Fitch Affirms Fresno, CA's Sub Lien Sewer Rev Bonds at 'AA-'; Outlook Revised to Stable

Fitch Ratings has affirmed the following city of Fresno, California sewer revenue bond ratings:

--$44.4 million senior lien bonds at 'AA';

--$159.8 million subordinate lien bonds at 'AA-'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are secured by net revenues of the sewer system, including transfers from the rate stabilization fund and connection fees.

KEY RATING DRIVERS

GENERAL GOVERNMENT PRESSURE EASES: The Outlook is revised to Stable due to improved financial performance in the general fund, which has regained structural budget balance and no longer appears likely to need sewer fund loans. Fitch affirmed the city's implied unlimited tax general obligation rating of 'BBB+' and revised its Outlook to Stable today.

SIGNIFICANT, STRESSED SERVICE AREA: The system provides essential retail sewer services to the 510,000 residents of the city of Fresno and wholesale services to nearby communities. The city is the economic hub of the San Joaquin Valley, one of the nation's most productive agricultural regions. Its economy appears to be growing at a healthy pace, but suffers from chronically elevated unemployment and low incomes.

STRONG FINANCIAL PERFORMANCE: Financial performance has been very strong with debt service coverage and liquidity levels above 'AAA' medians, but Fitch expects coverage and liquidity to decline to levels that are more typical for the rating as the city issues additional debt to fund the expansion of its recycled-water system.

AFFORDABLE RATES, LIMITED FLEXIBILITY: Rates are low; however, controversy over large water rate hikes creates some concern about the sewer utility's ability to secure future rate increases.

MODERATE DEBT BURDEN: Debt levels are currently below average and will remain slightly below average with $180 million of borrowing planned over the next five years.

MANAGEABLE CAPITAL NEEDS: The sewer system has significant long-term capital needs due to planned construction of a recycled-water distribution system, but the city has considerable flexibility as to the timing of capital plans and has shown a willingness to delay projects as necessary to maintain financial performance.

RATING SENSITIVITIES

PRESSURED BY ADDITIONAL LEVERAGE: The rating could come under downward pressure if rate discipline slips or debt service coverage falls below 1.5x for a sustained period due to additional leveraging.

CREDIT PROFILE

The utility is a monopoly provider of essential sewer services to California's fifth most populous city with about 510,000 residents. The service area is broader than the city alone with wholesale treatment services provided to the city of Clovis (a more affluent community with a population of about 100,000), the community of Pinedale and other unincorporated areas. Fresno 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.

STRONG SEWER FINANCIAL PERFORMANCE

The sewer system's financial performance has been strong and is expected to remain very healthy. Senior lien debt service coverage averaged 4.5x over the three fiscal years ended June 30, 2013, while all-in coverage averaged a strong 2.4x. Unaudited results for 2014 show 4.3x senior coverage and 2.5x all-in coverage.

A reasonably conservative city forecast shows coverage declining to 1.3x with the last of the planned bond issues in 2019. The forecast assumes no rate increases and very slow demand growth. Fitch believes there is considerable uncertainty about forecasts this far into the future, given the difficulty of projecting new connections and debt service costs of bonds that will be issued in four years. Management aims to keep coverage at or above 1.4x and tends to beat its conservative forecasts. While the utility's very stable revenues could support the current rating even with a significant decline in coverage, the rating could come under downward pressure if coverage dropped to management's 1.4x target on a sustained basis.

Liquidity grew rapidly in recent years as the utility prepared for the upcoming major capital projects. Cash was well above the 'AAA' median at 958 days at the end of fiscal 2013. Cash levels will decline as the city undertakes capital improvements, but are expected to remain adequate with at least six months of operating cash on hand across the forecast horizon.

Rates are very low, but rate flexibility appears to be limited. Residential bills are quite affordable at $25.75 per month, or 0.7% of median household income, and the Fresno City Council has raised rates as needed to support investments in the system's capital assets. However, the city is likely to need very large water rate increases over the next few years, and opposition to rate increases has forced policymakers to reverse recent rate hikes and reconsider capital plans. Water rate controversy could make it difficult to raise sewer charges, which are on the same bill. The city does not currently have any plans to raise sewer rates, but it has engaged a rate consultant to advise it as to whether rate increases will be necessary to complete its current capital and borrowing plans.

DEBT TO REMAIN MODERATE

The sewer utility's debt burden is currently quite moderate at about $985 per customer. The sewer utility's $388.1 million 2015-2019 capital improvement plan (CIP) includes about $180 million of additional borrowing. The CIP is driven by the need to expand its recycled-water distribution system, which will help the city reduce over-reliance on ground water. The proposed borrowing would push debt per customer to slightly below average at about $1,550 per customer in 2019 (versus an 'AA' category median of $1,973 per customer). Such debt ratios are unlikely to pressure the rating.

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:

2014 Outlook: Water and Sewer Sector

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

2014 Water and Sewer Medians

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

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=912355

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