Fitch Affirms Tallahassee, FL's Consolidated Utility System Revs at 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the 'AA+' rating on Tallahassee, FL's (the city) approximately $330 million in outstanding consolidated utility system revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a senior lien pledge of the net revenues of the city's water and sewer utilities, a gross lien on the storm drainage system (together, the consolidated system), and available system development charges.

KEY RATING DRIVERS

STABLE RESIDENTIAL CUSTOMER BASE: Tallahassee serves as the state's capital and is also home to both Florida State University and Florida A&M University, which together provide a stable underlying employment base. The customer base is diverse and mostly residential.

STABLE FINANCIAL PERFORMANCE: Financial performance remains solid in fiscal 2013 despite a sharp rise in annual debt service beginning in fiscal 2011. Very strong liquidity provides financial flexibility and serves as an offset to the slightly below average net revenue coverage.

MANAGEABLE CAPITAL PROGRAM: The system is nearing completion of a comprehensive capital plan that includes advanced wastewater treatment (AWT) upgrades necessary to meet stricter guidelines for biological nutrients. Going forward, capital needs will focus mainly on system renewal and replacement projects.

STABLE OPERATIONS: The near-completion of AWT coupled with sizable and relatively clean local water supplies leaves the system in a favorable operating position.

DEBT BURDEN TO REMAIN ELEVATED: The previously large capital program left the system with a slightly elevated debt burden. Slow amortization of existing debt along with a small amount of future debt will likely keep debt ratios somewhat high for the foreseeable future.

RATES TO REMAIN COMPETITIVE: Water and sewer rates have been on the rise but remain competitive. Storm system fees also are very manageable.

RATING SENSITIVITIES

STABLE FINANCIAL PERFORMANCE EXPECTED: A decline in net revenue debt service coverage (DSC) from current levels coupled with erosion in other financial metrics may put downward pressure on the rating.

CREDIT PROFILE

STABLE EMPLOYMENT BASE ANCHORED BY PUBLIC SECTOR

The city of Tallahassee (Fitch 'AA' implied general obligation rating) is located in northwest Florida about 20 miles north of the Gulf of Mexico. The city serves as the state's capital and the county seat of Leon County, and is home to two large public educational institutions: Florida State University and Florida A&M. Combined fall 2013 enrollment for the two universities was roughly 55,000.

Government and educational institutions provide a stabilizing force for employment and have historically insulated the area from high jobless rates and weak housing market trends prevalent throughout much of the state in recent years. The unemployment rate for the Tallahassee metropolitan statistical area dropped to 5.0% in April 2014, a nearly two percentage point drop in the rate since April 2012. The below-average wealth and income indicators are reflective of the area's large student population.

The city owns and operates the system, which was consolidated along with the natural gas system into a single underground utilities department in 2008. However, each utility is still accounted for as a separate enterprise fund of the city, and each is operated as a self-sufficient stand-alone utility. Only the revenues from the water, sewer and storm utilities are pledged to bondholders.

The system serves approximately 280,000 residents within the city and portions of Leon and Wakulla Counties through approximately 85,000 retail water and sewer customers in fiscal 2013. Wholesale water service is also provided to the city of St. Marks. The storm system contains roughly 90,000 equivalent residential units. The customer base is predominantly residential and stable with no customer concentration.

STABLE FINANCIAL PERFORMANCE EXPECTED

System financial results were strong historically with solid financial margins and cash flows producing strong DSC and robust annual free cash flow (FCF). However, the issuance of the series 2010 bonds led to a sharp rise in debt service and a subsequent decline in financial metrics. When calculating DSC using gross storm system revenues, coverage totaled 2.3x in fiscal 2013. However, Fitch believes calculating coverage using net revenues for all three enterprises more appropriately reflects actual results and provides a better picture of long-term system operating performance. On a net revenue basis, DSC was below average but adequate at 1.8x in fiscal 2013. Coverage of all system obligations, including annual transfers to the general fund, was satisfactory at 1.5x in fiscal 2013.

