November 4, 2016 - 3:11 PM EDT
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Fitch Affirms Tallahassee (FL) Energy System Revs at 'AA-'; Outlook to Positive

Fitch Ratings has affirmed the 'AA-' rating on the City of Tallahassee, Florida's (the city) $455.3 million energy system revenue and refunding bonds (series 2007, 2010 and 2010A-C).

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds are secured by net revenues of the city's combined electric and gas systems.

KEY RATING DRIVERS

SOLID SERVICE TERRITORY: The city's energy system provides retail electric and gas service to a sound service area, which includes the state capital and two major universities. Unemployment is below the state and nation. Wealth levels are below average, reflecting the proportionately high student population. Fitch recently upgraded the city's Issuer Default Rating (IDR) to 'AA+' from 'AA', lending support for this stable service territory.

STRONGER FINANCIAL PERFORMANCE: The Positive Outlook reflects improved financial performance exhibited in the past two years, comparable to 'AA' rated peer retail systems. The city implemented three base rate increases, which combined with improved sales, boosted cash flow and financial coverages. Debt service coverage (DSC) rose to 2.44x in FY2015 from 1.73x in FY2011. Coverage of full obligations climbed to 1.68x for FY2015, from 1.07x in FY2011, in-line with the 'AA' peer median (1.71x). The systems' strengthened liquidity (345 days cash FY2015) provides added support for the Outlook revision.

ADEQUATE COST RECOVERY: Fuel and purchased power costs for the electric and gas systems are passed through to customers on a timely basis via adjustment mechanisms. In addition, the city's autonomous rate-setting authority and competitive rates provide added rate and financial flexibility.

LACK OF FUEL DIVERSITY: The city's dependence on natural gas (96% of generation) exposes the system to price volatility. This fuel concentration risk is moderated by several factors: a fuel hedging program and adequate risk management policy, maintenance of strong liquidity, a prepay agreement providing a portion of natural gas at a discounted price, and projected low wholesale natural gas prices for the near term.

REPLACING GENERATION: The city recently approved the fiscal 2017 budget, which includes the replacement of older, less efficient generating units (135MW in total), with new natural gas-fired generation (75MW) and distributed generation (18MW). Capex for the five-year horizon ($296 million) is moderately higher than the prior forecast ($255 million), and expected to be primarily cash funded. The energy system projects fuel and cost efficiencies from the new facilities will offset the moderate increase in debt service.

MODERATELY LEVERED SYSTEM: Debt levels are on the decline, although modestly less favorable than 'AA-' peer medians. For FY2015, debt-to-funds-available for debt service and equity capitalization were 5.6x and 43.6%, compared to the rating category medians of 4.7x and 52.3%, respectively. With the likely moderate new debt requirements in the 2017-2018 timeframe, the energy system should maintain a sound balance sheet going forward.

RATING SENSITIVITIES

ADEQUATE FINANCIAL PERFORMANCE: The resolution of the Positive Outlook will reflect the Tallahassee energy systems' ability to sustain strengthened financial coverages, liquidity and capitalization measures consistent with 'AA' rating category medians, particularly as the city embarks on a moderately higher capital improvement plan (CIP) prospectively. A failure to implement adequate rate increases or material growth in utility transfers to the city (currently 10.1% of operating revenues) would likely result in an Outlook revision to Stable.

CREDIT PROFILE

The city owns and operates a combined energy system comprised of an electric generation, transmission and distribution utility and a natural gas distribution system serving 117,536 and 29,659 customers, respectively. The service areas for both systems are essentially the same, encompassing mainly the city of Tallahassee (city IDR 'AA+'). The city water and sewer system is also rated 'AA+' by Fitch. The combined energy systems are accounted for as an enterprise fund of the city.

IMPROVED FINANCIAL PERFORMANCE

Financial performance of the combined system had weakened in fiscal 2011 and 2012 as kwh sales contracted due to the moderate weather and the economic downturn, and annual debt service rose considerably. DSC fell to 1.73x (including subordinate obligations), and coverage of full obligations, which includes annual transfers to the city's general fund, dropped to 1.07x. The city has since been utilizing available electric operating reserves to supplement cash flow and mitigate rate increases.

Positively, the city has implemented several rate increases to bolster operating cash flow and reserves. Coupled with kwh sales growth beginning in 2014, financial results for FY2015 have notably improved, with DSC up to 2.44x and coverage of full obligations up to 1.68x - more in-line with 'AA' rated peers. The city also refunded a portion of the energy system debt in fiscal 2015 for economic savings, which will reduce annual debt service modestly going forward.

The energy system's financial position is further supported by consistently strong liquidity and a sound balance sheet (43.6% equity capitalization). Financial coverages are projected to remain similar to FY 2015 results through the next five years.

Balance sheet resources, including available reserves in the renewal, replacement and improvement (RR&I)funds for both systems, were equal to a sizeable 345 days cash in FY2015, well above the median (216 days) for comparably rated utilities. The city maintains a healthy financial target of 210 days operating cash.

POWER SUPPLY STRATEGY

The city owns and operates two large natural gas-fired generating units with a total capacity of 822MW; and a hydroelectric plant with a total capacity of 11MW (energy-only resource). Peak demand in 2015 was 601MW, resulting in solid planning reserve margin of 38.6%.

Fitch views the system's lack of fuel diversity as a credit concern, although the currently lower price environment for natural gas somewhat mitigates this risk. Additionally, the city maintains ample cash reserves, and a fuel and energy risk management program to help moderate the natural gas exposure.

Management's power supply strategy is centered on maintaining adequate, efficient and environmentally sound power supply resources. Towards this end, the energy system will continue its demand-side management and energy conservation efforts to alleviate the need for new generation, and add renewable purchases to modestly diversity power supply.

The city recently adopted its 2017 budget, which includes the accelerated addition of two small natural gas-fired combustion generation units in 2018-2019. In the prior year capital plan, these units were scheduled to come on line 2020-2021. The earlier addition of these new units is due to anticipated fuel economies and to alleviate transmission constraints. The additional generation will require debt financing of $20 million-$50 million more than the prior year forecast ($70 million).

Fitch anticipates the city will continue to maintain financial metrics and raise rates as needed through the revised capex plan. The resolution of the Positive Outlook over the next 12-18 months will depend on the energy system's ability to sustain stronger financial coverages, liquidity and capitalization measures consistent with 'AA' rating category peers, particularly through the larger CIP program. A failure to implement adequate rate increases, maintain robust liquidity, or material growth in utility transfers to the city (currently 10.1% of operating revenues) would likely result in an Outlook revision back to Stable.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, U.S. Public Power Rating Criteria.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Public Power Rating Criteria (pub. 18 May 2015)

https://www.fitchratings.com/site/re/864007

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014361

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014361

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Business Wire (November 4, 2016 - 3:11 PM EDT)

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