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

--$53.8 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-';

--$5.7 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

REDUCED MARGINS DUE TO DROUGHT: Drought related water conservation has lowered revenues and prompted the city to utilize rate stabilization funds (RSF) in fiscals 2015 and 2016 to close operating gaps. In addition, the city defeased a portion of various fiscal 2016 maturities to maintain its rate covenant as it has strong cash balances but is only able to replenish the RSF from operating surplus and not from reserves.

RATE INCREASES TO STABILIZE FINANCES: The city recently implemented a five-year rate package that includes two years of significant increases, followed by three years of modest hikes in order to stabilize its finances given lower water sales related to the prolonged state drought.

STRONG CASH BALANCES: System liquidity has been very good with a five year average of 590 days cash on hand. This is somewhat lower than historically due to drawdown of the RSF 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: The DSWP provides a new resource for the city that is expected to provide sufficient supply through at least 2025.

WEAK SERVICE AREA: Although improved since the economic downturn, the agricultural-based service area is below average relative to state and national economic indicators.

RATING SENSITIVITIES

DETERIORATION OF FINANCIAL PROFILE: An extended period of below-average debt service coverage (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. With the completion of the DWSP in 2012, the system's primary source of supply is the San Joaquin River, supplemented with water purchased from the Stockton East Water District (SEWD) and Woodbridge Irrigation District (WID), as well as groundwater sources.

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 system maintained adequate financial performance through the city's bankruptcy process, which ended in February 2015 with the approval of a plan of adjustment.

RATE INCREASES TO ADDRESS DROUGHT IMPACTS

As part of the state-wide mandatory conservation measures issued in May 2015, the State Water Board required a 28% conservation level for Stockton, revised to 26% in spring 2016. The city implemented drought rules including two day per week irrigation and achieved 37% conservation through May 2016. As such, water sales have been reduced and are expected to continue to be lower than historically.

In order to address declines in financial margins, the utility recently conducted a rate study and established a five-year rate package. Rates had previously increased significantly from 2010-2012 in order to pay for debt service costs associated with the DWSP and were expected to be inflation-based going forward. However, as recommended by the rate study, rates will increase significantly at 18.5% in fiscal 2017 and 11% in 2018, followed by three years of modest 3% annual increases. As such, the average monthly combined water and sewer bill for 7,500 gallons of usage will rise to about 2.4% of median household income (MHI) this fiscal year and 2.8% by fiscal 2021, which is above Fitch's affordability threshold of 2%. This may limit the utility's future rate raising ability.

REDUCED FINANCIAL PERFORMANCE

All-in DSC dipped to 1.28x and 1.08x in fiscals 2015 and 2016, respectively, on a Fitch-calculated basis (to the rate covenant on an indenture calculation basis) as the system absorbed effects from the drought. Senior DSC was lower but still strong at 4.7x and 3.8x in fiscals 2015 and 2016, respectively. The utility drew down the RSF, utilizing $5.6 million in fiscal 2015 and $2.25 million in fiscal 2016; the balance at fiscal year-end 2016 is estimated at $537,000. The utility also defeased a combined $4.8 million of bonds (series 2002A, 2009B and 2010A) in fiscal 2016 in order to meet its rate covenant and plans some additional defeasances in fiscal 2017. Given the use of the RSF and cash defeasance, the utility's strong cash balance has declined significantly but still remained strong at approximately $27 million at the end of fiscal 2016 (unaudited), including the RSF and unrestricted cash balances.

DSC had been mostly good yet volatile from fiscal 2010 to 2014, ranging from 1.36x to 2.31x on a Fitch calculated all-in basis and at least 6.0x on a senior-lien basis. The volatility was largely attributable to the quickly increasing operational and debt service costs associated with bringing the DWSP online.

Projected debt service, including the rate increase and reasonable assumptions such as annual increases of 6.5% for water purchases, 6% for benefits and 4% for utilities as well as customer growth of 0.5%, produces Fitch calculated annual all-in DSC of 1.17x to 1.29x for fiscals 2017 to 2021. Senior DSC projections over that period remain above 4.0x. If the implemented increases are not sufficient and/or the drought continues to weigh on revenues, the rating could be pressured.

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 2.8x and 1.6x the national medians. While improvement in the system's capital structure is expected over time, debt levels will continue to be a long-term concern as a below-average 60% of principal amortizes within 20 years. However, the utility's capital needs appear manageable, with a capital improvement plan totaling approximately $16 million over the next five years (fiscal 2017-2021), down from $26 million in the prior CIP. 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.

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. Median household income remains below state and national averages and poverty is high. Large employers include government, food production and medical centers.