Fitch Rates St. Petersburg, FL's Utility Revs 'AA'; Outlook Stable
--Approximately $51,000,000 public utility revenue refunding bonds, series 2016B;
--Approximately $46,000,000 public utility revenue bonds, series 2016C.
The bonds are expected to sell via competition during the weeks of October 4 (series 2016B) and October 26 (2016C). Proceeds will be used to finance the costs of various water and sewer rehabilitation and replacement capital improvements, refund portions of outstanding bonds and pay issuance costs.
The 2016B bonds will be covered by the combined debt service reserve fund. A debt service reserve funds will not be established for the series 2016C bonds.
In addition, Fitch affirms its 'AA' ratings for the following outstanding city bonds:
--Approximately $372 million in outstanding public utility revenue bonds.
The Rating Outlook is Stable.
The bonds are secured by a first lien pledge of the net revenues of St. Petersburg, Florida's public utility system (the system), which includes the water fund (including sewer and reclaimed water) and the stormwater system.
KEY RATING DRIVERS
SOUND FINANCIAL METRICS: Debt service coverage (DSC) was a sound 1.9x on the senior bonds and 1.7x all-in in fiscal 2015, weakening slightly from the prior year. Coverage net of transfers to the general fund (GF) remains slim at just 1.1x all-in. However, liquidity remains ample and rates are competitive, providing sufficient financial flexibility to the system. Forecasts point to DSC ratios staying at or near historical norms.
CAPITAL INVESTMENT AND DEBT GROWING: Due to regulatory driven needs, capital expenses are on the rise and will largely be debt-financed. While a long-term trend of rising leverage is a concern, Fitch expects the debt burden to remain consistent with similarly rated systems.
RATE HIKES TO ADDRESS CAPITAL: The city council adopted above-average rate increases across most of the city's utility systems to address growing debt costs and capital needs. User charges remain competitive with other regional utilities but have now reached Fitch's affordability threshold.
LIMITED EXCESS CASH FLOW: The system makes large annual transfers to the GF totaling 10% of operating revenues (roughly $13 million in fiscal 2015). The transfers absorb most of the excess cash flow, increasing the need for debt-funding of capital improvements.
WELL-MANAGED SYSTEM: Fitch views positively the city's various formal policies, comprehensive rate and capital planning, and ongoing system reinvestment.
REGULATORY NEEDS: The rating on the city of St. Petersburg's utility system revenue bonds could face downward pressure if significant additional debt is needed to address regulatory-driven capital requirements. Management of sound debt service coverage and healthy liquidity balances are key rating factors given system's growing debt profile.
St. Petersburg is located in Pinellas County (sewer revenue bonds rated 'AA'), approximately 20 miles southwest of Tampa. The system provides water, sewer, reclaimed water and stormwater service for an estimated 300,000 residents located within the city and adjacent areas of the county. The revenues of all four utilities are pledged to the bonds, although the stormwater system is accounted for and operated as a separate enterprise.
The system, mostly residential, serves approximately 92,000 water, 81,000 sewer, and 82,000 stormwater accounts. The customer base is diverse and stable, posting positive customer growth trends after several years of declines following the housing collapse and economic recession. Future customer growth is expected to be limited by the largely developed nature of the city.
The city's sewer operations include three treatment facilities, which treat effluent to advanced secondary standards, producing recycled water which is sold through the city's extensive reclaimed water distribution system and disposed of through deep injection wells. Average capacity in the system is strong with treatment capabilities at the three plants at roughly 50% of average daily flows, not taking into consideration heavy rain events.
The city does not own any drinking water resources but is one of six member governments of Tampa Bay Water (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 (utility system revenue bonds rated 'AA+') has existing water supplies to meet member needs for at least the next 15-20 years, or perhaps longer depending on growth and conservation efforts.
HEAVY RAIN EVENTS PRESSURE SYSTEM OPERATIONS
A series of severe rain events have had a significant impact on the city's sewer and stormwater systems, resulting in regulatory violations and the need for increased capital spending to address aging and compromised infrastructure. From August 2015 to August 2016 the city experienced three prolonged heavy rain events resulting in unpermitted sewer overflows into Tampa Bay. The situation was compounded by the planned closure of one of the city's water reclamation facilities in April 2015, which reduced overall capacity to 56 million gallons a day (mgd) from 68 mgd.
The heavy rain events resulted in a significant increase in the average daily demand, which triggered state regulatory requirements to address plant capacity. The city has received a draft consent order from the state Department of Environmental Quality to address necessary expansion, discharge events and mitigate future discharges.
REGULATORY DRIVEN CAPITAL PLANS
A significant portion of the city's $220 million capital improvement plan (CIP) will fund needed sewer system expansions and maintenance to address overflow events occurring during heavy rains. Highest priority projects include $48 million for a 5 mgd permitted capacity expansion of the Southwest Water Reclamation Plant (SWWRP), upgrades at the SWWRP plant to increase peak flow capacity and over $75 million in projects related to maintenance of the sewer collection system. The majority of the plan will be debt-funded. As additional costs associated with the consent order are included in the CIP, additional leveraging could put downward pressure on the rating without offsetting credit considerations.
