OREANDA-NEWS. Fitch Ratings has assigned an 'AA' rating to the following Winter Haven, FL (the city) revenue bonds:

--\$23 million utility system refunding revenue bonds, series 2015.

The bonds are expected to sell via competition the week of Feb. 2.

Proceeds will be used to advance refund a portion of the outstanding series 2005 bonds for interest savings and pay issuance costs.

In addition, Fitch affirms the following outstanding ratings:

--Approximately \$29 million utility system revenue bonds (prior to the refunding), at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a first lien pledge of the net revenues of the city's water and sewer utility system (the system), a portion of system development charges (impact fees) collected, and amounts on deposit in funds and accounts established under the resolution (excluding the rebate fund). The series 2015 bonds will not be covered by a debt service reserve.

KEY RATING DRIVERS

STRONG FINANCIAL METRICS, HIGH TRANSFERS: Financial margins are strong, leading to healthy debt service coverage (DSC) and liquidity. While metrics are expected to remain strong, the doubling of the annual transfer to the general fund (GF) beginning in fiscal 2013 significantly reduces financial flexibility.

MANAGEABLE CAPITAL NEEDS: Overall infrastructure capacity is solid, although lower capital spending in four of the past five years suggests a rise in deferred maintenance and potentially larger future capital requirements.

FAVORABLE DEBT PROFILE: Debt metrics are mostly favorable and have been slowly improving over the past five years. The debt burden is expected to continue to trend lower as the system has limited near-term borrowing plans.

AFFORDABLE RATES FOR AVERAGE USER: Rates for the average residential customer using 5,000 remain affordable. A multi-year rate ordinance increased rates by roughly 20% since 2011.

LIMITED LOCAL ECONOMY: The local economy is somewhat limited but slowly recovering from the recession and housing downturn.

RATING SENSITIVITIES

PROLONGED GF TRANSFERS: Continuation of large transfers-out to the general fund without a policy to sustain strong financial metrics and protect the long-term health of the system would likely result in downward rating pressure.

CREDIT PROFILE

The city ('AA-' implied GO) is located in Polk County ('AA' implied GO), about 50 miles southwest of Orlando and 50 miles east of Tampa. The system's service area includes the city, with an estimated population of about 34,000, Garden Grove (a subdivision in unincorporated Polk County), and unincorporated portions of Polk County. The system serves about 33,000 water accounts, 20,000 wastewater customers and a population of approximately 95,000 in total.

LIMITED LOCAL ECONOMY

The service area is mostly residential and the economy, which is mainly service and retail-based, is still recovering from the recession and housing downturn. Employment and population growth are positive and development is continuing. Winter Haven is home to the LegoLand theme park which opened in 2011. The unemployment rate for the county has been on a steady decline to 7.3% in October 2014 due to employment growth of about 4% over the past two years but remains above state and national levels. Wealth levels throughout the service area are generally below state and national averages.

STRONG FINANCIAL PERFORMANCE AND METRICS

Financial results have been solid historically despite recessionary pressures that led to a drop in margins and DSC in fiscal 2009. The city prudently approved and implemented a multi-year rate package that incrementally increased rates by 20% through fiscal 2015. The new rates coupled with lower operating costs led to a rise in operating margins (to over 40%) and stronger DSC reaching 3.1x in fiscal 2012 (2.2x net of GF transfers).

Unrestricted cash and investments totaled \$15.2 million at fiscal-end 2012, a roughly 80% increase since fiscal 2010, which is due to a combination of the increased margins and limited capital spending. Coupled with about \$3.8 million in renewal and replacement funds, the system's overall liquidity position was a very healthy 518 days cash on hand in 2012.

Strong financial performance continued in fiscal 2013 with another rise in operating income, and higher DSC of 3.4x. However, the increased GF transfer led to much lower, but still adequate 1.7x coverage of total fixed costs (debt service and transfers). Liquidity declined slightly but remained very strong despite a sizable increase in capital spending. Capital acquisition totaled more than \$7.7 million, or a solid 138% of annual depreciation in fiscal 2013 and nearly as much as was spent in the three prior years combined. The city used grant money and impact fees to meet most of these costs, allowing the ample liquidity to remain largely intact.

Preliminary financial results for fiscal 2014 (from recurring revenues) show a decline in DSC to 3.2x, and to 1.6x including transfers to the GF. Proceeds of a land sale provide approximately \$4.5 million in additional income, which is expected to be used for capital projects. The fiscal 2015 approved budget indicates another decline in coverage on the bonds to 3.0x, and to 1.3x including the GF transfers.

Rates for the average residential customer remain affordable assuming 5,000 gallons of use. When assuming use more typical of residential customers nationally (7,500 gallons), rates are still competitive but are 2% of median household income, raising affordability concerns. On the positive side, the city's rate ordinance includes automatic inflation-adjusted rate increases that do not need council approval, tempering concerns over future willingness to increase rates.

