Fitch Ratings has upgraded to ‘AA-‘ from ‘A+’ the following obligations of Lodi, California (the city):
–$29.8 million wastewater system revenue certificates of participation (COPs), series 2007A;
–$2.1 million (1991 Wastewater Treatment Plant Expansion Refunding Project) wastewater system revenue COPs series 2004A;
–$17.1 million refunding wastewater revenue bonds series 2012A issued by the Lodi Public Financing Authority, California (the authority).
The Rating Outlook is Stable.
The COPs are payable from sewer installment payments made by the city to authority, which assigns the right to receive payment to the trustee. The city’s obligation to pay installment payments is unconditional and is secured by a first lien on wastewater enterprise net revenues. It is not subject to appropriation. The series 2004A and series 2007A COPs have debt service reserve funds (DSRFs) sized to the IRS maximum while the series 2012A COPs have no DSRF.
KEY RATING DRIVERS:
–IMPROVED FINANCIAL OPERATIONS: The upgrade to ‘AA-‘ reflects the system’s improved financial profile, including sound debt service coverage, strong liquidity, and reasonable multi-year projections that suggest continued fiscal prudence. Several years ago the system suffered from very weak debt service coverage levels below 1.0x, net of transfers to the general fund.
–REDUCED REGULATORY UNCERTAINTY: Uncertainty that existed several years ago when the city’s discharge permit was under review has been resolved. A new five year discharge permit was issued in October 2013 and did not include increased capital requirements.
–MANAGEABLE DEBT PROFILE: Debt levels are slightly above average but should decline over time given moderate debt amortization and plans to fully fund the system’s five-year capital improvement plan (CIP) with pay-as-you-go financing.
–RATE INCREASES MODERATING: The system implemented substantial rate increases in fiscals 2011 and 2012 to support capital spending for regulatory compliance and to enhance the system’s financial position. A recently approved five-year rate plan suggests future rate increases will not exceed 3% annually.
–CONTINUED ECONOMIC RECOVERY: The city’s economic recovery is ongoing, with rapidly recovering home prices, new residential and commercial construction, and rising employment. However, income levels are below state and national averages, and unemployment remains high despite recent improvements.
–STABLE OUTLOOK: The rating is sensitive to shifts in fundamental credit characteristics including the system’s financial operations and debt profile. The Stable Outlook reflects Fitch’s expectation that such shifts are not likely over the next review cycle.
The city has a population of 63,300 in the San Joaquin Valley, about 34 miles south of Sacramento and 14 miles north of Stockton. The local economy is moderately concentrated in agriculture and food processing, although it also has large employers in the packaging, plastics manufacturing, and service industries. The area also benefits as a regional tourist destination.
The city’s wastewater system serves nearly 24,000 customer accounts in the city of Lodi, around 75% of which are residential. Customer growth is limited and concentration is moderate with the top 10 customers accounting for 9.3% of revenues. The wastewater system is operated as an enterprise fund of the city, with much of the management of the system linked to the city’s overall financial operations.
IMPROVED SYSTEM FINANCIAL OPERATIONS
The system’s financial performance has improved significantly over the past several years. Fiscal 2013 operations produced debt service coverage of 1.8x after a transfer out to the general fund. Liquidity also improved to $13.7 million of unrestricted cash, equal to 881 days cash. While management intends to spend down a portion of its cash cushion on capital, Fitch expects cash levels to remain at levels appropriate for the ‘AA-‘ rating level.
Debt service coverage improved from fiscal years 2009 and 2010 when coverage net of transfers out was just 0.8x and 1.1x, respectively. The low financial margins were the result of declines in connections fees and increased costs related to capital requirements. In response, the city implemented a series of large rate increases, refunded a portion of its debt for interest rate savings, and lowered certain expenditures. These measures, in addition to the system’s near-completion of its largest capital projects, have put the system on a sound financial footing with more modest rate increases planned moving forward. The council recently approved a five-year rate plan with rate increases not to exceed 2.5%-3% annually.
The system’s multi-year financial projections include reasonable revenue and expenditure assumptions, including no connection fees, and suggest recent years’ financial improvements are likely to hold or continue to improve. Forecasted debt service coverage levels, net of transfers out, range from 1.92x-2.19x from fiscal years 2015-2019.
The system’s flat wastewater rate for a residential three-bedroom house is $44.12, or 1.1% of median household income. Although Fitch regards this rate as high, it is comparable to other regional systems pressured to upgrade treatment standards given San Joaquin Delta-related environmental pressures. The city is in the process of transitioning to installing water meters for each customer, which will impact wastewater billings as well. Once metered, customers will move to a flow-based rate structure instead of a flat fee per household. This may introduce some revenue variability in the future, depending on water consumption.
REDUCED REGULATORY CONCERNS
Fitch views positively the system’s five-year renewal of its discharge permit with no significant capital requirements. The system’s former permit had been remanded back to the Regional Water Quality Control Board over nitrogen level concerns, an issue that impacted the broader region. The city proactively invested to reduce its nitrogen output, which was part of the larger capital spending plan of the last decade. Ultimately, the permit renewal did not include any increased regulatory restrictions beyond the city’s current treatment process.
Subject to certain customer expansion opportunities, management may also have the opportunity to sell more of its treated effluent, which could reduce discharges from the environmentally sensitive San Joaquin Delta (the delta) to various above ground usages. If enacted, this change may significantly mitigate environmental and related capital concerns stemming from the system’s historical dependence on delta discharges.
ADEQUATE DEBT PROFILE
The system’s debt levels are elected at $2,189 per customer ($823 per capita) and debt to net plant of 56%, but are expected to decline as debt amortizes and further capital improvements are completely pay-as-you-go financed. Principal amortizes moderately, with 41% and 82% of debt retiring in 10 and 20 years, respectively. The system’s five year CIP is manageable at $25.4 million, or $214 per capita, and consists of various maintenance projects and new pipelines required to divert water discharges from the delta to other usages.
STABLIZING SERVICE AREA ECONOMY
The city’s economic performance continues to improve from trough levels reached during the recession. The housing market has shown marked improvement, with increasing residential construction and rising home values.
Although the city’s economy continues to recover, its key economic data is somewhat weak. Unemployment registered a high 8.8% in April 2014, which compares poorly to the state and national averages of 7.4% and 5.9%, respectively. Income levels also lag the state and nation. Compared to the Stockton regional economy, however, Lodi’s key economic metrics compare favorably.
In addition to the sources of information identified in the U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope, and Zillow.
Applicable Criteria and Related Research:
–‘Revenue-Supported Rating Criteria’ June 16, 2014;
–‘U.S. Water and Sewer Revenue Bond Rating Criteria’, July 31, 2013;
–‘2014 Water and Sewer Medians’, Dec. 12, 2013;
–‘2014 Outlook: Water and Sewer Sector’, Dec. 12, 2013.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2014 Water and Sewer Medians
2014 Outlook: Water and Sewer Sector