OREANDA-NEWS. Fitch Ratings affirms the following St. Augustine, FL (the city) revenue bonds:

--\$20 million water and sewer revenue refunding bonds, series 2005 at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a senior pledge of the net revenues of the city's water and sewer system (the system), including connection fees.

KEY RATING DRIVERS

STABLE FINANCES, STRONG LIQUIDITY: System financial performance has been stable with annual financial margins around 36% and debt service coverage (DSC) between 1.5x-1.7x over the past five years. Liquidity remains strong, providing financial flexibility.

MANAGEABLE AND IMPROVING DEBT PROFILE: The debt burden continues to improve with outstanding debt equal to a manageable 32% of net capital assets and \$1,035 per customer as of fiscal 2013. Debt ratios are generally below the medians for utility systems rated in the 'AA' category by Fitch. With limited additional bonding plans, debt ratios should remain modest over the next several years.

HIGH USER CHARGES: Rates for combined service are somewhat high, especially relative to the below-average income levels of the area. Rates are expected to continue to increase at a modest pace pursuant to previously approved annual inflation-indexed rate adjustments, which is expected to provide for some baseline revenue growth.

MANAGEABLE CAPITAL NEEDS: Capital spending has outpaced system depreciation over the past seven fiscal years, which Fitch views favorably. The current capital spending plan calls for a continuation of this trend, with projects focused on system renewal and maintenance.

LIMITED, STABLE ECONOMY: The economy is concentrated in tourism, although employment in government, healthcare and education, and manufacturing provides some diversity. However, the city is located within commuting distance to the city of Jacksonville and positive employment growth throughout the county has led to a declining unemployment rate the past few years.

RATING SENSITIVITIES

STABLE FINANCIAL MANAGEMENT: The rating is sensitive to shifts in financial management and performance. A decline in debt service coverage and liquidity could result in downward rating pressure.

CREDIT PROFILE

St. Augustine (Fitch implied general obligation rating of 'AA-' with a Stable Outlook) is located on Florida's northeast coast, approximately 35 miles south of Jacksonville.

SOMEWHAT SMALL BUT STABLE AND RESIDENTIAL CUSTOMER BASE

The water and sewer system serves residents of the city as well as portions of unincorporated St. Johns County. The system is relatively small, serving just 11,658 water customers, 9,410 sewer customers, and about 34,000 residents in 2013. Overall, the customer base is mostly residential and stable, demonstrating some resilience to the economic and housing downturn.

The local economy is somewhat limited and based mainly in tourism, although the largest employers provide some diversity, and proximity to Jacksonville provides additional employment options. Top employers include St. Johns County School Board (3,700), Flagler Hospital (1,887), and Northrop Grumman (1,100). The county's unemployment rate is low (4.7% in October 2014) relative to the state and nation and has been on the decline for several years. However, median household income is just 79% of the state average, and 72% of the national average.

STABLE FINANCIAL PERFORMANCE, RATES ARE SOMEWHAT HIGH

Financial performance has been stable historically due in part to modest annual rate increases that improved financial margins and eased the substantial reduction in connection fee revenues from the housing downturn and recession as well as management's ability to hold down operating and maintenance expenses. Operating revenues increased by 27% from fiscal 2008 through fiscal 2013, which is notable given the roughly 13% increase in operating expenses over that time and the decline in connection fees from over \$8 million in 2008 to just \$155,000 in 2013.

The system ended fiscal 2013 with roughly \$4.7 million in net revenues for debt service, which covered annual debt service by about 1.7x. Preliminary results for fiscal 2014 show similar margins.

Liquidity is strong, providing the system with some financial flexibility. At fiscal 2014 year-end (preliminary and unaudited), the system had roughly \$10 million in unrestricted cash and investments and renewal and replacement funds on hand, which is equivalent to an ample 423 days of operations. Fitch anticipates liquidity will decline somewhat due to expected pay-go funding of system capital improvements, but should remain at healthy levels.

The city has full rate-setting authority and reviews rates annually during the budget process. Rates are structured with a minimum fixed monthly charge for service and commodity charges - based on consumption. The fixed monthly charge comprises nearly 50% of the total bill, which Fitch views favorably as revenues are less dependent upon flows. The average residential customer living within the city limits pays roughly \$86 for combined service (assuming 7,000 gallons of use), which is a high 2.7% of median household income. However, most residents use closer to 4,200 gallons per month. Rates have been adjusted annually based on changes in a consumer price index; this practice is expected to continue.

MANAGEABLE DEBT BURDEN AND CAPITAL NEEDS

The system currently has just \$20 million in revenue bonds outstanding, leading to a moderate overall debt burden. Key debt ratios are low and compare favorably to the medians for 'AA' category; debt-to-net plant totals just 32% and debt per customer was \$1,035 in fiscal 2013.

The system's infrastructure and water supply are more than sufficient to meet the long-term needs of the community, limiting future capital needs mainly to system renewal and replacement. The city has identified approximately \$42 million in capital needs, which includes approximately \$13 million for phase two upgrade projects for the reverse osmosis water treatment plant and \$5.5 million for wastewater treatment plant upgrades.

The capital plan is flexible and according to management contains a fairly comprehensive list of projects that is likely to be scaled back once the pay-go funding sources are fully determined. Some additional debt is possible, although the city will determine when and how much debt is needed after a comprehensive rate study and updated capital forecast are completed. Fitch expects the debt burden will remain manageable even if additional debt is issued.