Fitch Rates Escondido Joint Powers Financing Authority, CA's Wastewater Revs 'AA-'; Outlook Stable

Fitch Ratings assigns an 'AA-' rating to the following Escondido Joint Powers Financing Authority, CA bonds, issued on behalf of the City of Escondido:

--Approximately $28.3 million revenue bonds (wastewater system financing), series 2012.

The Rating Outlook is Stable.

The bond proceeds will be used to fund new money needs of the city (approximately $23.7 million) and the remaining amount will refund the wastewater system's remaining $4.7 million share of the city's outstanding series 2000 certificates of participation. The bonds are expected to price via negotiated sale during the week of March 19, 2012.

SECURITY

The bonds will be issued by the Escondido Joint Powers Financing Authority on behalf of the City of Escondido. Bond repayment is secured by installment payments made by the city to the authority in accordance with an Installment Purchase Agreement (IPA) between the two entities. The obligation by the city to make the installment payments is absolute and unconditional and is not subject to appropriation. The purchase payments are secured by the city's wastewater system net revenues.

There is no debt service reserve fund for the 2012 bonds.

KEY RATING DRIVERS

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

HEALTHY FINANCIAL POSITION: Fitch expects net revenues will continue to provide healthy debt service coverage of existing debt, following a decline with the current issue. Reserve levels are strong albeit at a lower level following a loan to the city's general fund in November 2011.

SIZEABLE CAPITAL NEEDS: Debt levels are moderate and expected to remain close to the median for the rated water and sewer utilities as the city issues another $11 million of sewer revenue debt over the next five years.

RATE INCREASES NEEDED: Management's assumed future revenues rely on estimated rate increases that have not yet been adopted by city council. The rate increases appear to be of a manageable level at 6% annually.

RESIDENTIAL SERVICE AREA: The service area includes a stable residential sector and a potential market for the expansion of recycled water sales.

WEAK LEGAL PROVISIONS: Legal provisions are relatively weak with a 1.15x rate covenant and lack of a debt service reserve fund.

CREDIT PROFILE

The city provides retail wastewater service to the City of Escondido, which is located approximately 30 miles northeast of San Diego. The city also provides water services but those revenues are not pledged to bondholders with the exception of recycled water sales. The city has 54,252 wastewater customers that are mostly residential. Wealth levels in the community are 83% of the state average and unemployment levels of around 10% in 2011, which is below the state average.

Some customer concentration exists with one large customer accounting for 6.5%, but the facility, a natural-gas fired power plant, seems likely to remain in operation. Wastewater rates are billed as a percentage of indoor water use and recycled water rates are billed at 90% of potable water rates.

WASTEWATER SYSTEM

Wastewater treatment is provided by the city's Hale Avenue Resource Recovery Facility (HARRF) that was originally built in 1959 but has undergone a number of expansions and upgrades over the years. Proceeds from the series 2012 bonds will fund additional facility and technology upgrades at the HARRF. The treatment capacity of 18 million gallons per day (MGD) is partially owned by the City of San Diego and expenses are shared under a 1972 sewage disposal agreement between Escondido and San Diego.

The HARRF treated effluent is discharged through a 14 mile long pipeline owned by Escondido that connects to the San Elijo ocean outfall pipeline, owned by the San Elijo Joint Powers Authority. Escondido's contractual rights to 23.25 MGD capacity in the ocean outfall pipeline is in perpetuity. However, expansion of the outfall to accommodate growth is not practical for cost and environmental reasons.

The city has been able to address the growth in its wastewater effluent by increasing tertiary treatment at the HARRF to 9 MGD and building its distribution system for recycled water. Further extension of the pipeline out to agricultural customers in the eastern portion of the city is anticipated to increase recycled water sales in the next few years. The increased business line provides some cost benefit in that it reduces imported water costs to the city's water utility, but it also provides an opportunity for continued growth in the city without constraint from the city's wastewater system.

HEALTHY FINANCIAL POSITION

Debt service coverage has been strong at over 2.0 times (x) in the past three years. All-in debt service coverage levels are slightly lower but still over 2.0x. All-in coverage factors in the wastewater system's obligation on the outstanding series 2000 certificates of participation (COPs), paid to the water system. That obligation is being refunded by the series 2012 bonds and will become a parity obligation. Outstanding debt that will be parity with the series 2012 bonds includes the $30.7 million in outstanding COPs and the approximately $22.4 million in parity state loans.

Future debt service coverage, including the new money debt service portion of the series 2012 bonds, is projected by management to decline to between 1.7x and 1.8x. While this level of coverage is healthy for the rating, it is subject to assumed additional rate increases that have not yet been approved by the City Council as well as growth in recycled water sales. Fitch believes the system retains adequate but diminishing rate raising flexibility.

Liquidity was very strong at the end of fiscal 2011 with approximately $32.7 million in legally unrestricted reserves, or 702 days operating cash. Cash has declined in fiscal 2012 with a $4.2 million loan made to the city's general fund, which will reduce reserves at the end of fiscal 2012. However, remaining reserves are still strong. The loan to the general fund will be repaid over twenty years at an interest rate equivalent to the city's investment portfolio return.

RATE INCREASES EXPECTED

Escondido projects wastewater rate increases of 6% per year in the next four years. The city increased its recycled water rates by 12% as of Feb. 1, 2012. Another increase of this magnitude is anticipated in fiscal 2013. Rates are typical for the region. The combined water and wastewater charges of about $78.50 are near 2% of median household income, which is Fitch's affordability measure. However, this is for a monthly usage of 7,000 gallons per month, which is a relatively low assumed usage for the region.

MANAGEABLE CAPITAL NEEDS

Capital needs of the system relate primarily to upgrades to the HARRF and total around $59 million over the next five years. Proceeds of the series 2012 bonds will fund just under half of the system's capital needs. The utility expects it may borrow another $11 million in 2015 to fund additional components of the capital plan. Debt levels following this issue will about average with a debt load of $1,436 per customer.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 10, 2011.

Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647331

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Contacts:

Fitch Ratings
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San Francisco, CA 94008
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