NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings for Susanville Public Financing Authority (SPFA), CA:
--$8.9 million senior lien revenue refunding bonds at 'A';
--$24.5 million subordinate lien revenue refunding bonds at 'BBB+'.
The Rating Outlook 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 SPFA, which has assigned those payments to the bond trustee. The payments from the city of Susanville are absolute and unconditional.
KEY RATING DRIVERS
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 gas system revenues.
SHARED RATE STABILIZATION FUNDS: The two series of bonds share the benefit of each system's respective rate stabilization fund, 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 remained high during 2014 at 8.9%. Government employment accounts for more than 50% of the city's work force.
STATE IMPOSED WATER CURTAILMENTS: California has imposed mandatory water conservation of 36% for the city. The City's compliance could result in revenue loss thus further pressuring the City's already modest financial margins. While the diversion of funds from capital and infrastructure spending to debt service could mitigate the shortfall, Fitch notes that the City has yet to publicly adopt a formal mitigation plan.
GROWING GAS SYSTEM: The rating on the subordinate lien bonds reflects the positive cash flows at the gas system, system growth through continued conversion of customers to natural gas, risk of revenue variability, low commodity costs, and a debt burden which remains high since start-up financing of the system that began service in 2001.
PRESSURE FROM STATEWIDE DROUGHT: Pressure on water system financial margins is expected to occur based on the very large curtailment the city must impose on its water sales and the primarily volumetric rate structure. The City's inability to mitigate the resultant revenue loss could result in downward rating pressure.
INCREASED NATURAL GAS PRICES: Upward movement in the price of natural gas as compared to heating oil and propane over time could result in reduced revenues to the gas system given the city's use of a variable rate structure for certain large gas customers.
DECLINE IN RESERVE LEVELS: Depletion of the strong cash reserves at both systems could pressure the rating and/or outlook of either series of bonds.
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 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).
Susanville has a city population of approximately 9,100 and much of the city's economy revolves around two large correction facilities with a combined prison population of around 6,700. The two prisons account for about 46% 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 portion of the city's natural gas distribution system for transportation services.
WATER RESTRICTIONS PRESENT NEAR-TERM CHALLENGES
On April 18, 2015, as a response to the Governor's recent executive order to reduce annual water usage by 25% over 2013 levels, the State Water Resource Control Board (SWRCB) issued a revised plan for mandatory water cuts for all of California's water providers. The city's required reduction is 36% over 2013 levels, which is the highest of nine tiers of conservation mandated by the state (range is 4%-36%). Of concern is the city's slow response to date in adopting steps to curb water usage as it has focused efforts on receiving an exemption from the state due to its abundant water supplies that are not impacted by the drought. Moreover, the city's increase in usage of 7% in 2014 over 2013 levels due to water meter replacements has essentially increased the amount of curtailment needed to over 36%.
While historically consistent, financial performance of the water system has been modest and compliance with pending water restrictions could further pressure margins. Mitigating factors include the potential to defer capital improvements and the water system's exceptionally strong liquidity with $3.9 million in unrestricted funds at the end of fiscal 2014, or 1,173 days operating cash. Importantly, the ability to transfer rate stabilization funds from the gas system provides the city's water system with added financial flexibility.
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, including coverage of its debt obligations, no outstanding loans from the water system or general fund, and positive year end cash reserves.
The city has continued to build its reserves through consistent customer growth and lower than budgeted natural gas prices on the un-hedged portion of its portfolio. Unrestricted cash totalled $3.6 million at the end of fiscal 2014, or 555 days operating cash. Cash reserves include the $1.8 million rate stabilization fund required by the indenture.
Debt levels at the gas system are high and will remain so given slow amortization, with 13% of principal repaid in 10 years and 40% in the next twenty years. Debt service coverage in fiscal 2014 was 1.4x. Coverage of maximum annual debt service with fiscal 2014 revenues was adequate at approximately 1.26, given the continued potential customer growth at the system.
RATE STRUCTURE RISK
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 relatively low natural gas price environment seen in recent year is expected to continue, reducing any near-term risk from this rate structure. In addition, the growth in cash gas reserves to the currently strong levels mitigates concerns regarding the potential impact to financial margins.
SENIOR/SUBORDINATE BOND STRUCTURE IS COMPLEX
While the senior and subordinate bonds enjoy a combined pledge of both systems, the difference in Fitch's 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 is from the rate stabilization funds.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Public Power Rating Criteria' (March 18, 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria'(July 31, 2013).
--'Revenue-Supported Rating Criteria'(June 16, 2014).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
Revenue-Supported Rating Criteria