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
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Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014361
Endorsement Policy
https://www.fitchratings.com/regulatory
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