Fitch Rates Tallahassee, Florida 2005 Elec Rev Bonds 'AA-'; Negative Outlook.

NEW YORK -- Fitch Ratings assigns a rating of 'AA-' to the City of Tallahassee, FL's (the city) $125.9 million of series 2005 electric revenue bonds. The 'AA-' ratings are affirmed on the city's outstanding $205 million senior lien bonds. The Rating Outlook is now Negative.

Proceeds from the 2005 bonds will replenish the city's cash and construction reserves used to finance the acquisition and construction of two 47 MW simple cycle combustion turbines (to be located at the city's existing Hopkins station site), and also fund certain capital improvements to the city's transmission and distribution systems. The bonds are expected to price the week of Nov. 21, 2005 with Bear, Stearns & Co, Inc. as senior manager and Goldman Sachs as co-senior.

Tallahassee's Negative Rating Outlook primarily takes into account Fitch's concern with the electric systems' lack of fuel diversity and above average retail rates. The city's owned generation assets are almost exclusively natural gas-fired. The reliance on a single fuel is a risk. Currently elevated natural gas prices are expected to result in upward clearing prices in the Florida wholesale power market, as gas prices have yet to return to pre-Hurricane Katrina levels. However, most of the comparable municipal and investor owned utilities in the Southeast region benefit from a more diverse resource mix than Tallahassee, and therefore have operating costs that are somewhat less directly correlated to changes in the price of a specific fuel.

Of note, the city made it through Hurricane Katrina without serious service disruption. But, the utility is expected to initiate electric base rate increases in April 2006 and April 2008, following the 14% fuel adjustment that became effective Oct. 1, 2005. Indicative of the electric system's sensitivity to natural gas prices, the utility estimates, based on the utility's 2005 system average heat rate (and purchase power mix), that a $1.00 increase in natural gas prices translates to a $6.9 per 1,000 KWh effect on the city's retail rates. As such, sustained gas prices in the $10-$11/mmbtu range would translate into residential retail rates of approximately $132 per 1,000 KWh, which could place their rates at the significant upper end of utilities in Florida.

Support for the city's current credit rating reflects Tallahassee's diverse and stable service territory (driven largely by government employment, the presence of two major universities, and a growing health care sector) as well as management's ongoing efforts to reduce non-fuel related operating and maintenance expenses. Future efficiency measures are projected to save the city an additional $25-$50 million annually, and include the planned re-powering of the Hopkins Unit 2 and other process improvements. These savings should fully offset increases in debt service associated with the utility's capital plan. Sales of excess SO2 allowances are also expected to save the utility approximately $5.4 million per year (at today's market price of $900/ton) and will be used to partially offset energy cost recovery charges. Debt service coverage, is projected to remain above 2.0 times (x) through 2010, and is supportive of the rating category.

Looking forward, Fitch would like to see the city maintain strong liquidity, low leverage, and strong debt service coverage in line with other 'AA' systems. Cash reserves of $119 million net are currently equivalent to 144 days working capital, and provide some security in the event of sustained volatility in the wholesale power or natural gas markets. Nonetheless, there is concern that a prolonged period of elevated natural gas prices could result in political or community pressure motivating the utility to absorb some of the fuel costs rather than directly passing along these costs. This would place pressure on the electric system's financial position and could result in a lower rating.

At this point, Fitch recognizes favorably the city's fuel cost recovery mechanism and constructive governance environment which has allowed management to pass through elevated fuel charges to retail customers during this period, with no apparent political pushback. Efforts to improve fuel diversity are also viewed positively. Fitch also expects the city's retail rate levels relative to its peers will narrow somewhat, as both of the regional IOUs have petitioned the state public service commission for rate increases in recent months.

The City of Tallahassee provides electric generation, transmission and distribution service to more than 107,000 customers.

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