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MOODY'S ASSIGNS Aa3 RATING TO CITY OF LODI'S 2010 WATER REVENUE BONDS

11 Oct 2010

APPROXIMATELY $39.5 MILLION IN DEBT AFFECTED

Lodi (City of) CA Water Enterprise
Water/Sewer
CA

Moody's Rating

ISSUE

RATING

2010 Water Revenue Bonds

Aa3

  Sale Amount

$39,500,000

  Expected Sale Date

10/15/10

  Rating Description

2010 Water Revenue Bonds

 

 
Moody's Outlook   No Outlook
 

Opinion

NEW YORK, Oct 11, 2010 -- Moody's Investors Service has assigned an Aa3 rating to the Lodi Public Financing Authority's (CA) 2010 Water Revenue Bonds. Proceeds from the current offering will finance the construction of a new water treatment facility.

RATING RATIONALE

The water enterprise serves the City of Lodi, a large and diverse customer base, located in San Joaquin County. The rating assignment reflects the enterprise's high coverage on projected debt service, and Moody's expectation that coverage levels will remain stable. The enterprise's strong liquidity and reserves are also consistent with its rating level, and are more than sufficient to meet unexpected operating needs. However, the enterprise will continue to face operating challenges which include: long-term remediation and clean-up of the enterprise's five groundwater contamination plumes, construction of the new facility, and transition to a water metered rate system. The bonds are secured by a first lien on net water revenues.

STABLE RESIDENTIAL CUSTOMER BASE AND LOW FORECLOSURE RATE; BELOW-AVERAGE SOCIOECONOMIC PROFILE

Moody's expects that Lodi's customers' water demand will remain relatively stable due to its largely residential customer base. The City of Lodi has approximately 22,959 water accounts, with top ten principal water users accounting for just 6.7% of fiscal 2010 water revenues. The two largest users are Lodi Unified School District and the city, very stable accounts representing just 3.7% of 2010 water revenues. The enterprise's customer base is comprised mostly of single-family residential homes at approximately 21,500 accounts (or 94% of total accounts), which in 2010 generated approximately 81% of revenues. The enterprise's service area continues to see stable population growth; annual population growth over the last 10 years has averaged 1.2%. Moody's notes that despite a substantial increase in foreclosures in San Joaquin County over the last three years, the foreclosure rate in the City of Lodi remains relatively low at 0.64% of housing units. Concurrently, the payment delinquency rate experienced by the enterprise is also modest at 1.2% of total customer accounts in fiscal 2010. This is despite the fact that the city has a below-average socioeconomic profile; per capita and median family incomes for the City of Lodi are below the state median at 89% and 82% respectively. The unemployment rate in the City of Lodi also remains high at 12.5% in September, although comparable to the State unemployment rate of 12.4% in the same month. The city's employment base is moderate in size and diversified, which are favorable long-term rating factors despite the currently high unemployment rate and near-term economic challenges. The largest employer in the enterprise's service area is Lodi Unified School District, followed by the Lodi Memorial Hospital, Pacific Coast Producers, a fruit canning business, Blue Shield, and Cottage Bakery.

According to the city, the rate charged to residential customers remains average and competitive with surrounding communities at an estimated $40.28 per month for a 3-bedroom single-family home. Residential customers in the nearby City of Stockton experience a monthly rate charge of $38.05 and the lowest monthly rate charge is $22.31 in the City of Galt.

STRONG PROJECTED COVERAGE LEVELS AND CURRENT RESERVES ARE CREDIT STRENGTHS; CLEAN-UP COSTS AND METER ADOPTION PROGRAM ARE CONTINUING OPERATING CHALLENGES

Moody's believes the enterprise's strong balance sheet and projected debt service coverage levels are credit strengths. The enterprise has maintained excellent liquidity for its rating level; unencumbered reserves were estimated to be $14.1 million (or approximately 100% of projected 2011 revenues) at the beginning of fiscal 2011. However, the enterprise's reserves are projected to steadily decline beginning in fiscal 2012 because of the implementation of its water meter retrofit program. The enterprise instituted this program in fiscal 2009 and program spending is projected to escalate to approximately $6.7 million, $7.7 million, $8.9 million and $11 million in fiscal 2012, 2013, 2014, and 2015 respectively. Currently 80% of commercial users and 18% of residential users are metered, with the retrofit program projected to phase in all non-metered water service users by 2015. Moody's notes that a near-term operating challenge for the enterprise will be its conversion from a flat monthly rate system charged to residential customers to a metered monthly rate charge. However, given the city's demonstrated willingness to raise rates in prior years, prudent set-aside of reserves in anticipation of this program, and low water supply costs, it is likely that the enterprise will appropriately address this near-term challenge to help generate continued stable operating results. The enterprise has flexibility in the implementation of this program and could slow down program outlays in order to retain higher reserves, as state law does not require adoption of water meter installation until January 1, 2025.

