Fitch Affirms Fresno, CA's Sr and Sub Water Revs at 'AA'/'A+'; Outlook Stable

SAN FRANCISCO--(BUSINESS WIRE)--

Fitch Ratings has affirmed the following city of Fresno, CA (the city) ratings:

--$4.9 million senior lien water system revenue refunding bonds, series 2003A at 'AA';

--$101.5 million subordinate lien water revenue bonds, series 2010A-1 and 2010A-2 (taxable) at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by respective senior and subordinate liens on net revenues of the water system, excluding connection fees.

KEY RATING DRIVERS

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 invests heavily in capital and takes on new debt service.

LARGE INCREASE IN DEBT: Debt per customer will rise to about twice the median for rated water and sewer utilities over the next five years as the city borrows about $300 million to fund an ambitious capital improvement program.

STRENGTHENED SUPPLY POSITION: The city is investing heavily in surface water treatment capacity to take advantage of unused water rights and implement a conjunctive use strategy that will create a high degree of drought resilience in the future. The strategy should gradually reverse overdraft conditions in the city's groundwater basin.

RATE INCREASES APPROVED: The Fresno City Council last year approved a fiscal 2015 to 2019 rate plan that raises significant additional revenue to fund the city's capital investments, while offsetting revenue losses due to California's extreme drought.

REGIONAL SERVICE PROVIDER: The system provides essential retail water services to the city of Fresno. The city is the economic hub of the San Joaquin Valley, one of the nation's most productive agricultural regions. Its economy is growing at a healthy pace but suffers from chronically elevated unemployment and low incomes.

NOTCHING OF LIENS: The senior lien is rated two notches higher than the subordinate working lien, reflecting the closed lien and extraordinarily high debt service coverage.

RATING SENSITIVITIES

DECLINE IN FINANCIAL PERFORMANCE: The Fresno water revenue bond ratings could come under downward pressure if actual financial performance is weaker than forecast on a sustained basis, particularly if the city fails to meet its goal of maintaining debt service coverage of at least 1.5x and a reserve equal to 180 days cash.

CREDIT PROFILE

STRONG FINANCIAL PERFORMANCE

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 (DSC) excluding connection fees averaged a very high 21.4x over the three fiscal years ended June 30, 2015, while all-in DSC excluding connection fees averaged a strong 2.2x. All-in DSC dipped to a more moderate 1.4x in 2015 as the city began to conserve in the face of a record drought amid a decline in rates due to the rollback of an earlier rate plan. Through 2016, the city has reduced water consumption by more than 25% to comply with emergency state drought requirements.

MODERATION IN COVERAGE

The utility is in the midst of a large capital program that is likely to increase debt service significantly. Approved rates would stabilize coverage near 1.6x, according to a reasonably conservative city forecast. The forecast assumes that water conservation continues near current levels despite the easing of state drought regulatory requirements. Revenues are forecast to rise about 60% over five years on higher rates.

While Fitch believes the city's forecast assumptions are reasonable, there are greater downside risks to the forecast than usual. Consumers may react to the significant rise in rates by conserving more than expected, reducing the amount of revenue generated by rate increases. Also, operating costs of the major new water treatment plants could lead to higher than anticipated expenses. Fitch's expects the city to react as appropriate to maintain coverage above management's 1.5x coverage target, but the rating could come under downward pressure in the unlikely event that coverage fell below the target on a sustained basis.

STRONG LIQUIDITY

The enterprise's strong liquidity positions it well to withstand moderate deviations from the forecast. Unrestricted cash and investments rose to $70.9 million, or 499 days cash, at the end of fiscal 2015. Days cash averaged 456 days of operating expenses over the past three years. Fitch expects cash to moderate as the utility implements its large capital plan, but Fitch expects the utility to maintain a healthy liquidity reserve in compliance with a reserve policy that aims to maintain cash equal to at least six month of operating expenses.

RATE CONTROVERSY RESOLVED

Fresno policymakers approved a new five-year rate plan last year that will increase rates significantly through 2019 to fund the enterprise's ambitious capital plan. The rate increases followed a period of rate controversy and litigation that forced the city to withdraw an earlier rate plan that aimed to fund the city's conjunctive water use strategy. The new rates were approved last year, and the period in which ratepayers are allowed to contest the rates has expired. While rate controversy could re-emerge at any time, policymakers and the community appear to have reached an adequate degree of consensus on water rates and the city's capital plan.

Fitch believes the city has used much of the rate flexibility that its historically very low rates provided with the recent rate plan, but Fitch believes the city maintains a limited degree of rate flexibility. Rates remain affordable at 0.9% of median household income and continue to appear particularly low by California standards. Fitch expects the utility to continue to need rate increases in excess of inflation over the next rate plan, which the city has just begun to develop.

IMPROVED SUPPLY POSITION

The city has embarked on $429 million of capital improvements that should improve overdraft conditions in its groundwater basin and position it well for continued population growth. The centerpiece of the conjunctive use strategy is construction of a major water treatment plan that will allow the city to capitalize on its rights to significant surface water (via contracts with the federal Central Valley Project and the Fresno Irrigation District). With conjunctive use, the city would rely on surface water for most of its water needs in typical years and shift to stored groundwater during droughts. Either source appears sufficient to provide the city a large supply of water in normal years, and combining the two will position the city to withstand droughts without the need for extreme conservation measures.

RISING DEBT BURDEN

The utility's $199.3 million debt burden was below average at about $1,496 per customer or $383 per capita at the end of fiscal 2015. Debt is expected to rise to more than $3,000 per customer over the next five years. The city's capital plan includes about $330 million of additional borrowing, but recent cost estimates suggest the city may issue somewhat less (around $300 million). The debt will take the form of low interest state revolving fund loans. The loans are on parity with the rated subordinate lien water revenue bonds. The subordinate lien bonds were downgraded in 2013 in expectation of the rising leverage. With actual debt issuance coming in below the levels expected at that time, the new debt is unlikely to put downward pressure on the rating if the city is able to deliver financial performance near forecast levels.

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 Lumesis.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/site/re/869223

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013733

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013733

Endorsement Policy

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT 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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Copyright© 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.

The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001

View source version on businesswire.com: http://www.businesswire.com/news/home/20161025006784/en/