SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms the following city of Fresno, California, water revenue bond ratings:
--$144.2 million subordinate lien bonds at 'A+';
--$6.9 million senior lien bonds at 'AA'.
The Rating Outlook is revised to Stable from Negative.
SECURITY
The bonds are secured by net revenues of the water system excluding connection fees.
KEY RATING DRIVERS
OUTLOOK REVISED ON CITY FINANCES: The Outlook is revised to Stable due to improved financial performance in the general fund, which has regained structural budget balance and repaid its outstanding loan from the water fund. Fitch affirmed the city's implied ULTGO rating at 'BBB+' and revised its Outlook to Stable today.
SOLID FINANCIAL PERFORMANCE: The utility's financial performance has been very strong in recent years with coverage and liquidity above 'AA' medians. Coverage and liquidity are likely to decline as the utility makes large investments in surface water treatment capacity.
RATE CONTROVERSY, UNCERTAINTY: The city rolled back rates to 2013 levels after ratepayers sued to force a vote of the public on large rate increases needed to finance a new water treatment plant needed to reduce over-reliance on groundwater. The city is currently reconsidering capital spending and borrowing plans.
OVER-RELIANCE ON GROUNDWATER: Fresno and adjacent water users have over-pumped ground water for many years. The city has significant unused surface water supplies that could be tapped to restore the basin and create a high degree of drought resilience if policymakers can convince the public to pay for the project.
GROWING DEBT BURDEN: The utility's debt burden is above average and likely to rise as the city addresses groundwater overdraft conditions.
SIGNIFICANT, STRESSED SERVICE AREA: The system provides retail water services to an area with about 510,000 residents. The city is the economic hub of the San Joaquin Valley, one of the nation's most productive agricultural regions. The city's economy is recovering but remains stressed following a very deep economic downturn.
NOTCHING OF LIENS: The senior lien is rated two notches higher than the subordinate working lien, reflecting the closed senior lien and extraordinarily high debt service coverage.
RATING SENSITIVITIES
FAILURE TO ADDRESS SUPPLY CONCERNS: The rating could come under downward pressure if the utility fails to secure rates necessary to create a sustainable water supply plan or if financial performance weakens more than expected.
PRESSURE FROM STATEWIDE DROUGHT: The rating could come under downward pressure if the current, severe California drought forces multiyear water rationing that reduces financial margins and reserve levels more than expected.
CREDIT PROFILE
The utility is a monopoly provider of essential water services to California's fifth most populous city with about 510,000 residents. It is located about 250 miles north of Los Angeles in the heart of the agricultural San Joaquin Valley. The unemployment rate was 9.4% in August 2014. Median household income was 79.7% of the national level and the poverty rate was almost twice the national rate at 27.5% in 2012.
WEAKER FINANCIAL PERFORMANCE EXPECTED
The utility's financial performance has been very strong, but is expected to decline to levels that are more consistent with the current ratings as it implements a large, debt-financed capital improvement plan. Senior lien debt service coverage averaged an extraordinary 14.0 times (x) over the three fiscal years ended June 30, 2013, while all-in coverage averaged a solid 1.6x. Unaudited results for 2014 show 30.7x senior coverage and very strong 3.0x all-in coverage.
The utility is in the midst of a large capital program that is likely to increase debt service significantly and move coverage down to just above 1.4x over the next five years. The city is currently formulating the details of its rate and capital plans and doesn't currently have a five-year financial forecast.
LIQUIDITY RECOVERS
Cash levels recovered to a solid level in 2013 after a temporary dip in 2012 due to capital spending and early payment of capital charges related to the federal Central Valley Project. Unrestricted cash and investments rose to $40.6 million, or 330 days cash, at the end of fiscal 2013, from $11.6 million, or 89 days cash at the end of 2012.
The city's parking enterprise (recently folded into the general fund) took a $9 million loan from restricted water funds in fiscal 2012. The loan has since been repaid several years ahead of schedule as general fund revenues recovered more than expected in fiscal 2014. Fitch maintained a Negative Outlook on the water revenue bonds while further borrowing appeared a risk to water revenue bondholders, but the risk appears to have receded.
RATE CONTROVERSY & CAPITAL PLAN UNCERTAINTY
The city's rate, capital and borrowing plans are currently uncertain due to the rate controversy. The city recently rescinded four years of rate hikes that would have increased bills by 80% between 2014 and 2017. The rate hikes were passed in 2013 to support a large investment in surface water treatment capacity to relieve pressure on Fresno's over-drafted groundwater basin. The city rescinded the rates as part of a legal settlement with a ratepayer, who had sued the city and collected enough signatures to put the rate increases to a vote of the people.
The city is currently holding community meetings on a long-term water supply plan and reformulating its rate and capital plans. Fitch expects the city to present a somewhat scaled back or phased version of the earlier plan with lower rate increases in the near term but largely the same sort of capital investments over time. Fitch also expects that management would limit leverage to maintain its goal of keeping all-in debt service coverage at 1.4x or better. The rating could come under pressure if the city reduced its financial targets to accommodate more debt with smaller rate increases.
IMPORTANCE OF SUPPLY PLANNING
The rating could also come under pressure if the city failed to get community support for at least the capital projects that are necessary to stabilize its declining groundwater levels. Supply pressures are likely to emerge over a long time frame, but they could have a significant impact on the rating if the community's unwillingness to bear rate increases leads to difficulty in providing essential water services.
Fresno has long relied on its large and productive groundwater basin to provide water at very low prices. Overpumping has reduced groundwater levels and does not appear sustainable. The city planned to use its rights to significant surface water (via contracts with the federal Central Valley Project and the Fresno Irrigation District) to stabilize the groundwater basin by shifting to surface water usage in wet years. The move could position the city quite well with much greater drought resilience than the typical California water utility.
HIGH & RISING DEBT BURDEN
The utility's debt burden was slightly below average at about $1,553 per customer or $397 per capita at the end of fiscal 2013. The city does not currently have an approved capital plan, but it planned about $350 million of borrowing before rates were rejected. While the outcome of the rate and capital planning process is uncertain, the city appears likely to undertake borrowing that will add significantly to the debt burden.
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 informed by information from CreditScope and IHS Global Insights.
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=750012
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=912314
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