Fitch Ratings has affirmed its 'AA-' rating on the following bonds issued by the Escondido Joint Powers Financing Authority, CA (JPFA or the authority):

--Approximately $30.3 million Escondido Joint Powers Financing Authority revenue bonds (water system financing), series 2012.

The Rating Outlook is Stable.

SECURITY

Bonds are secured by installment payments paid to the JPFA from the city of Escondido, CA (the city). The obligation of the city to make installment payments is secured by a pledge of net revenues of the city's water system (the system); such obligation is absolute and unconditional and is not subject to appropriation.

KEY RATING DRIVERS

HEALTHY FINANCIAL PERFORMANCE: The system's all-in debt service coverage (DSC) has been healthy over the past five years, never falling below 1.9x.

BELOW-AVERAGE LIQUIDITY: In contrast to the system's DSC, liquidity has been and remains below average.

RELIANCE ON IMPORTED WATER: The city purchases 70% of its raw water supply from the San Diego County Water Authority (SDCWA, revenue bonds rated 'AA+' with a Stable Outlook by Fitch). This reliance is a vulnerability but also provides expenditure relief in years of declining water sales, since purchases can be curtailed as well given the take-and-pay contract with SDCWA.

HIGH RATES: Sizable rate increases have been necessary in recent years to absorb higher imported water costs and, more recently, mandatory cuts in water usage. Combined water and wastewater rates are now very high, although high rates are typical for the region.

MANAGEABLE CAPITAL NEEDS: The city's capital improvement plan (CIP) primary focus is completion of the Wohlford Dam Project. Implementation of the CIP is not expected to have a large impact on the city's somewhat already elevated debt levels as many of the projects are expected to be funded primarily from cash and, specifically for the Wohlford project, grants from the state.

RATING SENSITIVITIES

CONTINUED STABILITY: Failure to maintain financial and debt metrics near Fitch's 'AA' median levels could put downward pressure on the rating. Future increases in user rates may be necessary to maintain the system's metrics given the expected increases in water purchase costs from the SDCWA.

CREDIT PROFILE

The system provides retail water service to approximately 80% of the city, which is located approximately 30 miles northeast of San Diego. About 70% of the city's water supply is provided in untreated form by the SDCWA and is then treated at a city-owned treatment plant.

SOUND FINANCIAL PERFORMANCE, ADEQUATE LIQUIDITY

The system has exhibited sound financial performance over the past several years, although liquidity continues to trend below average. Since 2011, DSC has averaged a solid 2.2x and finished both fiscals 2014 and 2015 at above 2.5x. In comparison, Fitch's 'AA' median for all-in DSC is 2.0x. The coverage improvements in 2014 and 2015 are largely attributable to the system's proactive use of rate increases to balance the rising cost of wholesale water. Furthermore, the city's take-and-pay contract with SDCWA allows it to purchase less water if not needed, thereby reducing water purchase costs.

In contrast to the system's sound DSC, unrestricted cash remains below average. Emblematic of the below-average cash balances, fiscal 2015 finished with 177 days cash versus Fitch's 'AA' median level of 442. Although the city's liquidity trails its peers, days cash is still considered to be adequate by Fitch.

Resulting from both projected flat revenue growth and increases in water purchase costs, management's forecast shows DSC dipping to 1.3x in fiscal 2016 before rebounding to above 2.0x in 2020. Over the forecast period, management projects liquidity to remain at or near current levels. Although 1.3x is below Fitch's comparable median, a short-term decrease in DSC is not expected to impact the current rating of the system's revenue bonds. Management forecasts have historically trended conservative and therefore outperformance is viewed as likely by Fitch.

RATES ARE HIGH AND RISING

Due to the rising water purchase costs from SDCWA in pursuit of its water diversification strategy and, more recently, to curtail mandatory state-wide water use reductions driven by the state's historic drought, the city has implemented large annual rate increases over the past several years. The average residential water customer now pays about $73 monthly for 7,500 gallons of usage. On a combined basis, water and wastewater charges are about $113, which equates to 2.6% of median household income (MHI). Fitch considers combined bills of greater than 2% of MHI to be high and potentially limiting future rate-raising flexibility. Additionally, actual usage is likely greater than Fitch's usage assumption, pushing actual customer bills even higher. However, it does not appear that the city is an outlier in terms of its regional peers.

Further annual rate increases of 5.5% are expected through 2017 and then additional yet to be determined increases are expected through 2020. Management has indicated to Fitch that it has encountered no strong impediments to date in raising rates. As a positive, approximately 50% of residential rates are fixed which helps to prevent some revenue volatility.

MANAGEABLE CAPITAL NEEDS, DEBT

The five-year CIP totals a manageable $32 million. As was the case at Fitch's last review, the largest project includes the completion of a new dam to replace the aging Wohlford dam. The city anticipates borrowing approximately $25 million from the state in 2017 to complete the project.

At $2,336, debt levels are elevated on a per-customer basis, but debt-per-capita is more manageable at $409. This discrepancy is largely a result of some industry concentration from the larger agricultural customers. Additionally, lower-than-average wastewater debt serves to mitigate some of the higher water debt.

With the new state loan expected in 2017, debt-per-customer is projected to climb to an elevated but manageable $3,000 by 2020. Debt amortization is somewhat slow with 62% scheduled to payout over the next 20 years.

WATER SUPPLY AVAILABILITY AND THE CALIFORNIA DROUGHT

Significant investments by the SDCWA have allowed it to continue to meet water demands in its service area (including Escondido) during the current drought. Also a positive, the city's investment in its recycled water infrastructure has ameliorated some of the supply issues many of the city's regional peers may face. Nevertheless, the city has implemented level two of its drought response which limits watering days for all potable water customers. Given the city's take-and-pay contract with SDCWA, the recycled water facilities, and the implementation of recent rate increases, limited-to-no financial impact is expected in the short term. Importantly, the city reports that it met the requirements of the state-mandated water reductions in 2015.

MIXED SERVICE AREA

The city's unemployment rate improved to 4.6% in September 2015, besting the state's and nation's averages of 5.5% and 4.9%, respectively. However, at 21.6% in 2014, poverty rates have steadily risen since 2009 and remain above state (16.4%) and national averages (15.5%). Income levels were also below average in 2014, with MHI at 85% and 98% of state and national averages, respectively. Lastly, there is some customer concentration in the agricultural industry.

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

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223

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Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997711

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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