SAN FRANCISCO — A small public utilities district in California is trying to prevent its doors from closing after voters exercised their authority to lower their water rates below what district officials say is needed to sustain operations.

Voters in the Foresthill Public Utilities District, located 60 miles northeast of Sacramento, approved an initiative to roll back rates during a special June election.

The rollback, along with the district’s precarious finances, prompted Standard & Poor’s to slash its underlying rating eight notches Tuesday to B from A-minus. The bonds are insured by Assured Guaranty Ltd., rated AA-minus by S&P. The district was already in technical default because of rate covenant violations. 

“The district has not covered its cost of service for six years straight and have burned though their reserves,” said Leo Havener, the district’s new general manager hired in September. “The only possibility of survival is to increase the rates.”

If Foresthill is unable to raise enough revenue by fiscal year end on June 30, he said it will have to close its doors, which will likely result in transfer to another agency. Asked what has caused the district’s fiscal hardships, Havener said, “Unfortunately, it has been mismanaged.”

Located in Placer County in the foothills of the Sierras, Foresthill is run by a five-member board and 10 employees who provide water to 1,900 connections amid a population of over 5,000.

Aside from its fiscal challenges, the district is also in violation of its rate covenant, a technical default. “The district has not been in compliance with its rate covenant for several years,” said S&P analyst Tim Tung, author of the downgrade report.

Trustee Bank of New York Mellon recently posted on the Municipal Securities Rulemaking Board’s EMMA system a letter dated Dec. 13 disclosing that the district had incorrectly certified its compliance with rate covenants since fiscal 2009, that it had been out of compliance with those covenants, and that voters this year had reduced the district’s rates below those in effect at the time of the financing, putting it further out of compliance.

Tung said it’s difficult to know if the district will end up in a payment default if it shuts down, as it would depend on who takes over and if timely payments continue to be made. Foresthill has $2.4 million of long-term debt outstanding in the form of certificates of participation. The California Special District Association Finance Corp. acted as conduit for the $3.195 million issuance in 2003.

The debt was issued to purchase the Sugar Pine Dam and Reservoir and associated water rights from the federal Bureau of Reclamation. The district also had $2.9 million in property assessment-backed bonds issued in connection with a U.S. Department of Agriculture’s rural development program outstanding as of June 30, 2010, according to its most recent comprehensive annual financial report. At the time of issuance, the bonds carried a BBB-plus underlying rating from S&P.

The CSDA acts as a conduit issuer for small utility districts and does not back the debt. CSDA administrator Neil McCormick said he was aware that Foresthill is having problems.

Foresthill has run a deficit for the last six years. In fiscal 2010, it had a general fund budget gap of $224,000 with $1.4 million of revenue, the CAFR said.

To fund basic operations in fiscal 2011 and 2012, the district board used up much of its reserves and borrowed money from an assessment district that it also manages. To avoid a shutdown, the board told staff to try to reverse the rollback on rates as well as put a measure on the June 2012 ballot to get voter approval for a rate change.

Proposition 218, adopted by California voters in 1996, requires local governments and agencies to follow a prescribed set of rules to impose new or higher sewer or water fees. The board will vote to use Prop. 218 and also vote on a resolution for the ballot measure on Dec. 28, Havener said.

He said there is a high probability that opposition could form against the board’s push against the rollback. If the strategy fails, management said the state will likely have to move in, raise rates —  potentially doubling or tripling them — and find another agency to run the district.

Standard & Poor’s Tung said in a report Tuesday that if revenues recover, the rating could be raised, otherwise it could fall further. Most of the utility districts S&P covers are rated between A and AA, according to analyst Paul Dyson.

Dari Barzel, an analyst for Moody’s Investors Service, said even though voter-driven utility rate rollbacks are rare in California, they still are a concern.

 “We haven’t seen this as a widespread phenomenon among rated entities. It would be a credit negative if it occurred, as it demonstrates unwillingness to raise rates as needed to support operations and maintain anticipated coverage levels,” Barzel said in an emailed statement.

Foresthill is not the only utility in California to come under voter wrath recently. In 2008, Rohnert Park sewer rates were rolled back after 53% of voters passed a ballot initiative reducing rates by 30% for most homes.

In June, the city of Rio Vista also faced a rate-rollback initiative at the polls, which voters rejected. Had it passed, it would have dropped combined water and sewer rates in the city to $65 a month from $97 in one of the city’s districts and $132 a month in another.

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