Debt service is not expected to increase for at least the next several years, and coupled with automatic inflation-adjusted rate increases, financial performance should remain close to current levels over the intermediate term. While a small amount of additional debt is projected in about 2015, the city plans to undergo a comprehensive rate sufficiency analysis to determine if and how much debt might be needed to fund a portion of the capital program. Fitch does not expect current estimates of an additional $30 million in new debt will significantly impact system financial performance. City-provided pro forma budget estimates show steady net revenue coverage of 1.9x-2.0x over the next few years.

Liquidity is strong on a consolidated basis with over $62 million in aggregate unrestricted cash and investments from all three funds at the end of fiscal 2013. When coupled with approximately $30 million in renewal, replacement and improvement fund balances, system liquidity totaled over $92 million, or about 492 days of operating expenses. While liquidity is well above average, most of the cash is held in the storm system fund with the expectation for a portion of cash to be used to fund future storm system capital projects.

ELEVATED LEVERAGE BUT MANAGEABLE FUTURE CAPITAL NEEDS

System leverage has increased substantially since fiscal 2007. The system had a total of $350 million in outstanding debt in fiscal 2013, leading to a somewhat elevated but declining debt burden. Debt-to-net plant totaled 50% for the same period and debt per customer $2,076; both ratios are slightly above the medians for 'AA' category systems. Debt ratios are expected to remain near these levels going forward given the slow principal amortization of existing debt and the potential for a small amount of additional bonds within the next several years.

Of note, the city is in the latter stages of a large capital program that will allow the system to meet more stringent nutrient guidelines for treated wastewater. The updated five-year capital improvement plan (CIP) for fiscals 2014-2018 totals $167 million, is manageable and, as expected, is much lower than earlier versions that included the wastewater treatment plant upgrades.

A large proportion of the CIP will address renewal, replacement and improvement (RR&I) of system assets and requires only a small amount of additional bonds (about $30 million) to be issued in 2015 or 2016. Management expects the majority of the capital plan will be funded mainly with RR&I funds and other pay-as-you go sources, which Fitch believes to be feasible despite somewhat low FCF given the strong cash balances and approximately $20 million in expected annual cash flow prior to transfers.

STABLE OPERATIONS EXPECTED

Fitch views the system's stable operating profile positively, and expects operations to remain stable going forward. Raw water supply is abundant and relatively clean, in need only of chlorination and fluoridation at the well sites prior to distribution. Completion of AWT is viewed to be significant as it removes operating and capital uncertainties regarding the numeric nutrient limits facing many utilities throughout the state. Sewer treatment capacity is solid, and distribution and collection system pipes are well maintained as evidenced by acceptable levels of unaccounted for (and unbilled) water, and relatively low water line breaks and sewer overflows per 100 miles of pipes.

INDEPENDENT RATE-SETTING AUTHORITY

Rates are set by the city and are structured with base fees and volumetric charges with an inclining block rate charged per thousand gallons. Fixed monthly charges comprise a favorable 23% of the total bill, providing some stability to the revenue base. Most customers fall under the first tier, which includes the first 7,000 gallons used. For fiscal 2014, the typical residential customer pays a reasonable $70 for combined service.

Rates have been on the rise with the majority of the increases focused on the sewer system to fund the AWT project. Since 2006, sewer rates have been increased by roughly 39%, while water rates saw about a 30% increase over that time. For fiscal 2012 and going forward, the city implemented annual inflation-adjusted increases for both water and sewer service, which is viewed positively by Fitch. Rates for water and sewer service have been increased modestly over the past few years.

Monthly stormwater fees, which have also been increased, are based on a structure's impervious surface area. The current fee is $7.95 per equivalent residential unit, which is equal to about 2,000 square feet. Like the water and sewer charges, the stormwater fee is also competitive and has not been raised since 2010. The city undergoes a formal rate review about every two years (last one completed 2013), which allows for close monitoring of rates and revenue needs.

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' (June 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Outlook: Water and Sewer Sector' (December 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=840727

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Contacts

Fitch Ratings
Primary Analyst
Andrew DeStefano, +1 212-908-0284
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Eva D. Rippeteau, +1 212-908-9105
Associate Director
or
Committee Chairperson
Doug Scott, +1 512-215-3725
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Andrew DeStefano, +1 212-908-0284
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Eva D. Rippeteau, +1 212-908-9105
Associate Director
or
Committee Chairperson
Doug Scott, +1 512-215-3725
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com