the loan agreement, the city irrevocably pledges the net revenues of its water and sewer system (the system) in amounts sufficient to make principal and interest payments on the bonds. There is no debt service reserve fund securing the bonds.

KEY RATING DRIVERS

FINANCIAL STABILITY WITH RATE INCREASES: Though preliminary and unaudited fiscal 2014 financial results show strong debt service coverage (DSC) and ample liquidity, pro forma results through fiscal 2019 indicate additional rate increases are necessary to maintain financial stability.

RATE-SETTING FLEXIBILITY LIMITED: As average customer charges approach Fitch's affordability threshold, Fitch grows concerned that rate increases necessary to achieve revenue sufficiency may become more difficult to enact.

LOW DEBT: The system's total leverage equates to a modest 32% of net plant and just \$472 per customer. No indication of future borrowings suggests that the debt burden should remain low.

ADEQUATE CAPITAL PROGRAM: The system's cash-funded capital improvement plan (CIP) appears manageable following the construction of the system's large reverse osmosis (RO) plant shared with Miami-Dade County (water and sewer system revenue bonds rated 'A+', Stable Outlook by Fitch).

NARROW, RECOVERING LOCAL ECONOMY: The local economy is somewhat limited, centering on retail, services and light manufacturing, and is showing signs of continued recovery. The unemployment rate has gradually improved with employment gains, although income levels are still well below average.

RATING SENSITIVITIES

MANAGING INCREASING OPERATIONAL COSTS: Current projections predict a decline in financial performance due to rising operational costs. These costs are attributable to RO plant operations, steadily increasing wholesale rates and payments in lieu of franchise fees (PILOFFs). Fitch expects that the city will set rates sufficient to meet these rising costs and maintain adequate financial results; however, a failure to do so could result in downward rating pressure.

CREDIT PROFILE

The city's revenue bonds are issued through FMLC, which is a public body created under the laws of the state of Florida. FMLC finances projects on a cost effective basis and benefit municipalities through economies of scale. Its board of directors consists of seven elected officials appointed by the president of the Florida League of Cities, which is the program's administrator. The FMLC will stay in existence as long as any obligations of the issuer or of any other participating entities issued under the program remain outstanding.

MOSTLY BUILT-OUT SERVICE AREA

The city operates a water distribution and sewer collection system, providing service to approximately 234,000 residents through 54,500 mostly residential accounts. The city is located in Miami-Dade County and covers approximately 23 square miles. The local economy is heavily dependent on the service industry. However, the city's proximity to the Miami-Fort Lauderdale-West Palm Beach Metropolitan Statistical Area provides additional economic opportunity and diversity. Though the unemployment rate has shown improvement, declining to 7.6% in December 2014 from 11.8% two years prior, roughly 20% of the city lives at or below the poverty line. In addition, income levels equate to only 64% of the state and 56% of the nation.

While the city is mostly developed, an additional three square miles of undeveloped land in the northwest corner of Miami-Dade County was annexed by the city in 2005 to enable future growth opportunities. The area can accommodate an additional 6,000 new customers, but to date only modest residential development is underway. The county is also considering the construction of possibly the nation's largest indoor mall, called 'Dream America,' in the annexed area, which is expected to create between 75,000 to 200,000 new jobs. If implemented, this plan will likely be finalized in the coming year.

NEW FACILITY EXPANDS SUPPLY

The city is a wholesale customer of the Miami-Dade Water and Sewer Department (MDWASD) for potable water and wastewater treatment services. As a condition for the development of the aforementioned annexed land, the county and water regulator, South Florida Water Management District (SFWMD) required that Hialeah secure potable water for future customers from an alternative water supply instead of increasing its wholesale contract allocation. The city and county agreed to co-finance the construction of an RO plant that converts raw brackish water from the Floridan Aquifer into potable water. When operational in summer of 2015, the RO plant will be able to produce an additional 10 million gallons a day (mgd) of potable water, half of which will be available to the city to serve both existing customers and future expanding needs. The city's wholesale water purchases will be offset in part by this additional supply.

