SAN FRANCISCO--()--Fitch Ratings affirms the following rating for Susanville Public Financing Authority (Susanville PFA), CA:
--$9.35 million senior lien revenue refunding bonds at 'A-'.
Fitch also upgrades the following bonds for Susanville PFA:
--$25.2 million subordinate lien revenue refunding bonds to 'BBB' from 'BBB-'.
The Rating Outlook for all bonds is Stable.
The bonds are secured by installment payments made by the city of Susanville, CA from its water and gas enterprise systems to the Susanville PFA, which has assigned those payments to the bond trustee. The payments from the city of Susanville are absolute and unconditional.
KEY RATING DRIVERS
UPGRADE ON SUBORDINATE LIEN: The upgrade on the subordinate lien bonds reflects the positive cash flow at the gas system in the last two years and full funding of the system's $1.8 million rate stabilization fund.
SENIOR/SUBORDINATE BOND STRUCTURE: Both series of bonds are secured by unconditional installment payments made by the City of Susanville's water and gas enterprise systems. However, subordinate lien bonds are effectively secured only by the gas system revenues.
SHARED RATE STABILIZATION FUNDS: 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. Debt service reserve funds are in place for each series but do not provide cross-support to the other series.
LIMITED SERVICE AREA: The systems operate in a limited and concentrated local service area economy. Wealth levels are below state and national averages and unemployment in the county is high at 15.5% as of March 2012.
WATER SYSTEM: The rating on the senior lien bonds reflects the modest but stable financial margins of the water system, low treatment and delivery costs, diverse but small customer base and very high debt burden.
GAS SYSTEM: The rating on the subordinate lien bonds reflects the positive cash flows at the gas system, continued conversion of customers to natural gas, risk of revenue variability and fixed rates, very low commodity costs, and a very high debt burden used to build the system that began service in 2001.
WHAT COULD TRIGGER A RATING ACTION
DECLINE IN RESERVE LEVELS: Depletion of the strong reserves at both systems could result in a downgrade of both series of bonds.
UPGRADE REFLECTS IMPROVED CASH RESERVES AT GAS SYSTEM
The gas system has built its cash reserves from $84,000 at the end of fiscal 2010 to approximately $2 million estimated at the end of fiscal 2012, or 274 days operating cash. Stronger cash flow than originally anticipated has resulted from favorably low natural gas prices and faster paced customer conversions within the city from traditional heating sources. Water system reserves remain strong at over $3.6 million at the end of fiscal 2011, or over 1,000 days operating cash, given the small size of the system budget.
The shared rate stabilization funds provide a limited measure of additional credit support to the subordinate lien bonds from the water system's strong cash reserves. However, the indenture established rate stabilization fund requirement ($1.8 million for the gas system and $3 million for the water system) is based on all the utility's cash reserves. Although the city has set aside a portion of its cash in separate accounts, the fund is not legally restricted like the debt service reserve fund.
SENIOR/SUBORDINATE BOND STRUCTURE IS COMPLEX
While the senior and subordinate bonds enjoy a combined pledge of both systems, the difference in the two ratings reflects the structure of the payments and a dependence of the subordinate lien bondholders on payments from the city's natural gas system. Fitch views the natural gas system as weaker in credit quality than the water enterprise, largely because of its growth through the conversion of existing customers to natural gas, vulnerability to commodity price variability in its rate structure, and its slowly amortizing and escalating debt burden.
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 (series 2010A debt service in the case of the water system and series 2010B 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. The only degree of cross-over support are the rate stabilization funds.
LIMITED AND CONCENTRATED SERVICE AREA
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 count 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).
Susanville has a city population of around 9,500, and much of the city's economy revolves around two large correction facilities with a combined prison 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.
STABLE WATER ENTERPRISE FUND
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. Financial performance is expected to remain in this range. Liquidity is robust. Debt levels are high at $2,439 per customer for a system with limited treatment operations, and debt amortization is slow with only 29% and 71% of debt repaid in the next 10 and 20 years, respectively.
Water supply is provided by two springs and supplemented by four wells in summer months when usage is the highest. The water sources require minimal treatment or pumping, which keeps rates low. Rates were last increased in 2008 and are affordable at approximately $30 per month, or 1% of median household income. A component of the rates is designed to fund ongoing water main replacement and future capital needs are expected to be paid from this source. Customer concentration is not a credit concern with the top 10 customers accounting for only 10% of revenues and water revenues been relatively stable even through recent fluctuations in weather conditions across the state.
GAS ENTERPRISE GENERATING POSITIVE MARGINS
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. Fiscal 2010 was the first year the natural gas fund ended the year with a positive cash balance of $84,173. Cash balances grew to $1.3 million at the end of fiscal 2011 and based on unaudited information provided to Fitch by management, fiscal 2012 is expected to end at approximately $2 million. Debt service coverage in fiscal 2012, the first year of principal amortization, is projected above 1.3x, and management expects to coverage to remain above the 1.25x rate covenant going forward. Slight growth in customers is expected to keep pace with escalating debt service costs. Amortization of the debt is very slow with only 10% and 33% of debt maturing in the next 10 and 20 years, respectively. The gas distribution pipelines are relatively new and capital needs are limited to the city's possible decision to expand its distribution system beyond the city limits.
The city's gas rates do not include a fuel cost adjustment to track movement in natural gas prices, as is typically done by investor-owned utilities. However, commodity price risk is reduced by the city's practice of forward hedging for much of its winter gas needs. While this may result in above-market prices given the nature of purchasing ahead, it provides a more known and stable gas cost to the utility. The city's rate structure is exposed to variability in that 23% of its revenues are under variable rate pricing that allows customers to pay the lowest fuel cost of natural gas, propane, and fuel oil. The historic low natural gas prices in recent year are expected to continue, reducing any near-term risk from this rate structure. Customer concentration exists with the top 10 customers providing 27.5 of gas system revenues in fiscal 2011. Top customers include the hospital, community college, and the county.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria