OREANDA-NEWS. Fitch Ratings has affirmed the 'A-' rating on the following obligations issued by the Stockton Public Financing Authority, CA (the authority) on behalf of Stockton, CA (the city):

--$66.2 million wastewater system revenue refunding bonds, series 2014 (1998 Wastewater Project and 2003 Wastewater Project).

The Rating Outlook is Stable.

SECURITY

The 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 wastewater system (the system). 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 FINANCIAL PERFORMANCE: Debt service coverage (DSC) levels demonstrate sufficient strength at the current rating level through fiscal 2017. Updated projections were not provided, but Fitch expects metrics to worsen given additional capital needs.

HEALTHY CASH BALANCES: Liquidity has improved in each of the three last fiscal years to equal a solid one year of cash on hand.

EXTENSIVE DEBT NEEDS: The current strong debt profile is expected to worsen over the next few years as the system implements its five-year CIP. Projects relating to National Pollution Discharge Elimination System (NPDES) permits will be costly and, as the system expects to fund the majority of such projects with new debt, will significantly increase the utility's debt burden.

WEAK SERVICE AREA: The agricultural-based service area exhibits below average socio-economic metrics.

RATING SENSITIVITIES

MAINTENANCE OF FINANCIAL, DEBT PROFILE: A reduction in DSC or liquidity significantly beyond currently contemplated levels 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 wastewater service to the city of Stockton and eight service districts within a 100 mile service area. The total population served is approximately 370,000 through 140,500 largely residential connections, including some billed through the California Water Service Company.

The city's prior bankruptcy is not a rating driver. The rating is based purely on the credit profile of the system given the general legal protection and special revenue status of pledged utility revenues. The city's bankruptcy process ended in February 2015 with the approval of a plan of adjustment.

STRONG FINANCIAL PERFORMANCE EXPECTED TO WORSEN

The system finished fiscals 2015 and 2014 with very strong all-in DSC of 4.4x and 2.9x, respectively, after averaging 2.4x the prior three years. The current high coverage levels are primarily the result of significant rate increases in prior years.

Management projects all-in DSC of 2.6x and 2.7x in fiscals 2016 and 2017; figures were not provided beyond the fiscal 2017 budget. The city's prior forecast indicated declines to about 1.5x due to expected additional borrowing that would more than double the current debt service requirements. These debt issuances had been planned for fiscals 2015 and 2018 but have been delayed as the utility restructures its capital plan and devises a plan of finance. The utility now plans to issue a combined $150 million in early 2018 to fund wastewater treatment plant modifications related to its most recent 2014 NPDES permit.

The system's available liquidity has improved each of the last five years and stood at $38.5 million at fiscal year-end 2015, equal to a healthy one year of operational costs. Along with DSC, liquidity margins have rebounded over the past few years due to rate increases. However, Fitch expects cash to be drawn down somewhat in the coming years due to pay-as-you-go capital spending as projects ramp up.

SIGNIFICANT CAPITAL IMPROVEMENT PLAN, DEBT NEEDS

The utility's five-year CIP (fiscal 2017-2021) is essentially unchanged from two years ago and includes approximately $180 million of capital projects, $150 million of which are expected to be funded by future bond issues. However, capital expenditures have been pushed out and timing is uncertain. Major projects include two facility updates to address discharge requirements regulated by the prior 2008 and current 2014 NPDES permits estimated at $140 - $170 million. Given fairly rapid amortization of all outstanding debt within the next 15 years, the utility potentially has some capacity for additional debt going forward. Inclusion of the expected debt increases the currently low debt-per-customer of $494 to around $1,500 over the next several years.

RATES EXPECTED TO CONTINUE TO RISE

In response to the rate covenant violation in fiscal 2009, a five-year rate package was adopted in August 2010. The package included significant increases through 2016 followed by annual inflation escalators. The monthly combined water and wastewater bill for 7,500 gallons of usage will rise to about 2.4% of median household income (MHI) this year and 2.8% by fiscal 2021, which is well above Fitch's affordability threshold of 2%.

Future, potentially significant, rate increase may be required in order to finance the improvements necessary for compliance with the 2014 NPDES permit. Any such hikes when coupled with water rate increases may ultimately test the limits of the utility's rate flexibility.