Fitch Ratings assigns an 'AA-' rating to the following city of Pleasant Grove, Utah water revenue bonds:
--Approximately $9.3 million water revenue refunding bonds series 2015.
The bonds are scheduled to sell via negotiation on or about Jan. 29, 2015. The proceeds will refund portions of the utility's outstanding 2002B and 2006B water revenue bonds for level savings.
The Rating Outlook is Stable.
SECURITY
The bonds are payable from a first lien on net water revenues after payment of operations and maintenance expenses.
KEY RATING DRIVERS
STRONG SERVICE AREA: The utility provides retail water service to a gradually expanding suburban service area on Utah's economically vital Wasatch Front. The customer base is dominated by residential accounts and is diversified.
IMPROVING FINANCIAL PERFORMANCE: Financial performance is improving after a period of weakness caused by loss of connection and impact fee revenues during the economic downturn. Liquidity and debt service coverage (DSC) metrics are somewhat low for the rating category, but appear adequate given fairly low operating risks and exceptional revenue stability.
DELAYED RATE ADJUSTMENTS: The utility used reserves to allow a gradual adjustment of rates after a sudden drop in connection fees during the recession. The slow rate adjustments caused a period of coverage below 1.0x (violating the rate covenant) and may suggest limited rate flexibility.
DECLINING DEBT BURDEN: The debt burden is above average but expected to decline to below average over the next five years with rapid amortization and no new money borrowing plans.
SOLID SUPPLY POSITION: The utility benefits from an ample supply of local ground and surface water supplies, allowing relatively high levels of water use at low prices.
RATING SENSITIVITIES
FINANCES, RATES DRIVE RATING: The rating could come under downward pressure if financial performance erodes again, particularly if coverage excluding connection fees declines significantly from current levels or free cash to depreciation fails to remain at a level that allows sustained investment in system maintenance. However, continued progress in rebuilding coverage and good rate discipline allow for upward movement of the rating.
CREDIT PROFILE
Pleasant Grove is economically healthy suburb of 34,988 residents located 36 miles south of Salt Lake City and nine miles north of Provo in Utah County. The community is part of a large and diverse regional economy that has outperformed the nation in recent years. The unemployment rate was very low at 3.1% in November 2014. The individual poverty rate was about 2/3 of the national rate at 10.7% in 2013. Median household income (MHI) was 119% of the national level. The service area is primarily residential, and the top 10 customers provide a low 3.2% of revenues.
FINANCIAL PERFORMANCE RECOVERS
Financial performance is improving after a period of weakness caused by loss of connection and impact fee revenues during the economic downturn. The utility became highly dependent on development-related impact and connection fees during the housing boom. DSC fell below 1.0x and resulted in a covenant violation of the utility's 1.25x rate covenant for a number of years as the utility adjusted water rates gradually to recoup lost revenues over a period of four years. The utility has since lessened its dependence on connection fees. Rate adjustments improved DSC excluding connection fees to an adequate 1.3x in 2014 from a low of 0.7x during the recession, while a recovery in the housing market boosted overall coverage to a solid 1.9x. Free cash-to-depreciation was strong at 124% in 2014.
Fitch's rating is driven primarily by expectations of future performance that is better than recent historical performance due to the fundamental rebalancing of the utility's revenue mix. The utility's reasonably conservative forecast (which assumes very low connection fees and expenses growing faster than revenues) shows DSC excluding connection fees averaging a healthy 1.5x over the next five years. Fitch expects coverage to surpass this level including connection fees. Connection fees are positive for the utility, but the rating could come under downward pressure if management allows the utility to become overly reliant on connection fees again.
Liquidity remains adequate despite the extended period of weak coverage. The utility finished 2014 with healthy unrestricted cash and investments of $2.9 million, or 346 days cash. Reserves were boosted by a one-time transfer of $1.4 million from the utility's sewer fund in 2011 and conserved via reductions in capital spending to a very low level during the period of weak coverage. While such measures are not sustainable indefinitely, the efforts did allow the utility to weather a period of economic stress.
SLOW, BUT SIGNIFICANT RATE ADJUSTMENT
The utility's rate discipline has been mixed. While policymakers allowed a period of poor financial performance and rate covenant violations, they did systematically raise rates by more than 60% since 2010 to rebuild the utility's financial margins. The rate adjustments will better position the utility to withstand future weakness in development if the utility continues to set rates assuming minimal connection fee revenues.
Rate flexibility appears adequate for expected water rate increases of about 3% annually. Rates remain affordable compared to national benchmarks with the cost of 7,500 gallons of water costing a moderate 0.8% of MHI -- assuming 5,000 gallons for indoor use and 2,500 for outdoor use. Rates are somewhat high compared to neighboring communities, but recent rate increases have not generated political controversy despite very large cumulative increase in utility bills in recent years.
The utility's rate structure creates stable operating revenues, somewhat offsetting concerns about connection fee volatility. The city charges a flat rate for the first 5,000 gallons of culinary water and for unlimited amounts of outdoor irrigation water. This revenue stability allows the utility to operate comfortably with somewhat less robust margins and liquidity than categorical medians.
DECLINING DEBT BURDEN
The debt burden is high as a result of the city's construction in the 2000's of an independent irrigation water delivery system to serve outdoor usage needs with untreated water. Debt of $2,958 per customer is above average, and debt service consumes a high 34% of total revenues. Rapid amortization and a lack of issuance over the next five years will reduce leverage to a moderate $1,800 per customer and debt service to 26% of total revenues over the next five years. The debt structure is uncomplicated with all fixed-rate, fully amortizing debt. Amortization is quite fast with 48% of debt repaid in 10 years and 100% in 20 years.
The utility's five year capital improvement plan (CIP) is somewhat large at $18 million, or $461 per customer annually between 2015 and 2019, but the utility does not expect to need additional borrowing to complete the projects.
SOLID SUPPLY POSITION, LOW RISK OPERATIONS
The utility provides water via a culinary water system and a pressurized irrigation system. Water supplies appear solid. The culinary water system is supplied by ample rights to groundwater that requires minimal treatment. Culinary capacity of about 15,440 MGD (million gallons per day) is about five times actual use in recent years. The excess supplies create a high degree of drought resiliency with indoor water use unlikely to be subject to curtailment in drought periods.
The utility's secondary pressurized irrigation system provides untreated water for outdoor use. The city has rights to a variety of surface water sources that can provide about 7,328 MGD under normal weather conditions, about 150% of recent outdoor usage. These surface water sources are more variable than ground water sources. The utility can use excess culinary capacity to supplement outdoor usage in periods of drought. But it is likely to require some degree of outdoor watering conservation during extreme droughts. The utility's fixed outdoor watering charge (determined by lot size) insulates the utility from the typical revenue risks associated with shortages of supplies during drought or reduced demand during wet weather.
Operations are low cost with limited risks given the lack of complex water treatment plants and minimal staffing. With the exception of the recent recession years, the utility appears to have invested adequately in asset replacement keeping the average age of plant low at just 11 years.
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 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'2015 Water and Sewer Medians' (December 2014);
--'2015 Outlook: Water and Sewer Sector' (December 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
2015 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409
2015 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=976415
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