TEXT-Fitch affirms Tallahassee, Florida revs
Oct 17 - Fitch Ratings affirms the 'AA-' rating on the following bonds of Tallahassee, FL (the city): --Approximately $619.6 million energy system revenue bonds. The Rating Outlook is Stable. SECURITY The bonds are secured by net revenues of the city's combined electric and gas system. KEY RATING DRIVERS STABLE SERVICE TERRITORY: The city's utility system provides retail electric and gas service to a diverse and important service area that serves as the state capital. Wealth levels are below average, but unemployment continues to trend downward and remains below state and national averages. WEAKENED FINANCIAL PERFORMANCE: Operating results on a combined basis deteriorated in fiscal 2011 but remain acceptable for the rating. Higher debt service obligations prompted a decline in Fitch-calculated debt service coverage, adjusted to reflect subordinate obligations, to 1.7x, compared to a historical average of 2.4x over the prior five years and the rating category median of 2.5x. However, liquidity remained strong with nearly 230 days cash on hand and Fitch expects financial metrics to improve in fiscal 2013 and beyond. LACK OF FUEL DIVERSITY: The city's heavy dependence on natural gas exposes the system to price volatility, although projections of low natural gas prices mitigate this risk for the time being. Owned and purchased power resources provide the city with a reliable power supply sufficient to meet future needs. GOOD COST RECOVERY: Fuel and purchased power costs for the electric and gas systems are typically passed through to customers on a timely basis. In addition, the city's full rate-setting authority and competitive rates provide sufficient flexibility. LEVERAGED SYSTEM: Debt levels are high but should improve going forward, as the system continues to fund its capital needs from excess cash flow and existing reserves. Debt/funds available for debt service (FADS) and equity/capitalization weakened in fiscal 2011 to 7.9x and 39.6%, respectively. Additional debt issuance will likely occur over the longer term, depending on the system's need for additional capacity. WHAT COULD TRIGGER A RATING ACTION WEAKENED FINANCIAL RATIOS: The failure to return financial ratios to a level more consistent with historical results and rating category medians, as projected by the city, could pressure the rating. HIGHER DEBT PROFILE: Additional leverage beyond what is currently programmed into the system's capital improvement program would likely result in downward pressure on the rating. CREDIT PROFILE The city owns and operates a combined energy system composed of an electric generation, transmission and distribution system, and a natural gas distribution system serving approximately 114,000 and 26,400 customers, respectively. The service areas for both systems are essentially the same, consisting of the city of Tallahassee (Fitch maintains an implied general obligation rating of 'AA' with a Stable Outlook on the city) and certain adjacent unincorporated areas of Leon County (implied GO rating of 'AA+ with a Stable Outlook). WEAKER FINANCIAL RESULTS IN FISCAL 2011 BALANCED BY STRONG BALANCE SHEET Financial performance of the combined system weakened in fiscal 2011 but remains satisfactory for the rating. A nearly 10% decline in FADS coupled with a sharp rise in annual debt service prompted debt service coverage (DSC) to drop to 1.7x in fiscal 2011 compared to an average of 2.4x over the prior five years. Coverage of full obligations, which includes annual transfers to the city's general fund and purchased power costs, also deteriorated in fiscal 2011, dropping to just above 1.0x. Rating category median for both DSC and coverage of full obligations is 2.5x and 1.4x, respectively. Notwithstanding the weaker operating margins, actual results for fiscal 2011 proved better than the adopted budget, which included a $20 million transfer from reserves to compensate for management's decision to hold the line on rates. Positive variances related to sales and operating expenses reduced the actual transfer to a more modest $8.6 million, despite also making a one-time $6.9 million transfer to the city's internal services fund. The methodology for calculating transfers to the city's general fund has been changed multiple times in recent years.by the city commission. For fiscal 2012, transfers from both funds were set to equal 7% of the prior three-year average of retail revenues, leading to almost no change in the annual transfer amount. For fiscal 2013 the transfer from the electric fund was set at $23.9 million and will remain at this level in future years after adjusting the amount according to changes in the consumer price index. Financial projections through fiscal 2017 show annual DSC improving beginning in fiscal 2013 to about 2.2x based on what Fitch believes are reasonable assumptions. Balance sheet resources, including available reserves in the renewal, replacement and improvement (RR&I) funds for both systems, were equal to a sizeable 228 days cash in fiscal 2011, comfortably above the median for comparably rated utilities. The RR&I funds are not required by bond ordinance to carry a minimum balance, although management consistently adheres to the city's prudent policy of maintaining the funds at no less than 60 days of operating expenses. STABLE SERVICE TERRITORY Tallahassee is the state capital city, with a