Fitch Affirms San Jose-Santa Clara Clean Water Fin Auth, CA Sewer Revs at 'AAA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings affirms the 'AAA' rating on the following San Jose-Santa Clara Clean Water Financing Authority, CA (the authority) bonds:

--$33.35 million sewer revenue refunding series 2009A and 2005A.

The Rating Outlook is Stable.

SECURITY

The bonds are special obligations of the authority derived from base payments made by the city of San Jose (the city) pursuant to an improvement agreement. The city has pledged its net systems revenues to the authority as security for its obligations under the improvement agreement to make base payments and additional payments with respect to the bonds.

KEY RATING DRIVERS

ROBUST FINANCIAL METRICS: The system's financial position is healthy, generating high debt service coverage and maintaining strong liquidity.

EXTENSIVE CAPITAL PLAN: The system is at the start of an extensive capital plan to rebuild the system's 50 year old wastewater treatment plant (the plant). Total plan costs are estimated at $2.2 billion over a 30 year span. The 2015-2019 capital improvement plan (CIP) includes $715 million of plant-related projects.

LOW BUT GROWING DEBT BURDEN: Current debt ratios are very low and amortization is rapid, providing significant future debt capacity. The system's debt burden is expected to grow due to the plant rebuild which will be partially debt funded.

AFFORDABLE RATE, SECURE STRUCTURE: System rates are affordable and comparable with other regional providers. Fixed residential user fees are included on the property tax bill, payment for which is guaranteed by the county.

STRONG SERVICE AREA ECONOMY: The system's customer base is large and diverse with above-average wealth levels.

RATING SENSITIVITIES

ACCELERATION OF DEBT: Leveraging by the authority in excess of ranges currently envisioned to fund the plant renovations plan could significantly increase the system's debt burden.

CREDIT PROFILE

The cities of San Jose and Santa Clara established the San Jose-Santa Clara Clean Water Financing Authority in 1981 to finance improvements to the existing jointly owned wastewater treatment plant (the plant). San Jose administers and operates the facility on behalf of the two owners and the outside users (one city and five sanitary districts) and maintains over 80% ownership interest in the plant net assets.

STRONG FINANCIAL PERFORMANCE WITH AMPLE RATE FLEXIBILITY

System pledged revenues have significantly exceeded the below-average rate covenant of 1.15 times (x) annual debt service, averaging 7.5x coverage over the last three years. Including $18 million in subordinate state revolving loans (which matures in fiscal 2019), the three-year average all-in coverage was a high 4.5x. Following several years of above-average rate hikes, the city anticipates rate increase of approximately 5% or more starting in fiscal 2016 to maintain strong financial metrics and support the system's extensive capital plan.

With potential rates hike through fiscal 2019, the monthly bill would grow to only approximately $40, or 0.6% of the median household income, comfortably below Fitch's 1% affordability threshold. The system's historical liquidity levels have also been very high, ending fiscal 2014 with $348 million, equal to over 900 days cash on hand.

Fitch produced a base case scenario which included the following assumptions: 1%-5% annual increase in operating revenues (based on anticipated rate increases), 3% annual inflationary increase in operating expenses, and debt service costs associated with approximately $448 million in debt issued over the coming three years. All-in DSC based on these assumptions remains sound at 2.4x, aligning closely to Fitch's 'AAA' median of 2.8x. Projected debt per customer based on the assumed debt also remains adequate for the 'AAA' rating at $1,392, compared to Fitch's median of $1,341.

LONG RANGE CAPITAL PLANNING TO REBUILD PLANT

The primary focus of the CIP is on the rehabilitation and modernizing of the 50-year-old plant, referred to as the Plant Master Plan (PMP). The system has been planning a rebuild of the plant for several years and phase one project costs are now included in the capital improvement plan (CIP). The CIP for 2015-2019 grew significantly to over $1.11 billion, including projects for the plant rebuild (82% of the CIP) and the city's sanitary sewer collection system (18% of the CIP). The plan is almost double the 2013-2017 CIP of $557 million. However, system debt ratios are exceptionally low with debt to net plant at 11%, debt per customer of under $200 and very rapid amortization with 100% of the debt maturing in 10 years. All ratios fall well below Fitch's 'AAA' medians.

The PMP will be executed in stages with the first to include critical rehabilitation projects covering the various treatment process areas of the plant. Financing of the CIP is still in the preliminary stages with the city and other participants discussing the use of various forms of debt, including commercial paper, state revolving fund loans and revenue bonds. Rapid amortization allows for significant additional debt capacity in the next 10 years if needed for the plan, while maintaining adequate financial metrics. Acceleration of debt issuance in the near term could strain the system's metrics and potentially pressure the rating. Given the system's advanced planning, Fitch believes this scenario is unlikely.

In spite of these capital improvement needs, the system has performed well. In addition, the system does not face capacity constraints. Customer growth has averaged just under 1% per year resulting in sufficient capacity for the next 30 years.

STABLE, DIVERSE UNDERLYING ECONOMY

San Jose covers over 178 square miles at the southern end of the San Francisco Bay. Serving a population of about 1 million residents, the city is the largest in the Bay Area and the third largest in the state. Its economy, like that of the region, continues to be tied to the high-technology sector, although the focus has shifted somewhat from manufacturing to design, R&D, information, and software. The city benefits from its proximity to several universities, an abundance of venture capital companies, and a highly educated, affluent workforce.

Area unemployment has seen improvement over the last year, declining to 5% as of December 2014, down 1.3% for the year prior, and comparing favorably to the state's 6.7% and the nation's 5.4%. Poverty rates are below average and median household incomes are high at 134% and 154% of state and national levels, respectively.

Additional information is available at 'www.fitchratings.com'

In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from CreditScope.

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2015 Water and Sewer Medians' (December 2014);

--'2015 Outlook: Water and Sewer Sector' (December 2014).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2015 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409

2015 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981156

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Contacts

Fitch Ratings
Primary Analyst:
Teri Wenck, CPA, +1-512-215-3742
Director
Fitch Ratings, Inc.
111 Congress Avenue,
Austin, TX 78701
or
Secondary Analyst:
Karen Ribble, +1-412-732-5611
Senior Director
or
Committee Chairperson:
Amy Laskey, +1-212-908-0568
Managing Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Teri Wenck, CPA, +1-512-215-3742
Director
Fitch Ratings, Inc.
111 Congress Avenue,
Austin, TX 78701
or
Secondary Analyst:
Karen Ribble, +1-412-732-5611
Senior Director
or
Committee Chairperson:
Amy Laskey, +1-212-908-0568
Managing Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com