DECLINING FREE CASH FLOW REMAINS AN INTERMEDIATE-TERM CONCERN

The system historically transferred approximately \$3.2 million annually to the city's GF to help reimburse the city for indirect costs. There is currently no formal policy regarding this transfer, which doubled in fiscal 2013 to more than \$6 million. The increase in the GF transfer allows the city to avoid an increase in the ad valorem tax rate for the GF. While transfers to the GF are not uncommon, the near doubling of the transfer to roughly 24% of gross system revenues is somewhat unusual and akin to a subsidy payment. The lack of a formal policy regarding future transfers is somewhat concerning for Fitch.

A slightly smaller transfer is expected in fiscal 2014 (preliminary and unaudited) of about \$5.9 million; although the 2014 transfer is still significantly higher than historical amounts and well-above industry norms. Similar amounts are budgeted for fiscals 2015 and 2016. Fitch believes the system's strong cash flows, very healthy liquidity, and use of one-time revenue sources (land sales associated with the system, for instance) allow it to absorb a temporary increase in transfers.

However, the depletion of excess cash flow for non-system purposes, if prolonged, could cause an increase in the debt burden and/or a decline in liquidity to meet ongoing capital needs, or the deferral of necessary maintenance. This depletion of excess system cash flow could lead to significant degrading of system assets over time. Management has indicated that its goal over the next three to four years is to incrementally reduce the transfer to levels closer to the \$3.3 million payment prior to fiscal 2013. Fitch will continue to monitor progress made with respect to lowering the transfers out, and what, if any, impact the transfers have on system credit fundamentals.

UNCERTAIN OUTCOME TO LANDINGS LITIGATION

The city is facing litigation tied to a development project in which the city agreed to sell property to a developer, the Landings Partners LLC, for a mixed-use project. The city terminated the land sale citing a breach of contract by the developer and the developer has since filed a lawsuit against the city. The developer is seeking damages of as much as \$31 million. The city believes the damages claim is excessive, and has stated it would satisfy a judgment, if any, from any one or a combination of reserves, operating resources, or additional indebtedness. A timeframe for resolution of the litigation is unknown.

While not a claim against the system directly, Fitch is concerned a large judgment against the city (or settlement) could impact the system given the open flow of funds and high reliance the GF already has on system transfers. Fitch will closely monitor the legal proceedings given the magnitude of the damages claim.

SOLID INFRASTRUCTURE CAPACITY

The system has adequate existing raw water supply drawn from more than 20 Floridan Aquifer wells located throughout the service area that require only primary treatment. Officials secured a long-term consumptive use permit (CUP) from the Southwest Florida Water Management District that increased withdrawal capacity to just over 14 million gallons daily (mgd), which comfortably exceeds the average daily demand of about 9 million gallons per day (mgd) for fiscal 2014.

However, in early 2014 the city discovered a sinkhole had developed under one of its treatment facilities, the 2.6 mgd Winterset Gardens facility. The facility, which serves primarily the southern portion of the service area, temporarily lowers capacity until the plant and well can be replaced. Nevertheless, the current groundwater allotment should be sufficient for the next 15 years. The modified CUP expires in 2030.

The city's two wastewater treatment plants (WWTPs) have a total permitted treatment capacity of 9.2 mgd, which compares well to the average daily flows of 4.6 mgd in fiscal 2014 (70% utilization). The system provides some reclaimed water for re-use, however the majority of its effluent is discharged to a nearby surface water body. After the expected expansion and upgrade of WWTP #2, both facilities will treat to advanced standards, which will lower the city's exposure to increased limits for biological nutrient removal. Both treatment plants have current operating permits (WWTP#2's permit expires in April 2019, the larger plant's permit expires in August 2016) and the system is facing no regulatory issues.

MANAGEABLE CAPITAL NEEDS BUT INCREASE IN DEFERRED MAINTENACE

Capital needs are manageable with a five-year capital improvement plan (CIP) totaling \$36 million, or \$702 per customer. No additional debt is planned, which will keep debt levels low, although the city has not ruled out a small debt financing to replace the Winterset Gardens facility. The city is currently awaiting determination by its commercial insurance provider on whether the plant is covered by a provision in its policy for catastrophic ground cover collapse. If the plant does not qualify for insurance coverage, the city estimates it will cost \$5 million to replace the facility.

Debt metrics remain somewhat mixed with most ratios comparing favorably to the medians for 'AA' category. For fiscal 2013, debt per customer and debt per capita were \$1,077 and \$583, respectively, and debt carrying costs are a very reasonable 15% of gross revenues. Debt to net plant is a fairly high 92% in 2013 (compared to 50% median) but is 4.5x equity, which is favorable compared to the median of 6.5x.

Funding of the CIP will primarily come from system development fees and other internal sources. An additional \$6.5 million in capital funding is expected to come from the sale of city-owned land in 2016 (phase two). If development fees do not produce at projected levels, or if the land sale is delayed, the CIP could be adjusted and/or deferred accordingly. The absence of any regulatory mandates provides the city flexibility to defer capital projects if needed. However, Fitch is concerned that the average age of plant is rising and a delay in capital expenditures will lead to further deferred maintenance.