News Column

Fitch Affirms Escondido Joint Powers Financing Auth, CA's Wastewater Revs at 'AA-'; Outlook Stable

February 15, 2014

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 $27.4 million revenue bonds (wastewater system financing), series 2012 at 'AA-'.

The Rating Outlook is Stable.

SECURITY

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 wastewater system (the system); such obligation is absolute and unconditional and is not subject to appropriation.

KEY RATING DRIVERS

SOUND FINANCIAL PERFORMANCE: The system has performed well over the past five years, with all-in annual debt service (ADS) coverage ranging from 1.8x - 2.7x over this period. Liquidity, measured by days of operational cash, has been exceptionally strong, finishing fiscal 2013 at 812 days. However, ADS coverage has dropped and is expected to continue to decline over the next few years.

RATE INCREASES NEEDED: Rate increases will be needed to ensure ADS coverage remains adequate as debt service costs have risen as a result of the 2012 issuance. Rates have been held flat the last few years until a 4 percent increase was implemented in 2013.

CONSTRAINED WASTEWATER CAPACITY: The city's wastewater system capacity is constrained by a discharge pipeline. The city is making additional improvement to its recycled water treatment and distribution system to reduce its wastewater discharge.

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 with a large power producer accounting for an outsized portion of system revenues.

RATING SENSITIVITIES

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 will be necessary given recent increases in debt service costs.

CREDIT PROFILE

The system provides retail wastewater service to approximately 27,700 customers in the city, which is located approximately 30 miles northeast of San Diego. Wastewater treatment is provided by the city's Hale Avenue Resource Recovery Facility, which was originally built in 1959 but has undergone a number of expansions and upgrades over the years.

DECLINING COVERAGE, STRONG LIQUIDITY

The system's otherwise healthy financial performance has begun to decline primarily due to the rising costs of debt service associated with the series 2012 wastewater revenue bonds. All-in ADS coverage in fiscal 2013 finished at 1.8x, down versus the previous four years but in line with Fitch's 'AA' median. However, forecasts provided by management, which include assumed rate hikes of 4 percent over the next few years, project coverage to drop to 1.3x in 2014 before rebounding to 1.6x in subsequent years. In order to not pressure the rating at its current level, Fitch would expect future projections to continue to demonstrate a somewhat swift rebound in ADS coverage.

Liquidity, measured by days of operational cash held in unrestricted reserves, finished fiscal 2013 at an exceptional 812 days. In Fitch's view this will help to mitigate some of the projected declines in ADS coverage should they manifest.

RATES ARE HIGH AND RISING

The average residential water customer pays about $41 monthly for 7,500 gallons of usage. The combined monthly water and wastewater charges are about $104 or 2.7 percent median household income (MHI), which is higher than Fitch's affordability threshold of 2 percent. Actual monthly usage is likely much higher, resulting in an even higher monthly bill, although high rates are somewhat typical for the region. Rates are expected to climb 4 percent-5 percent per year over the next few years. Management has indicated to Fitch that it has encountered no strong impediments to its need to raise rates from wastewater customers.

MANAGEABLE CAPITAL NEEDS, ELEVATED DEBT BURDEN

The five-year capital improvement program totals a manageable $5.3 million, with no additional debt issuances planned for the foreseeable future. Major projects include expansion of the system's recycled water pipeline, which should produce more revenue over time as the treated water is sold to the city's large agricultural customers. Debt levels are elevated on a per customer basis at $2,840 but amortization is somewhat quick with 50 percent scheduled to payout in 10 years. Because of the lack of planned debt and the rate of amortization, customer debt levels are expected to improve quickly and be more in line with the 'AA' category medians over the next five years.

MIXED SERVICE AREA

The city's unemployment rate improved to 7.3 percent in October 2013, besting the state's average of 8.3 percent and was significantly lower than 2011's average of 11 percent. However, at 20.7 percent in 2012, poverty rates have steadily risen since 2009 and remain above state (16.4 percent) and national averages (15.7 percent). Income levels are below average with MHI at 77 percent and 88 percent of state and national averages, respectively, in 2012. Lastly, there is some customer concentration due to a single customer accounting for 7.7 percent of total revenues in 2011.

Additional information is available at '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:

Revenue-Supported Rating Criteria

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

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

2014 Water and Sewer Medians

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://fitchratings.com/gws/en/disclosure/ solicitation?pr_id=819513

((Comments on this story may be sent to newsdesk@closeupmedia.com))


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