AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the following Escondido Joint Powers Financing Authority, CA (the JPFA) bonds, issued on behalf of the city of Escondido (the city):
--Approximately $31.7 million revenue bonds (water system financing), series 2012 at 'AA-'.
The Rating Outlook is Stable.
Bond repayment is secured by installment payments paid to the JPFA from the city, in accordance with an installment purchase agreement between the city and the JPFA. The obligation of the city to make installment payments is secured by a pledge of net revenues of the city's water system (the system); such obligation is absolute and unconditional and is not subject to appropriation.
KEY RATING DRIVERS
STABLE FINANCIAL PERFORMANCE: All-in annual debt service (ADS) coverage for the system has been stable over the past five years, averaging a healthy 2.0x. Liquidity, measured by days of operational cash, finished fiscal 2013 at a below average but adequate 113 days.
RECENT RATE INCREASES SIGNIFICANT: Sizable rate increases have been necessary in recent years to absorb higher imported water costs; combined water and wastewater rates are now very high, although high rates are typical for the region.
RELIANCE ON IMPORTED WATER: The city purchases 70% of its raw water supply from the San Diego County Water Authority (SDCWA, revenue bonds rated 'AA+' with a Stable Outlook by Fitch), which is then treated at a city-owned treatment plant. This reliance is a vulnerability but also provides expenditure relief in years of declining water sales, since purchases can be curtailed as well. No reductions in water allocation from SDCWA as a result of statewide drought conditions is expected through at least 2014.
MANAGEABLE CAPITAL NEEDS: The city's capital improvement plan (CIP) most notably includes funding for the Wohlford Dam Project. Implementation of the CIP is not expected to have a large impact on the city's somewhat already elevated debt levels as many of the projects are expected to be funded primarily from cash and (specifically for the Wohlford project) grants from the State Water Board.
MIXED SERVICE AREA: The service area has seen strong improvements in unemployment rates since 2010, but individual poverty rates are increasingly high and income levels are well below state and national averages. The system's service area has some industry concentration in the agricultural sector.
CONTINUED STABILITY: Failure to maintain financial and debt metrics near current levels could put downward pressure on the rating. To maintain system metrics, future increases in user rates may be necessary given the expected rising costs of purchased water from the SDCWA. Additionally, costs will have to be managed with regard to lost revenue from agricultural users as they move to more recycled water usage.
The system provides retail water service to approximately 80% of the city, which is located approximately 30 miles northeast of San Diego. About 70% of the city's water supply is provided in untreated form by the SDCWA. SDCWA imports its water supply primarily from the Metropolitan Water District of Southern California (revenue bonds rated 'AA+' with a Stable Outlook). SDCWA has indicated that it does not expect any cutbacks to its customers through at least 2014 despite drought conditions affecting the state.
SOLID FINANCIAL PERFORMANCE, ADEQUATE LIQUIDITY
The system has exhibited solid financial performance over the past five years. During this period, ADS coverage averaged a solid 2.0x and finished fiscal 2013 also at 2.0x. Such stability was largely achieved by increasing user rates to match fee increases from the SDCWA. Also, to mitigate revenue reductions caused by lower demand in fiscals 2011-2012, the city's take-and-pay contract with the SDCWA allowed it to purchase less water, thereby lowering operational costs.
Liquidity, measured by days of operational cash held in unrestricted reserves, finished fiscal 2013 at a below average but adequate 113 days, which was mostly consistent with the system's five-year average. Projections provided by management demonstrate continued stability in ADS coverage and cash balances.
RATES ARE HIGH AND RISING
The average residential water customer pays about $62 monthly for 7,500 gallons of usage. The combined monthly water and wastewater charges are about $104 or 2.7% of median household income (MHI), which is higher than Fitch's affordability threshold of 2%. Actual monthly usage is likely much higher, resulting in an even higher monthly bill, although high rates are somewhat typical for the region.
The city increased its rates by 12% in both 2012 and 2013 for its residential customers. Agricultural customers' rates were held flat over this period given the high sensitivity of such customers to water rate increases which, in the past, have resulted in some larger customers relocating out of the area.
Further rate increases in the range of 7% are expected through 2017, at which time a 12% increase is targeted in order to pay the city's share of a large desalination project being undertaken by SDCWA. Management has indicated to Fitch that it has encountered no strong impediments to its need to raise rates with the exception of the protests from its agricultural customers.
MANAGEABLE CAPITAL NEEDS, DEBT
The five-year CIP totals a manageable $20.8 million. The largest project includes the design and construction of a new dam to replace the aging Wohlford dam. The city has received a 50% matching grant from the State Water Board to fund the project and expects to pay for the remaining portion using excess operational revenue and cash reserves. However, it is possible a new debt issue in the next few years may be required to complete the project. Technical design and construction risk should be manageable but, as with any construction project, could result in delays and cost escalation.
Debt levels are elevated on a per customer basis at $2,460, but debt per capita is more manageable at $437. This discrepancy is largely a result of some industry concentration from the larger agricultural customers. Debt amortization is somewhat slow with 59% scheduled to payout in 20 years. Planned capital expenditures are not expected to greatly affect the water system's debt profile in the near- to intermediate-term.
MIXED SERVICE AREA
The city's unemployment rate improved to 7.3% in October 2013, besting the state's average of 8.3% and was significantly lower than 2011's average of 11%. However, at 20.7% in 2012, poverty rates have steadily risen since 2009 and remain above state (16.4%) and national averages (15.7%). Income levels are below average, with MHI at 77% and 88% of state and national averages, respectively, in 2012. Lastly, there is some customer concentration in the agricultural industry with nine of the top 10 ratepayers in this sector, accounting for approximately 12% of system revenues.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 3, 2013);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);
--'2014 Water and Sewer Medians' (Dec. 12, 2013);
--'2014 Outlook: Water and Sewer Sector' (Dec. 12, 2013).
Applicable Criteria and Related Research:
2014 Outlook: Water and Sewer Sector
2014 Water and Sewer Medians
U.S. Water and Sewer Revenue Bond Rating Criteria
Revenue-Supported Rating Criteria