In 2016 the city will undertake a stormwater master plan to address localized flooding. The scope and cost related to the stormwater system are largely unknown at this time. The city recently adopted a significant stormwater rate increase of over 30% to fund the plan on a pay-go basis.
DEBT BURDEN TO RISE
With total outstanding debt as of fiscal-end 2015 of $372 million, the debt profile is manageable, but key debt metrics continue to trend upward. For fiscal 2015 debt per customer ($2,138 - water and sewer only) and debt-to-net fixed assets (59%) ratios are near the medians for systems rated in the 'AA' category by Fitch. Favorably, debt carrying costs are currently low at 18% of gross revenues. However, following this issuance, additional borrowings totaling approximately $128 million will increase debt ratios to roughly $3,400 per customer (water and sewer only) by fiscal 2021, which would be relatively high compared to similarly rated utilities.
Carrying costs will remain a moderate 19%-23% of gross revenues over the financial forecast, but debt amortization is somewhat slow. Payout of existing principal (including the proposed 2016 bonds) is just 27% over the next 10 years and just 65% over 20 years, ensuring the debt burden will remain above the medians for the foreseeable future. The city expects to continue to fund system renewal and maintenance at approximately $35 million to $45 million annually for the next 10 years. This represents an increase in annual CIP spending of about $10 million over past plans.
RATES ADJUSTED TO SUPPORT CAPITAL
The city undergoes an independent rate study, which it updates annually. The rate analysis helps provide consistency and transparency to the rate-setting process. The most recently available draft rate study (updated in September 2016) includes an updated 10-year financial and rate forecast based on planned capital spending, incorporating additional debt and long-term operating costs.
The forecast indicates the system will need above-average rate hikes for both the sewer and stormwater system to address overflow and flooding issues that arose from August 2015 through August 2016. For fiscal year 2017, the draft rate study recommends an over 30% rate increase in the stormwater fee, taking the fee from $6.48 to over $9, and a 9.75% rate increase on the sewer rates. Additional increases of 6.67% to 9.38% are expected annually for the stormwater system, along with more moderate 3% to 3.75% annual increases anticipated for the sewer system through 2021.
Water rates will remain flat for fiscal 2017, but 3% to 3.75% annual increases are anticipated from 2018 to 2021. Reclaimed water rates were increased by 4.25% for fiscal 2017, but annual 10% rate hikes are anticipated through 2022. City council has continually shown support for rate increases as demonstrated by over 14 years of council-adopted incremental increases.
Rate-setting is done annually, with adjustments put into place at the beginning of the fiscal year. Rates are structured with a 30% fixed base-rate charge providing consistency to the revenue stream, and inclining-block volumetric fees promote conservation. In addition, the monthly bill includes pass-through charges for TBW service.
The city retains some rate-raising flexibility as rates remain affordable despite recent increases, and monthly bills are in line with regional utilities. Following the implementation of the fiscal 2017 rate increases, rates have grown to $96.86, or 2.4% of median household income (MHI) based on 7,500 gallons of monthly water use. However, Fitch notes the average residential user consumes closer to 4,000 gallons per month, dropping typical charges to a more moderate 1.9% of MHI.
STABLE FINANCIAL PERFORMANCE, STRONG LIQUIDITY EXPECTED
Financial operations have been healthy, supported by sound fiscal oversight and annual incremental rate increases. DSC levels have weakened from previous highs with the issuance of additional debt over the past several years, although coverage is solid for the rating. In fiscal 2015, DSC on the senior bonds totaled 1.9x, and coverage including subordinate lien state revolving fund payments was 1.7x. However, Fitch notes coverage of all fixed charges, including transfer payments to the general fund (which represents payments in lieu of taxes and franchise fees) was a much slimmer 1.1x in fiscal 2015. These DSC ratios are down slightly from the prior year due to increased operating expenses and growing debt carrying costs.
DSC is projected to remain close to historical norms through the 2021 forecast period. Projected DSC levels are adequate for the rating, and supported by the strong liquidity position. However, Fitch believes the modest free cash flow (after payment of operations, debt service and transfers) will result in reliance on debt funding for most future capital needs. Fitch expects stability and predictability in the transfers to the general fund as they are formulaic and capped by city policy. The utility includes the transfers in its rate-setting process and they are paid subordinate to debt service.
The utility maintained a strong balance sheet with $116 million in unrestricted cash and investments or 468 days cash on hand at the close of fiscal 2015. A significant portion of the utility's reserves were funded from the sale of water supply facilities to TBW in 1999. These reserves are designated solely for water purchases and the development of water production and transmission facilities. Management intends to keep reserves at similar levels going forward.