Fitch Ratings has assigned an ‘AA-‘ rating to the city of Gainesville, Florida’s (the city) approximately $43.185 million utilities system revenue bonds, 2012 series A issued for the Gainesville Regional Utilities (GRU).
GRU expects to issue the bonds via negotiated sale the week of July 9, 2012. Proceeds will be used to refund outstanding 2003 series A and 2005 series A bonds, and to pay the cost of issuance.
In addition, Fitch has downgraded the ratings on the following GRU outstanding debt:
–$932.12 million utilities system revenue bonds to ‘AA-‘ from ‘AA’.
Fitch has also affirmed the ‘F1+’ rating on GRU’s $62 million of outstanding commercial paper notes.
The Rating Outlook on all bonds is Stable.
The bonds are secured by a first lien on net revenues of the combined electric, gas, water, wastewater and telecom system (collectively, the systems). GRU will not fund a debt service reserve fund for the 2012 bond financing.
KEY RATING DRIVERS
SOLID COMBINED UTILITY SYSTEM: GRU is a combined utility system providing retail electric, gas, water, wastewater, and telecom services to the city of Gainesville, FL (non-ad valorem bonds rated ‘AA-‘ by Fitch) and surrounding areas. The systems are stable, do not exhibit customer concentration and do not have any significant environmental or adequacy of supply challenges over the near term.
CHALLENGING BIOMASS PURCHASE CONTRACT: The rating downgrade to ‘AA-‘ from ‘AA’ reflects numerous challenges that have emerged as a result of GRU’s agreement to purchase energy from the Gainesville Regional Energy Center (GREC), a 100MW biomass facility due on-line by 2014. GRU’s resources are already well in excess of peak demand and the total cost of energy produced by the unit will be high ($130/MWh).
RELUCTANCE TO INCREASE RATES: GRU’s projected performance suggests a reluctance to implement electric rate increases sufficient to cover the entirety of GREC-related costs. GRU is pursuing cost mitigation initiatives, but any shortfall will likely reduce net margins. GRU’s electric rates are already higher than average compared to the state’s other municipal systems.
WEAKER METRICS EXPECTED: GRU’s projected debt service coverage (DSC) will remain healthy, but is expected to weaken from historical levels of over 2.0x to 1.7x-1.8x as a result of increasing operating costs and tempered rate increases. Adjusting for sizable transfers to the city general fund (9.3% of revenue in 2011) DSC will fall to 1.21x to 1.29x.
STRONG REGIONAL DEMOGRAPHICS: The GRU service area is the home of the University of Florida (50,000 students) and has exhibited economic indicators including population growth, per capita income and unemployment rates that consistently compare favorably with state and national averages.
MANAGEABLE CAPITAL PROGRAM: GRU’s sufficiency of resources through 2032 has resulted in a capital plan that is manageable and will largely be funded with cash flow from operations through 2017, thereby limiting future debt requirements.
WHAT COULD TRIGGER A RATING ACTION
RETURN TO HISTORICAL METRICS: Evidence of a return to stronger financial metrics would be viewed favorably by Fitch.
FAILURE TO MANAGE INCREASING COSTS: GRU’s inability to manage the increased costs related to GREC likely would exert additional downward pressure on the rating or Outlook.
GRU provides retail electric (92,272 customers), gas (33,207 customers), water (68,952 customers), wastewater (61,370 customers) and telecomm (7,198 customers) service to its residential, commercial and industrial customers. The city is home to the University of Florida, one of the largest universities in the nation. Gainesville’s economy has weathered the economic downturn reasonably well, and wealth, employment and housing data compare favorably with state averages.
Diverse Combined Utility System
The electric system is the largest of the combined systems -accounting for 73.4% of utility revenues – and provides retail electric service to consumers in the city and the surrounding unincorporated area. In addition, the system provides wholesale electric service to Seminole Electric Cooperative and Alachua County.
The water, wastewater, and gas systems serve territories similar to the electric system. The systems are stable, do not exhibit customer concentration, have rate flexibility, and do not have significant environmental or supply issues on the horizon. Each system is self-supporting by own-source revenues and GRU’s five-year capital improvement plan appears manageable.
Excess Power Supply Resources
GRU’s owned power supply resources have a combined net summer capacity of 610.2MW. Coal and natural gas make up the largest generation fuels, 60% and 17%, respectively. A long-term firm power supply contract with Progress Energy Florida, Inc.(PEF; 50MW) increases total resources to 650.2MW, well in excess of the system’s 2011 peak demand of 445MW.
Expensive New Renewable Capacity
GRU has agreed to purchase all of the output of GREC, a 100MW biomass generating project, upon its anticipated completion in 2013. A portion of the GREC capacity will replace the expiring PEF purchase agreement. However, the remaining 50MW will add to GRU’s already-excess power supply resources.
The all-in cost of power supplied by GREC is also forecast to be relatively expensive at $130/MWh. GRU is exploring a range of cost mitigation initiatives including debt refunding opportunities, system wholesale power sales and energy prepayment opportunities, along with an effort to sell GREC capacity and output. The utility has indicated a reluctance to increase rates beyond the levels initially forecast when the GREC agreement was reached, therefore, any shortfall in cost reduction will likely reduce net revenues, as well as related DSC and cash flow coverage.
The successful operation of GREC would obviate the need for additional resources at GRU through 2032; however, the utility’s ability to manage its excess capacity and mitigate the effect on cost of service and retail rates will be a meaningful challenge that Fitch will monitor closely.
Strong Historical Financial Profile
GRU’s financial performance has been strong and relatively stable since fiscal 2007 as evidenced by Fitch-calculated DSC consistently over 2.0x. Funds available for debt service (FADS) have grown over the period commensurate with higher debt service requirements reflecting the steady and reasonable rate increases implemented by GRU. DSC ratios were lower excluding general funds transfers from FADS but remained solid and consistently over 1.5x.
Leverage in recent years has also declined modestly when measured both in terms of total debt/FADS (6.7x in fiscal 2011 vs. 7.5x in fiscal 2009) and net assets/capitalization (30% vs. 32%) despite steadily rising debt. The improvement is again attributable to the retention of net margins, even after transfers to the city’s general fund. Liquidity in terms of cash on hand was also very strong at 164 days at Sept. 30, 2011.
Healthy but Lower Forecasted Metrics
GRU’s projected performance is expected to remain relatively stable and strong through fiscal 2013, characterized by DSC of approximately 2.0x and 1.5x after factoring in transfers. However, beginning in fiscal 2014 the effect of the GREC-related costs is expected to drive GRU’s targeted (and realized) DSC lower toward levels of 1.7x-1.8x and 1.21x-1.28x after transfers. Failure to realize the projected, but more speculative cost reductions, would result in even lower coverage (1.6x-1.7x and 1.16-1.10x, respectively).
Fitch believes that GRU’s forecasted performance, the challenge of managing excess capacity and higher costs, and the utility’s reduced rate flexibility are more consistent with the ‘AA-‘ rating category.