Fitch Affirms Atwater Public Financing Auth, CA's Sewer Revs at 'BB'; Outlook Revised to Positive

SAN FRANCISCO--()--Fitch Ratings has affirmed its 'BB' rating on the following Atwater Public Financing Authority, CA (the authority) obligations issued on behalf of the City of Atwater, CA (the city):

--$19.225 million wastewater revenue bonds, series 2008.

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds are secured by installment payments made by the city to the trustee as assignee of the authority. The city's obligation to make installment payments is secured by a pledge of gross revenues of the city's sewer system (the system). The bonds are also secured by a cash-funded debt service reserve fund (DSRF), funded at the maximum amount allowable by law and held with the trustee.

KEY RATING DRIVERS

STRUCTURAL BALANCE EXPECTED; INTERFUND LOANS REMAIN OUTSTANDING: The Positive Outlook reflects the city's recent revenue-raising actions designed to eliminate structural imbalances in the city's general, water and sanitation funds thus reducing pressure on the sewer fund. According to management, all funds are now structurally balanced and will require no additional interfund loans.

STABILIZED POOLED CASH: The city's pooled cash position has stabilized after drawdowns due to deficits accumulated in various funds. System pledged revenues are included in the city's pooled cash and, as a result, is owed money from these other operations. Council new interfund loan policy combined with the improved operations of city funds reduce the likelihood of future draws on system cash.

WILLINGNESS-TO-PAY CONCERNS LESSENED: The city had considered entering into confidential negotiations with creditors under California's A.B. 506 process or petitioning for Chapter 9 bankruptcy protection. Given the new revenues, two years of balanced budgets and modestly improving economy, Fitch believes this risk is significantly diminished.

LOWER COVERAGE LEVELS TO CONTINUE: Recent bond issuances resulted in narrow system debt service coverage (DSC) levels. Fiscal 2012 resulted in a very slight increase in coverage and unaudited fiscal 2013 results show further modest improvement after a drop to near sum-sufficient in fiscal 2011 including transfers out to other city funds.

HIGH DEBT, SLOW AMORTIZATION: The city's recent succession of debt issuances to complete construction of a new wastewater treatment plant in order to comply with environmental requirements has resulted in high debt levels and slow amortization.

LIMITED SERVICE AREA AND RATE FLEXIBILITY: Monthly charges are substantially higher than surrounding communities and Fitch's affordability threshold. Recently implemented increases in water and sanitation rates may further pressure the base. Moreover, the service area's below-average income metrics and high unemployment challenge the city's ability to increase rates in the future.

RATING SENSITIVITIES

CONTINUED FISCAL SUSTAINABILITY: Given the sound performance of the system itself, continued progress towards structural balance across all funds and increased overall liquidity could result in a rating more reflective of system performance than risks from the city's other funds. Positive rating action could result in a rating upgrade to 'BBB' category.

WILLINGNESS TO PAY: Fitch's ongoing review will consider both future actions by the city that could affect the system as well as any developing external system pressures. A return to consideration of the A.B. 506 process or vote to petition for Chapter 9 bankruptcy protection would put into question the city's willingness to pay and place severe credit pressure on the rating.

CREDIT PROFILE

FAVORABLE ACTIONS TO ACHIEVE STRUCTURAL BALANCE

The Positive Outlook reflects the city's actions to date to address structural deficits in the general, water, and sanitation funds through fiscal year 2013 that stemmed largely from declining revenues, rising expenditures, and failure to raise rates in the water (for 20 years) and sanitation funds (for 10 years). For the general fund, home values dropped severely during the downturn, significantly reducing property tax revenues. In addition, almost all other general fund revenues, with the exception of sales taxes, also experienced declines.

To boost revenues and move towards budgetary balance, the city recently implemented a five-year water rate package that increased rates for typical users by 40% for fiscal 2014, followed by additional increases of 15% annually through fiscal 2018. Further, the city implemented a sanitation rate increase that increased rates 63% for fiscal 2014, followed by 6%-7% annual increases through fiscal 2018. The city had implemented a series of sewer rate increase through fiscal 2012 to fund increased debt service costs and does not expect any additional increases in the near term. While Fitch views the actions as positive, the combined water/sewer rates are now $90.50 per month, or 2.6% of median household income. Rates are well above those of surrounding communities and Fitch's affordability threshold; as such, system rate flexibility is likely constrained.

