Fitch Maintains Rating Watch Negative on Stockton Public Finance Authority, CA's 'BB+' Water Revs

Fri Jun 7, 2013 5:51pm EDT

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Fitch Maintains Rating Watch Negative on Stockton Public Finance Authority, CA's 'BB+' Water Revs

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: Fitch remains concerned about potential event risks that may arise following the city's petition for chapter 9 bankruptcy protection on June 28 that 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 effect of negotiations and the plan of restricting on pledged revenues and declaration by creditors of an event of default under the financing agreements. Union Bank, the letter of credit provider for the series 2010A bonds, stated in a May 1, 2012 letter that it does not intend at this time to formally declare an event of default or exercise any of its rights or remedies under its reimbursement agreement with the city; however, it reserves the right to do so in the future.

CITY ACTIONS IMPAIR SYSTEM CREDIT QUALITY: The city's actions in recent months 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, exposing the system to possible bond acceleration.

ADEQUATE OPERATIONS: System financial performance historically has been sound, and its current financial position appears adequate.

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

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

RATING SENSITIVITIES

DEVELOPMENTS AFFECTING THE SYSTEM: The ratings could deteriorate rapidly and significantly, sensitive to future actions by the city and developing external pressures, including bankruptcy court rulings, higher reset rates for series 2010A bonds and potential bank bonds, which could adversely impact system operations and bondholders.

CREDIT PROFILE

Negative Watch Reflects Ongoing Risks

The Negative Watch primarily reflects Fitch's ongoing concerns regarding possible conditions both within and outside of city government that may affect system operating results. These risks include, but are not limited to, treatment of pledged revenues and allowable system operating and maintenance expenses related to the authority's debt under a plan of restructuring as well as elevated reset rates and potential bank bonds associated with the 2010A bonds.

The city's actions have had and will continue to have some direct bearing on the system's credit quality. 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.

After a trial held in March to determine the city's bankruptcy eligibility, the judge approved the city's bankruptcy eligibility on April 1. A status conference will be held June 12.

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.

For fiscal 2011 total debt service coverage (DSC) on system bonds equaled 1.15x, with the federal interest rate subsidy for 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%.

Unaudited fiscal 2012 results were largely as expected. For the year total DSC rose to 1.50x when treating the BABs subsidy as revenues and deducting capitalized interest from debt service costs. The city also reports that unaudited cash balances were little changed from fiscal 2011, with the system maintaining around $36 million in unrestricted cash as well as slightly more than $8 million in the system rate stabilization fund (RSF).

Fiscal 2013 financial results are also forecasted to remain relatively favorable based on the plan adopted by the city council which included 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.

Fitch has assumed a net $1.5 million reduction in operating costs in determining fiscal 2013 net revenues, 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.

Through the 11-month period ending June 2013, the city reports revenues at fiscal year-end 2013 are expected to be close to budgeted amounts while expenditures are expected to be slightly under budget. Revenues may be negatively affected by sequestration cuts to the federal BABs subsidy for the year. However, Fitch does not believe that DSC will be materially affected or that the system will face liquidity pressures as a result of the cuts.

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. 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 50% 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+';

--$15.6 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+'.

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

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 12, 2012;

--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 3, 2012.

For information on Build America Bonds, visit 'www.fitchratings.com/BABs.'

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

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

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684901

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=793186

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Fitch Ratings, Inc.
Primary Analyst
Shannon Groff, +1-415-732-5628
Director
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Doug Scott, +1-512-215-3725
Managing Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
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Media Relations:
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+1-212-908-0526
elizabeth.fogerty@fitchratings.com

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