Fitch Affs Susanville PFA, CA Water and Gas Util Sr Revs at 'A-'; Sub Revs at 'BBB-'; Outlook Stable

SAN FRANCISCO--(BUSINESS WIRE)--In the course of routine surveillance, Fitch Ratings affirms the following ratings for Susanville Public Financing Authority (PFA), CA, issued on behalf of the city of Susanville:

--$9.7 million revenue refunding bonds, series 2010A affirmed at 'A-';

--$25.2 million revenue refunding bonds, series 2010B affirmed at 'BBB-'.

The Rating Outlook is Stable.

RATING RATIONALE:

--Both series of bonds are secured by unconditional installment payments made by the city of Susanville's water and gas enterprise systems. However, the water system makes installment payments equal to debt service on the senior lien bonds and the gas system makes installment payments equal to subordinate lien debt service. Once the installment payments are received by the trustee, the funds are allocated to senior lien bonds first.

--The sizable rating differential between the two series results from the obligation of each enterprise to only pay debt service on its respective series of bonds (senior 2010A bonds for the water system and subordinate 2010B bonds for the gas system). As such, the subordinate lien bonds rely solely on the gas system for payment.

--The two series of bonds share the benefit of each system's respective rate stabilization funds, which can be used to support a shortfall of either series of bonds. This provides a limited measure of additional credit support to the subordinate lien bonds from the water system's healthy cash reserves. The rate stabilization fund is not a legally restricted fund but the city has designated the funds and use of the funds would require City Council action.

--The systems operate in a limited and concentrated local service area economy.

In addition to the credit factors above, the 'A-' rating on the senior lien bonds reflects:

--Modest but stable financial position of the water utility.--Potential financial pressure that could result from the use of all or a portion of the water rate stabilization fund to support the natural gas system;

--Consistent water supply with low treatment and delivery costs that is sufficient to meet current and expected demand in the city;

--Diverse, albeit small, customer base (which excludes large prisons in the area) with limited growth pressure;

--High debt levels but limited future capital needs that are funded on an ongoing basis from rates.

In addition to the credit factors above, the 'BBB-' rating on the subordinate lien bonds reflects:

--Financial performance of the gas system improved to break-even in fiscal 2010 and exhibited stronger performance based on unaudited results for fiscal 2011, including improved cash reserves;

--Debt service coverage is projected to remain modest around 1.25 times (x), based on the escalating debt service structure and an extended bond amortization schedule with final maturity in 2045;

--The natural gas system is relatively young (service began in 2001) and plans to continue building its customer base, primarily by converting existing businesses and residents to natural gas from existing heating fuel sources given limited growth in the service area.

--Revenue variability may result from a variable-rate structure applicable to certain large customers that pay rates based on the lowest index price of three different heating fuels, regardless of gas costs;

--The city does not have a fuel adjustment factor in its rate structure, but the resulting risk of timing mismatch between expenditures and revenues is partially mitigated by a consistent fuel purchasing strategy;

--Limited counterparty risk exists based on a full requirements contract with Interstate Gas Services Resources (IGI) for natural gas and Tuscarora Gas Transportation Company for transportation services.

KEY RATING DRIVERS:

--Continued success in converting residents to natural gas customers from existing fuel oil and propane heating sources;

--Movement of indexed prices of natural gas compared to heating oil and propane over time given the city's use of a variable-rate structure for certain large natural gas customers;

--Ability and willingness to adjust rates for each system, when needed, to account for cost increases, fuel costs, fund the liquidity reserve at the required amount, and preserve margins for bondholders;

--Continued economic stability resulting from the two prisons in the community that account for over half of the city's employment;

--Depletion of the water system's strong liquidity position could result in a downgrade of both series of bonds.

SECURITY:

Bonds are secured by installment payments made by the city of Susanville, CA from its water and gas enterprise systems to the Susanville Public Financing Authority, which has assigned those payments to the bond trustee. The payments from the city of Susanville are absolute and unconditional.