population of nearly 181,500. A sizeable higher education presence along with the city's role as the state capital provides a stable employment base with several large employment anchors. Consequently, collection of annual billings continues to approximate nearly 100%, and bad debts have historically remained below 1%. Roughly 90% and 10% of the combined system's revenues are derived from electric and gas sales, respectively. The customer base is highly diverse and moderately high sales and revenue concentration attributable to the system's 10 largest users is mitigated by the size and stability of the customers, including Florida State University, Florida A&M University, and city and state agencies. Residential users account for roughly 85% of the base while commercial, industrial and government make up the balance. Sales and revenue derived from the 10 largest users were relatively unchanged from prior years, accounting for about 30% and 25%, respectively. The local housing market has not exhibited the same level of stress as in many Florida communities, experiencing minimal tax base loss and foreclosure rates only slightly above the national average. The city's August 2012 unemployment rate of 7.4% continues to trend below state and national averages while income levels are comparatively weaker due in part to the large student population. AMPLE POWER SUPPLY Fitch has long cited the system's lack of fuel diversity as a concern, although the currently lower price environment for natural gas somewhat mitigates this risk. The city owns and operates two large natural gas-fired generating units with a total capacity of 870 MW (megawatts). The city also owns and operates a hydroelectric plant consisting of three generating units with a total capacity of 11 MW. A long-term firm power supply contract with Progress Energy Florida (PEF; long-term Issuer Default Rating of 'BBB' with a Stable Outlook) provides an additional 11.4 MW of capacity through 2016. Peak demand in 2011 was 590 MW, significantly lower than in prior years and equal to an adequate planning reserve margin of 26% (excluding purchased power). Despite having excess capacity, the city is reportedly continuing to pursue other alternative energy resources, notwithstanding the fact that Florida has not yet implemented portfolio standards. Fitch views the system's strategy favorably. COMPETITIVE RATES The city's electric rates are about in line with the average for all Florida electric utilities, which suggests some degree of revenue-raising flexibility. However, the city elected to defer recent rate increases in a weakened sales environment. The city intends to supplement incremental revenue requirements with its sizable cash balances. The city's average rate revenue/kWh (kilowatt hour) of 12.70 cents in fiscal 2011 was slightly higher compared to the statewide average of 11.90 cents, but the typical monthly residential bill is currently below the statewide average of municipally owned systems. The city commission essentially has exclusive authority to set electric and gas rates. Electric rates consist of a customer charge, a demand charge for large commercial customers, a non-fuel energy charge, and an energy cost recovery charge (ECRC). The city reviews the actual over- or under-recovery of these costs on a monthly basis and modifies the ECRC charge, if required, on at least a semiannual basis. The Gas Utility's retail rate structure includes a base rate and a fuel recovery charge designed to recover the operating expenses exclusive of fuel, plus scheduled transfers for debt service; renewal, RR&I; and a transfer to the city's general fund. The fuel recovery charge is passed through to customers similar to the ECRC. Over the last several years the electric and gas bills for residential customers have been adjusted downward by a meaningful 28% to reflect the declining cost of natural gas. Recent changes in the base rate include 1.1% and 3.8% increases adopted in fiscals 2011 and 2012, respectively. City Ordinance provides for automatic rate adjustments for city utilities, including the electric and gas systems, at the beginning of each fiscal year equal to the prior 12-month increase in the Consumer Price Index (CPI). The annual adjustment was implemented to better align rates with the cost of service and avoid sharp changes in user charges, which Fitch views favorably. The city's adopted budget incorporates an additional 1.7% base rate increase prompted by the change in CPI. HIGH LEVERAGE Leverage is high for the rating category. Issuance of the series 2010 bonds increased leverage by a sizeable 35%, reversing what had been a positive trend of improving debt ratios. As a consequence, debt/FADS increased to 7.9x in fiscal 2011 compared to the rating category median of 4.8x, and equity/capitalization dropped to 40% compared to the median of 54%. Debt per customer also increased to a very high $5,630, although as a combined system this ratio is somewhat overstated. Fitch expects the system's debt profile to improve over the next several years given the likelihood that capex will be funded entirely from current resources. Future borrowings will hinge on the need to add capacity, which is currently not expected at least over the medium term. Historical capex was significant, averaging slightly more than twice the annual depreciation amount.
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