KBRA Downgrades Ratings for the City of San Diego, CA Water Revenue Bonds to AA from AA+, and for the Subordinate Water Revenue WIFIA Loans to AA- from AA; Outlook Remains Stable
4 Jun 2024 | New York
KBRA downgrades the long-term rating on the City of San Diego's (the "City") Senior Water Revenue Bonds to AA from AA+. Concurrently, the long-term rating on the Subordinate Water Revenue WIFIA Loans was downgraded to AA- from AA. Both liens have a Stable Outlook. The City's Senior Water Revenue Bonds (the Bonds) are issued by the Public Facilities Financing Authority of the City of San Diego and secured by installment payments made by the City of San Diego. The City’s obligation to make the installment payments on the Bonds is secured by the net revenues of the City’s water system.
The downgrade on the ratings of the City's Water System Senior Water Revenue Bonds and Subordinate WIFIA loans reflects the system’s moderately weaker liquidity, as expenditure growth has outpaced revenues and customer delinquencies continued to rise in FY2023, impacting cash reserves. Financial metrics remain strong, although more in-line with ‘AA’ rating level characteristics. A key credit strength is the City’s independent rate-setting authority and history of implementing timely water rate increases. Conversely, the ongoing Proposition 218 rate litigation (City of San Diego vs. Patz), which is pending appellate court review, adds a measure of uncertainty with respect to the timeliness of future water rate adjustments.
The water system provides an essential service to a large, diverse service area with a strong underlying economic base. While leverage, as measured by long-term debt to net fixed assets is relatively low, it is projected to rise throughout the five-year financial forecast period, driven by sizable capital needs related to environmental compliance, ongoing maintenance, and long-term water supply reliability. Rates will consequently be pressured through 2029 which is a credit concern, although KBRA views present water bills as competitive and affordable, providing adequate rate flexibility going forward.
Key Credit Considerations
The rating was downgraded because of the following key credit considerations:
Credit Positives
- Diversified, largely residential customer base in a broad service area with above average socioeconomic indicators.
- Foundation of fiscally conservative policies along with a history of timely rate increases.
- Sound financial metrics, stable debt service coverage and adequate liquidity, albeit maintained at moderately lower levels to mitigate rate impacts through the capex cycle.
Credit Challenges
- Ongoing water supply and cost challenges are expected to continue to necessitate water rate increases.
- Significant capital program and associated debt requirements to fund the Pure Water Program and ongoing CIP capital needs.
- Proposition 218 litigation adds uncertainty with respect to the implementation of timely rate increases.
Rating Sensitivities
For Upgrade
- Full implementation of the Pure Water Project and/or other programs on-time and under budget, thus reducing projected debt requirements.
For Downgrade
- Significant delays and cost escalations relating to the large capital program which pressure leverage, debt service coverage and customer rate affordability.
- Inability to moderate growth in account receivables which results in a material weakening of liquidity.
- Inability to effectuate timely rate increases as needed.
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