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Feb 25 - Fitch Ratings downgrades the rating on the following bonds issued by the city of St. George, UT (the city): --$5.42 million water revenue refunding bonds, series 2011 to 'A+' from 'AA-'. The Rating Outlook is Stable. SECURITY The bonds are secured by a first lien and pledge of the city's water system (the system) net revenues. KEY RATING DRIVERS WEAKENED FINANCIALS DRIVE DOWNGRADE: The downgrade to 'A+' from 'AA-' reflects a decline in debt service coverage (DSC) to the rate covenant level of 1.15x due to increased water purchase costs. In addition, liquidity levels have been reduced due in part to capital spending in advance of collection of impact fees. While DSC is expected to rise to more historical levels beginning in fiscal 2013, liquidity is not anticipated to improve materially if at all as surplus revenues are expected to be used for capital projects. RATE AFFORDABILITY DESPITE HIKE: After four years of flat rates, the city raised water rates around 7% to improve financial results. While the increase in rates was moderately high, affordability - which has been ample - is unaffected, as sewer rates were decreased by a corresponding amount. LIMITED OPERATIONAL RISK: As primarily a distribution system that purchases water from the Washington County Water Conservancy District, UT (WCWCD) according to a take-and-pay contract, the system has limited operational risk. FAVORABLE DEBT PROFILE: Debt levels are low and expected to decline over time, given capital needs over the fiscal 2017 forecast period will be funded from surplus cash flows. RATING SENSITIVITY IMPROVED MARGINS: Improved financial margins consistent with forecast levels are important to maintaining the rating. CREDIT PROFILE St. George covers approximately 71 square miles located about 120 miles northeast of Las Vegas and 300 miles south of Salt Lake City. The system serves an estimated population of 74,500 residents. COVERAGE AND LIQUDIITY DECLINES DSC fell to the rate covenant of 1.15x in fiscal 2012 from a combination of rising water purchase costs in light of a decline in available local water and a lag in receipt of annual WCWCD rebate monies. In fiscal 2012 the city took some of its wells offline due to recent stricter federal arsenic regulations. This change led to the city purchasing additional supplies from WCWCD at a higher cost than historical local production costs. However, because of the new regulations, purchased water from WCWCD is more economical than the city treating the arsenic present in its own wells. As a result of its water purchases from WCWCD, the city receives an annual rebate from WCWCD for the amount exceeding what is needed to cover designated fixed costs. However, because the WCWCD has a different fiscal year than the city, there is a one-year lag when the rebates are accounted for on the system's financial statements. The rebate related to fiscal 2012 payments of about $1.2 million is more than double that of the prior year because of more water being purchased and will be received in fiscal 2013; future rebates are expected to be of comparable levels. Apart from declining DSC, cash also declined in fiscals 2011 and 2012 due to capital spending ($3.1 million in fiscal 2011 and $2.8 million in 2012). The city recently added a tank in a growth area of the city at a cost of $4 million. It drew down reserves ahead of receipt of related impact fees. RATE INCREASES EXPECTED TO IMPROVE FINANCES The city increased water rates effective fiscal 2013 (rates had not been increased since 2008), and concurrently decreased sewer rates by approximately the same amount. For the water system, base fees were increased by $6.60, equating to about a 7% rate increase for residential customers. Due to the decrease in sewer rates, the combined utility bill for most customers remained flat and rates are still very affordable and expected to remain so. Given the rate increase and the more than doubling of the WCWCD rebate in fiscal 2013, the system's forecast shows all-in DSC of not less than 1.8x over the next three years, rising to above 2.0x thereafter. LIMITED OPERATIONAL RISK Operations are limited. The water system is primarily a distribution system, purchasing the majority of its water from WCWCD. Water purchases are made on a take-and-pay basis through a contract with WCWCD that runs into perpetuity. As such, the city pays only for the water it purchases. MANAGEABLE CAPITAL PLANS Debt levels are low at about $979 per customer and are expected to decline over time given limited capital needs and lack of future borrowing plans. The system's expected capital spending over the next five years includes $12.5 million to increase tank capacity and for various repair and replacement projects.