SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following city of Fresno, California sewer revenue bond ratings:

--$60.2 million senior lien bonds at 'AA';--$159.8 million subordinate lien bonds at 'AA-'.

The Rating Outlook remains Negative.

SECURITY

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

KEY RATING DRIVERS

GENERAL GOVERNMENT PRESSURES: The Negative Outlook reflects liquidity pressures associated with supporting the city's struggling general fund. Fitch affirmed the city's implied ULTGO rating of 'BBB+' with a Negative Outlook today.

SIGNIFICANT, STRESSED SERVICE AREA: The system provides an essential service to an area with over 500,000 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.

STRONG FINANCIAL PERFORMANCE: Financial performance has been very strong with debt service coverage and liquidity levels above 'AAA' medians despite a sharp downturn in the local economy and drop in development-related revenues. The utility appears fundamentally sound, absent pressures from the weak general fund.

AFFORDABLE RATES: The city council implemented the significant rate increases planned at the time of the last bond issue and maintains some rate flexibility due to relatively low sewer rates.

MODERATE DEBT BURDEN: Debt levels are currently below average and expected to remain below average even with a possible $63 million financing near the end of the current capital improvement plan (CIP).

MANAGEABLE CAPITAL NEEDS: The sewer system has significant long-term capital needs due to 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

INCREASED GENERAL FUND PRESSURES: The current rating assumes some degree of general fund financial stress and ongoing intrayear cash flow support, but the rating could face downward pressure if deterioration in general government financial performance leads to increased borrowing from the utility.

CREDIT PROFILE

The utility is a monopoly provider of essential sewer services to California's fifth most populous city with about 500,000 residents. It is located about 250 miles north of Los Angeles in the heart of the agricultural San Joaquin Valley.

GENERAL FUND PRESSURES

The Negative Outlook reflects liquidity pressures from a dependent general fund that uses some of the sewer utility's liquidity to manage general government cash flows throughout the year. Fresno has largely depleted general fund reserves since the recession due to a sharp decline in revenues that could not be fully offset by expenditure reductions. These liquidity pressures are currently quite manageable for the utility (which shares the burden with the city's water fund and other enterprises).

General fund pressures have decreased from the time of Fitch's last review, when the city expected to finance a 2013 operating deficit with a small ($4.2 million) interyear loan from the sewer fund. Improved general fund revenue performance and tight expenditure controls allowed the city to avoid the loan, and its current projections show no need for borrowing from the sewer fund. Still, general fund liquidity needs could pose a more significant burden on the utility funds if the city experiences another revenue shock. Fitch is likely to maintain the Negative Outlook until the general fund is able to build up a modest financial cushion.

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 4.3 times (x) over the three fiscal years ended June 30, 2012, while all-in coverage averaged a strong 2.5x. Unaudited results for 2013 show 4.4x senior coverage and 2.5x all-in coverage.

Liquidity grew rapidly in recent years, as the utility prepared for the upcoming major capital projects. Days cash was more than twice the 'AAA' median at 1,097 days at the end of fiscal 2012. Cash levels will decline as the city undertakes capital improvements, but are expected to remain very strong across the forecast horizon. Coverage is expected to gradually decline, but remain at or above a very healthy 1.9x without connection fees.

The utility's forecast appears reasonably conservative in terms of operating revenues and expense growth. While connection fees could pose some downside risks to the forecast, the utility's coverage is sufficient without connection fees to support the current rating.

The city council raised rates as needed to support the utility's large capital improvement program. Rates rose an average of 10.2% a year over the past five years and are expected to hold at the current level for the next five years. Current rates are affordable at $25.75, or 0.7% of median household income. Rates are also sufficient to provide solid coverage of existing debt and significant excess cash flow to support the utility's capital improvement program.

DEBT TO REMAIN MODERATE

The sewer utility's debt burden is currently quite moderate at about $1,050 per customer or $430 per capita. The sewer utility's $207.1 million 2014-2018 capital improvement plan (CIP) includes about $63 million of additional borrowing, but the timing and necessity of such borrowing remains uncertain. Debt per customer would remain below average even with the additional debt at about $1,200 in 2018.

The CIP is driven by ongoing repair and renewal of the system and the need to expand its recycled water distribution system, which will help the city reduce over-reliance on ground water. The city has delayed issuing significant additional debt to expand the recycled water system and water treatment capacity due to a slowdown in the economy and development.

The city now plans to phase the expansion of the recycled water program in steps that can be funded on a pay-as-you-go basis. System engineers believe they may be able to upgrade the capacity of the existing 80 million gallon per day (MGD) treatment plant to about 90 MGD, which would delay the need for additional treatment capacity well past the current CIP, considering current growth rates and declines in flows related to water conservation. A renewal of more traditional growth patterns would put greater pressure on capacity, but would also come with additional revenues that are not currently expected.

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);--' 2013 Water and Sewer Medians' (Dec. 5, 2012);--'2013 Outlook: Water and Sewer Sector' (Dec. 5, 2012).

Applicable Criteria and Related Research:Revenue-Supported Rating Criteriahttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499U.S. Water and Sewer Revenue Bond Rating Criteriahttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=7152752013 Water and Sewer Medianshttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=6957562013 Outlook: Water and Sewer Sectorhttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695755

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