Four-notch drop for a California city's sewer revenue bonds

A sharp decline in debt service coverage helped drive a four-notch downgrade and CreditWatch placement for wastewater revenue bonds issued by Salinas, California.

S&P Global Ratings Monday cut the debt to BBB-plus from AA-minus and put the rating on CreditWatch with negative implications.

"The downgrade reflects our view of the utility's weak financial performance trend based on weak cost recovery practices," S&P credit analyst Scott Sagen said in a statement.

The system's all-in coverage has declined below its 1.2x rate covenant for fiscal 2023, and below 1.0x in unaudited fiscal 2024 figures, S&P said, from its historically healthy coverage metrics.

"The CreditWatch placement reflects our view that we could lower the rating one or more notches if the system is unable to restore debt service coverage levels above its rate covenant of 1.2x, its liquidity position weakens further below 90 days' cash, or if management's efforts to implement multiyear rate increases beginning in 2025 are unsuccessful," Sagen said.

The sewer system had $13.3 million in debt outstanding at the end of fiscal 2023 after issuing $14.4 million of taxable revenue refunding bonds in 2020 to advance refund its tax-exempt Series 2012 bonds.

The sharp decline in debt service coverage ratios was reported in an interim financial report posted to the Municipal Securities Rulemaking Board's EMMA disclosure website in October.

The sewer system's operation and maintenance expenses increased sharply in fiscal 2022 and fiscal 2023, that report said.

"The city is in the process of conducting a sewer fee study with the intent of increasing current sewer rates," according to a footnote to Salinas' interim report. "If the proposed rate adjustments are implemented, the city is expected to meet or exceed the 125% debt service coverage ratio in the future."

S&P views the timing and magnitude of the potential rate increase as uncertain.

"We view the absence of a debt service reserve for the series 2020A bonds as a credit weakness because coverage metrics have weakened below its rate covenant, and its liquidity position has also weakened," the S&P report said.

Salinas officials did not return requests for comment Friday morning.

The city of 162,000 is a hub for the agricultural economy of the Salinas Valley. Its wastewater system had almost 50,000 residential and business connections in 2020, according to the official statement for its revenue bonds. The city is responsible for sewer collection within its boundaries, and delivers the wastewater to the regional Monterey One Water agency for treatment.

S&P assigns the city of Salinas its AA-minus issuer credit rating.