In the course of routine surveillance, Fitch Ratings upgrades $20.7 million in outstanding Yuba City, California wastewater revenue certificates of participation, series 2000 and 2002 to 'A+' from 'A'. The Rating Outlook is Stable.

The upgrade to 'A+' from 'A' reflects the wastewater system's (the system) financial performance which has surpassed projections; lower than expected leverage; reduced revenue concentration; the adoption of a rate ordinance with annual increases at the greater of 4.3% or the statewide CPI, and the renewal of the system's discharge permit. The 'A+' rating incorporates the system's strong financial results, sound management, and weakened economic conditions. Financial metrics are marked by a solid cash position and good historical, as well as projected, debt service coverage. Economic conditions have softened noticeably in recent months, led by a severe decline in the housing market.

The wastewater certificates are secured by a senior lien and pledge of net revenues from the enterprise, supported by a covenant to set rates and charges sufficient to yield net revenues at or in excess of 1.2 times (x) maximum annual debt service (MADS). Issuance of additional bonds requires that historical net revenues equal at least 1.2x MADS.

Yuba City, which is located about 40 miles north of Sacramento with a current estimated population of about 60,000, has grown rapidly in recent years due to annexation and new housing development. The area has a strong agricultural base, including farming and related industry, and until recently benefitted as a more affordable alternative to the rapidly growing Sacramento area. With the decline of the regional housing market, Yuba City's economy is showing signs of weakening. Unemployment, although predictably higher than the state average, rose to a very high 13.4% in June 2008 compared to a more typical 10.5% in June 2007.

The system provides service to approximately 14,000 customers. The wastewater treatment plant has a current capacity of 10 million gallons per day (mgd) compared to demand of about 6 mgd. Capacity can be expanded modularly when development continues; however, system expansion plans have been postponed until necessary. The city's projected population at build out is about 140,000. Water and wastewater service are billed together and totals about $45 for a typical household, which appears competitive compared to other similar providers. The customer base is increasingly diverse, with the largest customer (Sunsweet Growers Inc.) representing about 7.4% of fiscal 2007 revenues.

The system's financial operations are solid with healthy liquidity levels and strong debt service coverage. Coverage of MADS over the past three years has averaged 4.1x. This is far in excess of the original projections of about 1.5x; the difference is primarily a result of very conservative operating costs estimates. Pro forma MADS coverage is conservatively projected to decline to 1.5x for fiscal 2009 and 2010 before increasing moderately to 2.0x in fiscal 2012. The net revenue pledge includes connection fees, projections for which the city has significantly revised downward. However, if the lower projected growth does not materialize, the city may need to revise upward its planned rate increases.

The system's five-year wastewater discharge permit was approved by the Regional Water Quality Control Board in October 2007 but has been appealed by an environmental group. If the appeal is upheld, the system may require additional capital investments in order to improve the quality of discharge. Notwithstanding the above, the enterprise's five-year capital program currently totals $6.2 million, primarily to address major maintenance needs and does not include additional debt issuance. Current debt per customer is low at about $1,300.

Fitch has issued an exposure draft on July 31 proposing a recalibration of tax-supported and water/sewer revenue bond ratings which, if adopted, may result in an upward revision of this rating (see Fitch research 'Exposure Draft: Reassessment of the Municipal Ratings Framework').

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