In connection with this financing, the enterprise has adopted reasonable pro forma revenue and expenditure projections over the next five years. The enterprise is projecting 0.2% increase in customer connections which appears to be reasonable given the city's population growth rate. Additionally, the enterprise's projected revenues reflect a 2% rate increase effective January 2011, which has been approved by city council, and council-approved future rate increases based on an inflation index. The city is assuming future rate increases of 3.5% in water service rates. This rate increase assumption is based on the Engineering News 20-cities inflation index, which has averaged 3.5% over the last 10 years. However, Moody's notes that inflation remains at a below-average level so near-term rate increases may be below the enterprise's assumption. In connection with the meter retrofit program, the enterprise prudently forecasts a 10% reduction in water usage that has been reflected in the enterprise's pro forma projections. However, the City is assuming an increase in connection fees to $8,140 per unit beginning in fiscal 2012 from the currently well below-average fee of $1,024 per unit. Moody's believes this assumption is aggressive considering that the fee increase has not been adopted yet. On the expense side the enterprise is assuming 3.4% annual increases in personnel services and 3% annual increases in supplies and materials. The enterprise will also retire a state loan using approximately $1.4 million outstanding in October with cash on hand, which is a prudent move in anticipation of this financing. Based on these assumptions and the retirement of the state loan, the enterprise projects well above-average debt service coverage levels; beginning in fiscal 2011, coverage levels excluding connection fees are projected to be 2.92x annual debt service. Coverage levels excluding connection fees are projected to remain relatively stable from fiscal 2011 through 2015 at a projected range of 2.56x annual debt service to 3.12x annual debt service. The high coverage levels are a primary factor in the Aa3 rating assignment and are a key credit strength. In addition, the utility's operating ratio and net-take down is stable and satisfactory for the rating at 70.7% and 43.4% respectively in fiscal 2009.

Moody's notes that the enterprise continues to face long-term operating pressure from costs related to the clean-up and remediation of five groundwater contamination plumes. The enterprise has an estimated unfunded liability of $23.2 million related to this remediation program and it remains unclear how the program will be funded beginning in 2020. The total liability was initially estimated to be as high as $70 million in fiscal 2009, but has since been revised down to $41.2 million based on current clean-up expenditures and indications from regulatory agencies regarding clean-up requirements. The groundwater was contaminated with tetrachloroethylene (also known as PCE) and trichloroethylene (TCE). The enterprise received approximately $14.6 million from a recent settlement to cover the costs of the clean-up, which in addition to $3.4 million in reserves, has been segregated in a separate fund. The combined $18 million is projected to cover these clean-up costs through at least fiscal 2020. Additionally, the chemical DBCP (1,2-dibromo-3-chloropropane) was discovered in 6 groundwater wells and the enterprise has implemented another remediation program to clean-up this chemical. However, this program remains well-funded and has no unfunded liability because of the terms of the settlement reached with various companies in 1996. The terms include a guarantee by the companies that their annual payments to the city will at least exceed annual clean-up costs by 10% and payments are required up to 2036. In fiscal 2010, DBCP payments exceeded treatment and legal costs by approximately $130,000. The clean-up of all these chemicals requires additional management oversight, and along with the sizable unfunded liability, could result in fiscal stress should annual costs begin to exceed future funding sources.

PROCEEDS TO FUND CONSTRUCTION OF NEW WATER TREATMENT PLANT; SURFACE WATER ADDITION WILL BENEFIT OPERATIONS

The enterprise anticipates that the current offering will be sufficient in size to finance the construction of a new water treatment facility in its entirety with no additional bond issuances. Moody's notes the moderate risks associated with construction, cost, and initial operation of this facility. This facility will treat surface water from the Mokelumne River and is expected to commence operations in fiscal 2013. The enterprise entered into a 44-year contract with Woodbridge Irrigation District in 2003 to annually purchase 6,000 acre-feet (AF) of water from the river at a cost of $1.2 million per year, which includes an annual CPI inflation adjustment. The enterprise has banked 42,000 AF from this agreement so far. The City of Lodi's primary water source is 27 groundwater wells, so the new water treatment facility will expand and diversify the enterprise's water supply to include surface water from the river, which is beneficial to the enterprise's operations on a long-term basis. Annual usage from all enterprise customers was approximately 16,000 AF in fiscal 2010.

The current issue will be structured with level debt service through its 30-year maturity. The enterprise may issue taxable Build America Bonds (BABs) in addition to tax-exempt debt, although the decision to issue BABs will be made at the pricing of the bonds.

TYPICAL COVENANTS ASSOCIATED WITH CALIFORNIA WATER ENTERPRISE ISSUANCES

The enterprise's rate covenant on the current issue is 1.25x annual debt service, which is a typical level associated with California water enterprise revenue bonds. Additional bonds may be issued with 1.25x coverage of maximum debt service on outstanding and additional bonds by net revenues from 12 of the last 18 months plus an allowance for any adopted rate increases . Pursuant to the enterprise's Installment Purchase Agreement, the Series 2010 bonds are secured by a first lien on net water revenues.

The financing authority's bonds are additionally secured by a debt service reserve fund, which is required to be funded at the lesser of 10% of original proceeds, maximum annual debt service, or 1.25x average annual debt service. The debt service reserve fund requirement will be met through cash from proceeds.

WHAT COULD CHANGE THE RATING - UP:

Continued reserve strength combined with improved debt service coverage could improve the enterprise's credit rating.

WHAT COULD CHANGE THE RATING - DOWN:

Material narrowing of the enterprise's balance sheet or prolonged weakness of the district's debt service coverage could apply pressure to the rating.

KEY STATISTICS

Operating ratio: 70.7%

Debt service coverage (estimated fiscal 2011): 2.92 times

Net-take down: 43.4%

Debt service safety margin: 39.3%

The principal methodology used in rating Lodi (City of) CA Water Enterprise was Analytical Framework For Water And Sewer System Rating, rating methodology published in August 1999. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, confidential and proprietary Moody's Investors Service's information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Sujay Umashankar
Analyst
Public Finance Group
Moody's Investors Service

Dari Barzel
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

MOODY'S ASSIGNS Aa3 RATING TO CITY OF LODI'S 2010 WATER REVENUE BONDS
No Related Data.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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