CREDIT SUMMARY:

Fitch views the natural gas system as significantly weaker in credit quality than the water enterprise, largely because of its recent need for operating subsidies until fiscal 2010, vulnerability to commodity price variability in its rate structure, and the need to grow in order to continue to spread fixed costs over a larger customer base.

COMPLEX TRANSACTION STRUCTURE

The bond repayment structure is complex. The installment sale agreements that the Susanville Public Financing Authority has with each enterprise system only requires each system to make payments equal to the debt service on one series (senior debt service in the case of the water system and subordinate lien debt service in the cash of the gas system). There is no requirement for either system to make additional payments in the event the other system does not make its full payment to the trustee, other than the degree of cross-over support from the rate stabilization fund held by each enterprise that the city may use to make payments to the trustee for either system in the event that net revenues are insufficient. In the case of the gas system, access to the water system's $3 million rate stabilization fund provides a degree of additional financial support.

REMOTE SERVICE TERRITORY

The city of Susanville is located in northeastern California, approximately 85 miles northwest of Reno, Nevada, and 135 miles northeast of Sacramento, California. Susanville is the county seat of Lassen County. Its location is fairly remote and the local economy is concentrated in the employment provided by two prisons (one state and one federal). The population of the city is around 17,500 but this includes an inmate population of around 8,000. The two prisons account for over 50% of the city's employment. The prisons are not direct customers of either the water or gas enterprise systems. They have their own water and natural gas supplies but they do use the city's natural gas transportation services to deliver the gas.

HEALTHY WATER ENTERPRISE

Financial performance of the water system is modest but consistent. Debt service coverage has been over 1.4x in the past three years, resulting in surplus revenues annually of between $300,000 and $400,000. Liquidity is robust with $3.4 million at the end of fiscal 2010, or 1,107 days operating cash. Debt levels are high at $2,500 per customer for a system with limited treatment operations. However, the enterprise fund does not anticipate additional debt issuance in the near future. The water system has provided liquidity support via inter-fund loans to the gas system in the past. However, any significant use of its operating reserves to support the gas system or an ongoing demand on its surplus revenues, as pledged, could result in a deterioration in credit quality of the senior lien credit rating.

START-UP GAS ENTERPRISE

During its initial years, the start-up nature of the gas enterprise resulted in the need for the gas system to rely on the city's general fund and water fund for operating cash. In fiscal 2010, the system began to break even, including coverage of its debt obligations, no outstanding loans from the water system or general fund, and positive year end cash reserves. Fiscal 2010 was the first year the natural gas fund ended the year with a positive cash balance ($84,173). Based on unaudited information provided to Fitch by management, fiscal 2011 appears to have been another good year for the system financially. The natural gas system accumulated $1.36 million in cash reserves, The city was able to build reserves through unbudgeted customer growth, lower than budgeted natural gas prices on the unhedged portion of its portfolio, and lower debt service costs in fiscal 2011 due to the refunding and principal that does not begin to amortize until 2012. Reserves must grow to a funding level of $1.8 million as required by the bond indenture to fund the natural gas system's rate stabilization fund.

Debt levels at the gas system are high and will remain high with the slow amortization although no additional debt is expected for the system. Principal begins to amortize in fiscal 2012, which will reduce the margins of the system. Financial projections provided by the city indicate that with the escalating debt service on the 2010B bonds, 1% growth in revenues, and 1% growth in expenses (including natural gas commodity purchases) debt service coverage should exceed 1.25x. Projections indicate surplus annual revenues should exceed $400,000.

For more information on the system, see Fitch Report 'Susanville Public Financing Authority, CA', dated Aug. 19, 2010.

Additional information is available at 'www.fitchratings.com'

In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

'Revenue-Supported Rating Criteria', \ June 20, 2011;

'Public Power Rating Guidelines', March 28, 2011;

'Water and Sewer Revenue Bond Rating Guidelines', Aug. 6, 2008.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=613065

Water and Sewer Revenue Bond Rating Guidelines

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=395918

Susanville Public Financing Authority (CA) (Utility Enterprise Project Revenue Bonds)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548186

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.