On the general fund side, in March 2013 voters approved a 10-year one-half-cent sales tax restricted for public safety spending. The sales tax is expected to generate $1.5 million, $1.1 million of which will be used to restore salary increases for public safety. While these funds are not expected to increase reserve levels, it will improve cash flow and reduce what otherwise could have been significant wage pressure.

IMPROVED FINANCIAL POSITION

The structural imbalances in the city's general, water, and sanitation funds over the last few years eroded the city's fiscal capacity and led to a sharp reduction in city pooled cash resources. The drawdown of pooled cash negatively affected system cash balances. According to management, all funds are now self-supporting and will require no additional interfund transfers from the sewer fund. Further, the council recently adopted an interfund transfer policy requiring council approval of transfers and more transparent reporting. The sewer fund is still owed about $1.5 million from other funds and management expects repayment will take some time. Repayment is not considered in the rating for the system bonds.

According to unaudited fiscal 2013 data and fiscal 2014 estimates, the system is generating positive cash flow and the city projects debt service coverage for fiscals 2013 and 2014 of 1.3x and 1.4x, respectively. Currently, pooled cash balances of $9.5 million (as of Jan. 1, 2014) are sufficient to meet a $3.2 million system debt service payment due May 1.

WILLINGNESS-TO-PAY/ACCELERATION CONCERNS LESSENED

The city council declared a fiscal emergency in October 2012, but did not pursue any additional steps to erode its perceived willingness to pay system bonds. Moreover, in November 2012 the city council closed discussion related to possible confidential mediation process with creditors pursuant to the state's A.B. 506. The city also passed a fiscal year 2013 budget in February 2013 and an operationally balanced budget for fiscal 2014 in June 2013.

Fitch does not currently anticipate that the city will enter into the A.B. 506 process and/or file for Chapter 9 bankruptcy protection.

REGULATORY ISSUES LED TO ELEVATED DEBT PROFILE

The system currently operates one wastewater treatment plant (WWTP). The authority has issued approximately $64 million in wastewater revenue bonds since 2008 - nearly tripling outstanding system debt - to construct the new WWTP. The WWTP was designed to comply with more stringent requirements associated with the system's discharge permit, including a move to tertiary treatment standards. As a result of the authority's recent debt issuances, system per customer and per capita debt levels are 5x-8x higher than Fitch's national medians. In addition, amortization of principal is very slow, with just 44% of principal retired in 20 years.

SMALL AND STRAINED SERVICE AREA

Atwater is located in northeast Merced County, in the central portion of California's San Joaquin Valley. With a population of about 28,000, it is a small agricultural based community with a federal prison at the site of the former Castle Air Force Base, which closed in 1995. The sewer system provides wastewater collection, treatment, and disposal to the city's residents and to the Town of Winton (population of about 9,000), a U.S. penitentiary (inmate population of around 1,200), and Castle Airport Aviation. These three customers combined provided about 25% of service charge revenues in fiscal year 2013.

Typical of agricultural communities, unemployment levels (13.9% for November 2013) are well above state and national averages while income levels are below average. The area has experienced a significant slowdown in growth in the past several years as exemplified by a sharp decline in connection fee revenues and city assessed values (AV). AV increased moderately in fiscal year 2014.

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

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 3, 2013);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);

--'2014 Water and Sewer Medians', dated Dec. 12, 2013;

--'2014 Outlook: Water and Sewer Sector', dated Dec. 12, 2013.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=822975

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Contacts

Fitch Ratings
Primary Analyst
Shannon Groff, +1 415-732-5628
Director
Fitch Ratings, Inc.
650 California St., Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Scott Monroe, +1 415-732-5618
Director
or
Committee Chairperson
Karen Ribble, +1 415-732-5611
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Shannon Groff, +1 415-732-5628
Director
Fitch Ratings, Inc.
650 California St., Fourth Floor
San Francisco, CA 94108
or
Secondary Analyst
Scott Monroe, +1 415-732-5618
Director
or
Committee Chairperson
Karen Ribble, +1 415-732-5611
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com