Fitch Affirms Susanville PFA, CA's Water & Gas Utility Revs; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the following ratings for Susanville Public Financing Authority (SPFA), CA:
--$8.3 million senior lien revenue refunding bonds at 'A';
--$24.6 million subordinate lien revenue refunding bonds at 'BBB+'.
The Rating Outlook on both series of 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 SPFA, which has assigned those payments to the bond trustee. The payments due from the city of Susanville are absolute and unconditional and not subject to appropriation. Payment on the subordinate lien bonds is subject to the prior pledge of SPFA revenues on the senior lien bonds.
KEY RATING DRIVERS
DROUGHT PRESSURE ON WATER REVENUES: State imposed conservation has resulted in reduced water sales in fiscal 2016, which pressured the City's already modest financial margins. While all-in debt service coverage on the senior and subordinate lien debt (secured by the combined revenues of the two utilities) is projected above 1.0x in fiscal 2016, the net revenues of the water system by itself are projected below 1.0x.
WATER RATE INCREASES PLANNED: The city is in the process of adopting a large water rate increase that will become effective mid-year fiscal 2017. The increase is designed to increase water revenues to support the water system's obligations on the senior lien bonds in fiscal 2017.
STRONG GAS SYSTEM FINANCIALS: Growth in the customer base of the gas system and low commodity prices have produced positive cash flows and strong reserve levels for the gas utility 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, given the limited water system payments, subordinate lien bonds are effectively repaid only from 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 in January 2016 at 8.2%. Government employment accounts for 64% of the city's work force.
SUSTAINED DECLINE IN WATER FINANCIALS: Pressure on the City of Susanville's water system financial margins is occurring in fiscal 2016 as a result of the very large curtailment on water sales and the primarily volumetric rate structure. Water rates are being increased in fiscal 2017, which is expected to restore the system's financial performance. However, if financial margins at the water system persist at the low levels anticipated in fiscal 2016, downward rating pressure could result.
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).
The population of the city is 9,129 but this does not include an inmate population of around 6,700 as of fiscal 2015. While the prisons do not purchase their physical gas and water supplies from the city, they do utilize a small portion of the gas system's distribution network for transportation purposes. This activity does not provide significant net revenues to the gas enterprise.
DROUGHT CONSERVATION PRESSURES WATER FINANCIAL MARGINS
In 2015, the State Water Resource Control Board (SWRCB) assigned mandatory conservation tiers for all of California's water providers in response to the increasing severity of the drought. Susanville was placed in the highest tier, requiring a 36% reduction in water sales between June 2015 and February 2016 over 2013 levels. The city was slow to achieve sizable conservation amounts but is currently at 30%. The state has since reduced the city's required amount to 33% although the reduction is not as significant as the city would have liked given the limited impact that the drought has had on the availability of its specific water supplies.
Financial performance of the water system had historically been modest but consistent. Debt service coverage averaged 1.75x in fiscals 2012 - 2014. However, coverage for the water system declined to 1.3x in fiscal 2015 and is projected by management to end fiscal 2016 below 1.0x.
The senior lien bonds benefit from payments from both water system and natural gas system. Debt service coverage offered by the combined net revenues was 1.24x in fiscal 2015 and is projected by management to end fiscal 2016 at 1.13x.
Water system liquidity remains robust with $4.2 million at the end of fiscal 2015, or 1,160 days operating cash. However, $3 million of the balance is attributable to the rate stabilization fund, which is required to be maintained at this amount by the bond indenture. These funds can be used for any purpose but must be replenished within 120 days from the water system cash flow. Without the $3 million reserve, cash levels are still solid at 260 days operating cash.
WATER RATE INCREASES TO REVERSE DECLINING FINANCIAL TREND
Susanville recently completed a full water cost of service study and City Council has approved the notification and public hearing required to adopt a new water rate structure in California. The proposed rate increase consists of higher volumetric rates for summer usage and implementation of a drought surcharge at times with City Council has enacted the city's water shortage plan. Management estimates that the rate proposal will increase revenues by 20% in fiscal 2017. This should improve water system debt service coverage to over 1.4x and combined water and gas system debt service coverage to over 1.3x.
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. However, margins at the gas system have been positive in the past five fiscal years and have continued to increase reserve levels. Cash at the gas system was $3.9 million at the end of fiscal 2015, or 729 days cash on hand. This includes the bond indenture required amount of $1.807 million in the rate stabilization fund.
Debt levels at the gas system are high and will remain high given slow amortization, with 13% of outstanding principal repaid in 10 years and 40% in the next twenty years. No additional debt is expected for the system. Principal began to amortize in fiscal 2012. Debt service gradually ramps up from $1.49 million in fiscal 2013 to $1.8 million by 2025. Debt service coverage has trended down slightly from 1.54x in fiscal 2013 to 1.38x in fiscal 2014 and 1.22x in fiscal 2015, as a result of increasing debt service costs. Management projects coverage in fiscal 2016 from gas system net revenues will be 1.27x. Coverage of maximum annual debt service with fiscal 2015 revenues is adequate at about 1.1x, 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 retail gas utilities. However, commodity price risk is reduced by the city's practice of forward hedging for most of its natural gas needs. 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 years is expected to continue, reducing near-term risk from this rate structure. In addition, strong cash reserves mitigate concerns regarding the magnitude of 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). The specific dollar amounts of the annual installment payments due from each system are listed in the installment payment agreements. 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. Therefore, the senior lien bonds enjoy the combined net revenue payment from both utilities but the subordinate lien bonds are practically paid only by the gas system payments.