SAN FRANCISCO--()--Fitch Ratings assigns its 'AA' rating on the following St. Petersburg, Florida (the city) public utility (the utility) revenue bonds:
--$38.1 million public utility revenue bonds, series 2013A;
--$39.5 million public utility revenue refunding bonds, series 2013B.
Bonds are expected to price on Dec. 18, 2012 in a competitive sale. Proceeds of the series 2013A bonds are expected to fund a wastewater treatment plant project that is expected to provide long-term operational savings, fund a debt service reserve fund and pay costs of issuance. Proceeds of the series 2013B bonds will refund outstanding series 2003 bonds for savings and pay costs of issuance.
Fitch also affirms its rating on the city's parity outstanding bonds as follows:
--$257.6 million utility revenue bonds at 'AA'.
The Rating Outlook is Stable.
The bonds are secured and payable by an irrevocable first lien on the net revenues of the utility.
KEY RATING DRIVERS
HEALTHY FINANCIAL METRICS: Debt service coverage levels are healthy, although have experienced a decline, as anticipated, from previously high levels as a result of additional debt issuance. Liquidity remains strong, providing good financial flexibility to the system.
DEBT LEVELS INCREASING: Capital needs, which primarily consist of repairs and upgrades to existing infrastructure, will be funded primarily by additional debt. Fitch does not expect the increased leverage and debt service costs over the next five years to result in a further decrease to coverage levels.
ANNUAL RATE INCREASES EXPECTED: Rate flexibility appears strong and rates are in line with other regional utilities. Fitch expects the city should be able to implement the annual rate increases needed to fund planned capital spending.
FORMALIZED RATE STUDY: Fitch views the city's formal annual rate study as a positive credit factor that should provide timely cost recovery and mitigate the net revenue impact of sales declines and cost pressures.
SOLID OPERATING PROFILE: The city benefits from a water supply provided by its participation in Tampa Bay Water (TBW), the region's highly rated wholesale water supply authority. The city provides its own wastewater services, which includes a substantial recycled water system.
WHAT COULD TRIGGER A RATING ACTION
FURTHER DECLINE IN COVERAGE: Any further decline in debt service coverage levels could pressure the rating.
COMBINED UTILITY COVERS LARGELY BUILT-OUT SERVICE AREA
St. Petersburg is located in Pinellas County (Fitch sewer revenue bond rating 'AA+'), approximately 20 miles southwest of Tampa. The city's utility system is composed of assets providing water, wastewater, reclaimed water and stormwater service for an estimated 300,000 residents located throughout the region. Revenues of all four utilities are pledged to the bonds. The customer base is largely residential in nature. Average daily demand declined between 2006 and 2010, a reflection of conservation policies of the city and a declining housing market leading to an increase in home foreclosures and vacancies. Future growth will be limited by the largely developed nature of the city.
AMPLE SYSTEM CAPACITY
The city does not own any drinking water resources but is one of six member governments of TBW, a special district of the state created by inter-local agreement to plan, develop, and deliver a high-quality water supply to the region. TBW (rated 'AA+' by Fitch) has existing water supplies to meet member need at least over the next 10 to 15 years.
The city operates four wastewater treatment plants and a collection system. The recycled water is sold through the city's extensive recycled water distribution system and disposed of through injection wells. No discharge is emitted into Tampa Bay, limiting environmental concerns for the system.
CAPITAL SPENDING RELATES TO REPLACEMENT AND UPGRADE OF EXISTING ASSETS
The utility's 2013-2017 capital improvement plan (CIP) totals $190.3 million, of which the majority will be debt funded, including the 2013A bonds. The series 2013A bonds will fund the decommissioning of the oldest wastewater treatment plant and divert flows to one of the other three treatment plants. The project should save the city operating and maintenance costs over time. The CIP also includes a $32 million waste to energy facility that will generate electricity from the sludge by-product and reduce the city's sludge disposal costs and electricity costs.
Remaining capital spending relates primarily to repair and replacement of the water distribution and wastewater collection systems. Approximately $16.8 million of the total relates to storm water projects. The additional borrowing will increase debt ratios slightly above 'AA' category rating median levels. Debt amortization is also slow, with principal payout at 26% and 57% in 10 and 20 years, respectively.
RATES SHOULD KEEP PACE WITH COST INCREASES
Rate setting is done annually with rate adjustments put into place for each utility at the beginning of the fiscal year. Management conducts an independent rate study annually, which is viewed favorably by Fitch. The study includes a 10-year rate forecast based on planned operation and capital spending incorporates additional debt. Assumptions used in rate planning rely on a zero-growth scenario, which appears reasonable. Retail water sales were flat in fiscals 2011 and 2012 following a cumulative 19% decline from 2006 to 2010. Fitch assumes any further decline in consumption would be mitigated by the city's annual rate action.
Followed by 7.5% rate increases in fiscals 2011 and 2012, a more modest 2.75% rate increase was adopted in fiscal 2013. The prior years included the additional debt costs associated with the 2010 bond issuance. The rate study projects annual rate increases over the next 10 years of 4.25% in fiscal 2014 and 3.75% thereafter for each system. Rates are in line with regional utilities and the city appears to have solid rate flexibility with regard to future needed increases.
DEBT SERVICE COVERAGE DECLINES; LIQUIDTY STRONG
Financial operations have been healthy, supported by annual incremental rate increases that have supported rising operating and debt service obligations. However, coverage levels have declined from previous high levels with the additional debt issuance. Debt service coverage of all-in annual debt service (ADS) in fiscal 2011 was 1.9 times (x) (including junior lien state revolving fund payments). Debt service coverage after the transfer payment to the general fund (which represents payments in lieu of taxes and franchise fees) was 1.3x.
Based on preliminary unaudited financials, all-in debt service coverage in fiscal 2012 is projected in line with 2011 levels. Coverage levels are expected to remain around this level through the five year forecast. Free cash flow (after payment of debt service and transfers) is modest(below annual depreciation in the last five years), resulting in a reliance on debt funding for most capital needs.
The city makes transfers from the water and stormwater funds to the general fund. The transfer payments absorb much of the excess cash flow from the utilities, increasing the utility's use of debt funding for capital. Transfers are based on a formula that provides payments to the city in lieu of taxes and franchise fees, so Fitch expects them to be stable and predictable. The utility includes the transfers in its rate setting process and they are paid subordinate to debt service.
The utility maintains a strong balance sheet with $109.5 million in unrestricted cash and investments or 475 days cash on hand at the close of fiscal 2011. A significant portion of the utility's reserves were funded from the sale of water supply facilities to TBW in 1999 and are designated solely for water purchases and the development of water production and transmission facilities. Management intends to keep reserves at the current levels.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'Water and Sewer Revenue Bond Rating Guidelines' (Aug. 3, 2012).
For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria