TEXT - Fitch may still cut California's Stockton Public Finance Authority rtgs

Tue Dec 18, 2012 1:53pm EST

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Dec 18 - Fitch Ratings maintains the Rating Watch Negative on Stockton
Public Finance Authority, California's (the authority) 'BB+' underlying ratings.
A complete list of the authority's ratings can be found at the end of this press
release.

SECURITY

The 2005 series A and series 2010A bonds are payable from installment payments 
made by the city of Stockton, California (the city) to the authority, with such 
installment payments secured by a senior lien pledge of net revenues of the 
city's water system (the system).  The series 2009A and 2009B bonds are 
subordinate lien bonds and 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

NEGATIVE WATCH MAINTAINED: With the city's petition for Chapter 9 bankruptcy 
protection on June 28, Fitch remains concerned about potential event risks that 
may arise and could negatively impact the financial health of the system or the 
ability of the system to make full and timely payment to bondholders. These 
event risks continue to include, but are not limited to, the treatment of 
pledged revenues during bankruptcy proceedings and declaration by creditors of 
an event of default under the financing agreements.  

CITY ACTIONS IMPAIR SYSTEM CREDIT QUALITY: The city's actions in recent months, 
culminating with the bankruptcy filing in June, call into question the city's 
ultimate willingness to pay debt service on system obligations. While the system
currently remains solvent and appears capable of meeting near-term obligations, 
various events of default have been triggered under the system's financing 
agreements, having exposed the system to possible bond acceleration. 

ADEQUATE OPERATIONS: System financial performance historically has been sound 
and the system's current financial position appears adequate.

ELEVATED LEVERAGE: The system maintains a high debt burden coupled with an 
extended amortization schedule.

  

DEPRESSED SERVICE AREA: The service area has been significantly affected by weak
economic and housing conditions.

WHAT COULD TRIGGER A DOWNGRADE

DEVELOPMENTS AFFECTING THE SYSTEM: Fitch's ongoing review will consider both 
future actions by the city that could negatively affect the system as well as 
any developing external system pressures, including bankruptcy court rulings 
adversely affecting system bondholders as well as higher reset rates and bank 
bonds associated with the 2010A bonds. Depending on the nature of the event(s), 
the ratings on the system bonds could deteriorate rapidly and significantly from
the current rating level.

CREDIT PROFILE

NEGATIVE WATCH REFLECTS ONGOING RISKS

The Negative Watch primarily reflects Fitch's ongoing concerns regarding 
possible conditions both within and outside of the city government that may 
affect system operating results. These risks include, but are not limited to, 
treatment under the bankruptcy code of pledged revenues and allowable system 
operating and maintenance expenses related to the authority's debt as well as 
elevated reset rates and potential bank bonds associated with the 2010A bonds. 
Evidence or expectation of deteriorating system performance or increased system 
exposure to various risks would likely lead to deterioration of system credit 
quality, and such downward rating action(s) may be acute and rapid. 

CITY GENERAL FUND DRIVES BANKRUPTCY 

The city's general fund operations have faced severe financial weakness in 
recent years as a result of escalating budgetary costs coupled with 
deteriorating revenues stemming from a significant economic downturn within the 
city. As a result, the city initiated a neutral evaluation process with 
creditors in February for the purpose of obtaining concessions that would allow 
the city to balance its fiscal 2013 budget. 

The confidential mediation process concluded on June 25, 2012 as scheduled, 
without providing sufficient cost reductions to balance the city's fiscal 2013 
budget. As a result, the city council passed various resolutions at its June 26,
2012 meeting which included the adoption of a pendency plan (the plan), and on 
June 28, 2012, the city formally filed for Chapter 9 bankruptcy protection.

The plan provides a balanced general fund budget for fiscal 2013, eliminating a 
$26 million gap through cost reductions to labor, retirees, debt and other 
obligations. The plan will serve as the city's fiscal 2013 budget while the city
is under Chapter 9 bankruptcy protection. 

WATER SYSTEM REMAINS SOLVENT

Despite the city's general fund fiscal problems, the system continues to perform
largely as expected relative to projections at the time of the issuance of the 
2010A bonds. This performance, and Fitch's expectation of the protection of 
pledged revenues for system bondholders under bankruptcy proceedings which would
allow continued performance on system obligations have limited deterioration in 
system credit quality to date. Nevertheless, the city's actions cannot be 
completely separated from the system's credit as they have exposed the system to
bond acceleration risk and other potential risks. Consequently, the city's 
actions have had and will continue to have some direct bearing on the system's 
credit quality.

For fiscal 2011 total debt service coverage (DSC) on system bonds equaled 1.15x,
with the federal interest rate subsidy related to the series 2009B Build America
Bonds (BABs) treated as revenue as opposed to an offset to debt service. For the
same period, the system maintained strong liquidity at 779 days cash while 
surplus net revenues covered depreciation expenses by a reasonable 89%. 

For fiscal 2012, revenues and expenses reportedly tracked close to budgeted 
figures. Consequently, based on budgeted net income, estimated debt service for 
the year, and treating the BABs subsidy as revenues, total DSC is expected at 
around 1.4x for the year. Unaudited cash balances are little changed from fiscal
2011. The city reports that the system maintained around $36 million in 
unrestricted cash as well as slightly more than $8 million in the system rate 
stabilization fund (RSF).

For fiscal 2013, financial results are also forecasted to remain relatively 
favorable based on the plan adopted by the city council which includes 
implementation of a 10% rate increase - the final year of a package that was 
approved by the city council in 2009. Total DSC is projected at just under 1.2x,
assuming weekly resets of the 2010A bonds at significantly higher amounts than 
historically achieved as well as treatment of the BABs subsidy as revenues; to 
date resets have been below budgeted amounts. 

In determining fiscal 2013 net revenues, Fitch has assumed a net $1.5 million 
reduction in operating costs based on a budget amendment approved by the city 
council on Sept. 11, 2012. Also, Fitch has assumed in its calculation a net 
increase in revenues of $3.6 million based on the same budget amendment. Of the 
increase in revenues, just over $3 million is attributable to transfers in from 
the RSF to meet the rate covenant. 

ELEVATED DEBT PROFILE

The system's debt profile is weak as a result of historical growth projects as 
well as because of Delta Water Supply Project (DWSP) costs. Construction related
to the DWSP has been completed and was reportedly on budget. The project is 
operational and currently is in the testing phase, with no issues being 
reported.

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 only 46% of 
principal amortizes within 20 years.

Fitch maintains the following authority ratings on Rating Watch Negative:

--$55 million variable rate demand water revenue bonds, series 2010A (Delta 
Water Supply Project) 'BB+';

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

--$18.6 million water revenue bonds, series 2009A (Delta Water Supply Project) 
'BB+';

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