The RO plant is regulated by the SFWMD under the county's existing 20-year consumptive use permit and was constructed through a design, build, and operate (DBO) agreement with GF INIMA USA and AECOM. This third-party DBO agreement is for 15 years and somewhat offsets operational risk. According to pro forma financial projections compiled by a rate consultant, annual RO plant operating costs will increase system expenses by an additional average of \$5.2 million--or roughly 9% of unaudited fiscal 2014 operating revenues. These additional costs will be offset somewhat by the decline in wholesale water costs.

SOLID FINANCIAL MARGINS EXPECTED TO DECLINE

Unaudited fiscal 2014 results continued a strong historic trend of DSC with 5.1x coverage of the senior lien debt and 4.8x coverage when including state revolving fund loan payments. The series 2011D bonds represent 97% of the system's outstanding debt. Debt amortization is slow with only 21% and 56% of principal retiring in 10 and 20 years, respectively. Annual debt service payments have been interest-only to date but are gradually ramping up and will level off in fiscal 2017 at about \$3.5 million annually. Based on pro forma results provided by a rate consultant, senior lien and all-in DSC are expected to decline to a minimum 1.35x and 1.28x, respectively, in fiscal 2015. Subsequent coverage levels improve slightly assuming the successful implementation of an estimated 8% rate increase in fiscal 2016 and inflationary adjustments through the forecast period.

The pro forma DSC level declines are also attributable to increased operating costs. The rate consultant forecasts standard 3% annual wholesale cost adjustments, the initiation of DBO operational costs, and the inclusion of PILOFFs that are subordinate to debt service but were included in the forecast operating costs. The PILOFF is expected to eventually equate to 10% of the system's operating revenues, which Fitch considers high. Projected DSC declines are significant relative to prior years but are still in line with the rating category. The pro forma does not include the potential for MDWASD to pass down additional rate increases to meet its regulatory-driven capital projects.

Positively, unrestricted cash and investments at the end of unaudited fiscal 2014 totaled \$54 million and equated to a strong 441 days' cash on hand. Cash is expected to remain solid through the forecast period.

RATE-RAISING FLEXIBILITY NARROWING

Rates consist of a base readiness-to-serve charge and tiered, inclining block volumetric charges. Assuming consumption at the rate of the national average of 7,500 gallons consumed per month (gpm), the typical residential bill for combined service exceeds Fitch's affordability threshold of 2% of median household income (MHI). Fitch notes that the actual customer consumes closer to 4,500 gpm and at this rate charges are approaching the 2% benchmark. The city generally imposes automatic inflation-based rate adjustments, as well as passes on wholesale rate increases from MDWASD directly to its retail customers, which Fitch views favorably.

However, pass-through costs from MDWASD are expected to increase significantly in the next few years as the county implements a large regulatory-driven capital program. Given the currently elevated rates and the city's below-average wealth and income levels, expected future rate increases may cause affordability concerns to rise.

MANAGEABLE CAPITAL PROGRAM AND LOW DEBT

As construction of the RO plant nears final completion, the majority of the \$31.9 million fiscal 2015-2019 CIP will address renewal and replacement projects such as water main, sewer line and pump station rehabilitation. System expansion costs related to the annexed area are expected to be largely borne by private developers through impact fees. About 43% of the CIP is frontloaded in fiscal 2015 and much of this will support the close-out activity of the RO plant. These RO plant costs are supported by remaining bond proceeds however capital needs otherwise will be supported by free cash flow.

Debt levels are low and projected to remain manageable barring any additional issuances. Debt per customer was only \$472 in unaudited fiscal 2014, well below average for Fitch-rated water and sewer systems in the 'A' category (the 'A' median is \$2,218). Debt comprised a low 32% of the system's net plant that same year, which will likely stay at this level for some time given the slow principal amortization schedule.