Fitch Affirms Stockton Public Financing Authority, CA's Water Revenue Bonds; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed its ratings on the following obligations issued by the Stockton Public Financing Authority, CA (the authority) on behalf of Stockton, CA (the city):

--$54 million water revenue bonds, series 2010A (Delta Water Supply Project) at 'A-';

--$24.2 million 2005 water revenue bonds, series A (Water Capital Improvement Projects) at 'A-';

--$9.1 million water revenue bonds, series 2009A (Delta Water Supply Project) at 'BBB+';

--$154.6 million water revenue bonds, series 2009B (taxable Build America Bonds) (Delta Water Supply Project) at 'BBB+'.

The Rating Outlook is Stable.

SECURITY

The 2005 series A and series 2010A bonds are secured by installment payments from the city to the authority, payable from a senior lien pledge of net revenues of the city's water system (the system). The series 2009A and 2009B bonds are secured by net system revenues after payment of senior lien obligations. The authority has assigned its rights to receive installment payments from the city to the trustee for the benefit of bondholders.

KEY RATING DRIVERS

ADEQUATE HISTORICAL FINANCIAL PERFORMANCE: The system maintained adequate financial performance through the city's bankruptcy process, which ended in February 2015 with the approval of a plan of adjustment. Fiscal 2014 finished with a below-average but sufficient all-in debt service coverage (DSC) of 1.4x.

LOWER DSC FORECAST DUE TO DROUGHT: Water conservation has lowered revenues and prompted the city to utilize rate stabilization funds in fiscals 2015 and 2016 to close operating gaps. In addition, the city plans to effect a defeasance of a portion of fiscal 2016 maturities for series 2002A, 2010A, and 2009B bonds to maintain its rate covenant, as it has strong cash balances but is only able to replenish the rate stabilization fund from operating surplus and not from reserves. Even so, DSC is estimated at a low 1.1x for fiscals 2015 and 2016.

STRONG CASH TO MODERATE: System liquidity has been very good with a five-year average of 760 days cash on hand (DCOH). However, cash is expected to decline to still good levels with the use of rate stabilization funds for operations and unrestricted cash for defeasance.

ELEVATED LEVERAGE BUT MANAGEABLE CAPITAL: The system maintains a high debt burden coupled with an extended amortization schedule. However, given the recent completion of the Delta Water Supply Project (DWSP), capital needs are more limited going forward.

SUFFICIENT SUPPLY: Completion of the DSWP provides a new resource for the city which is expected to provide sufficient supply through 2025.

WEAK SERVICE AREA: Although improving, the agricultural-based service area has been significantly affected by weak economic and housing conditions.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: Pressure on system financial margins could worsen if water sales fall below already low budgeted levels in fiscal 2016 and projected levels in 2017. The authority plans to use reserves in its rate stabilization fund to offset lower water revenues in fiscals 2016-2017 and reserves are expected to remain lower but healthy.

DETERIORATION OF FINANCIAL PROFILE: An extended period of inadequate DSC and/or a decline in DSC significantly beyond levels currently expected could lead to negative rating action.

CREDIT PROFILE

The city is located in the San Joaquin Valley, about 78 miles east of the San Francisco Bay area and about 45 miles south of Sacramento. The system provides water service to 55% of the water accounts within Stockton through approximately 49,900 connections, while California Water Service Company services the majority of the remainder of the city's connections. The city's prior bankruptcy is not a rating driver. The rating assigned by Fitch is based purely on the credit profile of the system given the general legal protection and special revenue status of pledged utility revenues.

DROUGHT IMPACTS WATER SALES

In May 2015, The State Water Board mandated 28% conservation for Stockton. The city implemented drought rules including two-day per week irrigation and thus far the utility has achieved 38.6% conservation. As such, water sales have been significantly impacted and are expected to continue to be reduced throughout the 2016 fiscal year. The city is currently undergoing a rate study with a Proposition 218 hearing expected in the fall for implementation in fiscal 2017.

LOWER DSC EVEN WITH USE OF RESERVES, DEFEASANCE

Coverage levels are expected to be marginal over the near term. Management estimates all-in DSC at 1.08x in fiscals 2015 and 2016 as the system absorbs effects from the drought. This coverage includes the use of rate stabilization funds of $4.1 million and $2.3 million, respectively, in fiscals 2015 and 2016. In addition, it includes the defeasance of a combined $4.8 million of bonds (series 2002A, 2010A and 2009B) in fiscal 2016. Without the use of the rate stabilization funds and defeasances, estimated DSC would be below 1x. Given the use of reserves, the utility's strong cash balance, which has averaged a very robust 760 DCOH over the last five years, is expected to decline to still strong levels.

Apart from fiscal 2015 and 2016 expected performance, the system finished fiscal 2014 slightly better than expected with adequate all-in DSC of 1.36x, which ranks just below Fitch's median for the rating category. DSC has been mostly good yet volatile over the past five years, ranging from 1.36x to 2.31x on an all-in basis and at least 6x on a senior-lien basis. The observed volatility is largely attributable to the quickly increasing operational and debt service costs associated with bringing the DWSP online.

The system implemented significant rate increases in 2010 to 2012 to pay for increases in debt service costs associated with the DWSP. Considering Fitch's average monthly usage assumption of 7,500 gallons, rates are affordable at about 1% of median household income (MHI). However, as mentioned, further rate increases are expected.

ELEVATED DEBT PROFILE BUT MANAGEABLE CAPITAL NEEDS

The system's weak debt profile is primarily due to financing of the DWSP. Overall, debt per customer and debt per capita are around 3x the national median. While improvement in the system's capital structure is expected over time, debt levels will continue to be a long-term concern as less than 40% of principal amortizes within 20 years. However, the utility's capital needs are manageable with approximately $26 million budgeted over the next five years. Future capital projects are expected to be funded by cash and should therefore keep debt metrics from worsening.

WATER SUPPLY ENHANCED WITH DELTA PROJECT

The DWSP allows the district to pump and treat 33,600 acre-feet (af) of water from the San Joaquin River. With the completion of the DWSP, the district has been able to reduce its treated water purchases from the Stockton East Water District to 17,500 af from 27,000 af under a take-or-pay contract. The DWSP's capacity of 30 million gallons per day (mgd) is sufficient through about 2025. Further, the utility can double the capacity of the DWSP to 60 mgd relatively easily and ultimately to 160 mgd with major investment.

WEAK SERVICE AREA

The Stockton area was among the hardest hit in the recent recession, as evidenced by high unemployment rates and severe declines in housing prices. Located in the most productive agricultural region of the country, the city has historically posted elevated unemployment. However, July 2015 unemployment of 9.6% was much improved from the high of 20.7% in 2011 due to strong employment growth. MHI remains below state and national averages and poverty is high. Large employers include government, food production and medical centers.

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

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria -- Effective July 31, 2013 to September 3, 2015 (pub. 31 Jul 2013)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990360

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst:
Shannon Groff, +1-415-732-5628
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA94108
or
Secondary Analyst:
Andrew Ward, +1-415-732-5617
Director
or
Committee Chairperson:
Douglas Scott, +1-512-215-3725
Managing Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
New York
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Shannon Groff, +1-415-732-5628
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA94108
or
Secondary Analyst:
Andrew Ward, +1-415-732-5617
Director
or
Committee Chairperson:
Douglas Scott, +1-512-215-3725
Managing Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
New York
sandro.scenga@fitchratings.com