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���������ֳ� - San Francisco - 18 Nov 2022: ���������ֳ� has assigned a 'AAA' rating to the following bonds issued by the City of San José Financing Authority (the authority) on behalf of the City of San José, CA (the city):

--$275.6 million wastewater revenue bonds, series 2022B (green bonds - climate bond certified).

The bond proceeds will be used to refund all of the authority's outstanding subordinate wastewater revenue notes, series A, and pay the costs of issuing the series 2022B bonds. The bonds are scheduled to sell on or around Dec. 1 via negotiation.

In addition, ���������ֳ� has assessed the city's wastewater treatment system's (the system) standalone credit profile (SCP) at 'aaa'. The SCP represents the credit profile of the system on a standalone basis irrespective of its relationship with and the credit quality of, the city (Issuer Default Rating [IDR] AA+/Stable).

The Rating Outlook is Stable.

ANALYTICAL CONCLUSION

The 'AAA' rating on the bonds and SCP assessment of 'aaa' reflect the system's exceptionally low leverage in the framework of very strong revenue defensibility and very low operating risk, both assessed at 'aa'. The system benefits from a very favorable service area including the city of San José, the largest city in Silicon Valley, and surrounding communities. Its rate flexibility is strong, and the majority of sewer rates are collected on the property tax bill.

Operating risk is very low given a generally stable operating cost burden and high levels of capital investment relative to depreciation. Assuming implementation of the capital improvement plan (CIP), additional borrowing, and a continuation of recent levels of rate increases, leverage is expected to remain under 2.0x through the five-year horizon.

The city fully owns the system's sanitary sewer collection and conveyance system (collection system) and, together with the city of Santa Clara, the San José-Santa Clara Regional Wastewater Facility (the treatment plant). It receives operating and maintenance (O&M) and capital cost contributions from Santa Clara and five tributary partners.

The system also participates in a regional water reclamation program, known as the South Bay Water Recycling Program (the recycling program). Revenues from the program represent about 5% of total system revenues. While recycling program revenues are not included in pledged revenues, they are included in ���������ֳ�'s analysis as they are contained within the system's audited financial statements.

CREDIT PROFILE

The system includes the collection system, which serves the city through approximately 344,000 accounts, and the treatment plant, which is a regional facility owned by the city and the city of Santa Clara and includes the recycling program's system as well as the treatment facilities. The treatment plant is the largest advanced wastewater treatment plant in the western United States serving approximately 1.4 million residents. The city operates the treatment plant on behalf of both the city and Santa Clara, and their tributary partners, comprised of the City of Milpitas, West Valley Sanitation District, Cupertino Sanitary District, County Sanitation District 2-3, and Burbank Sanitary District.

Approximately 80% of the treated water from the treatment plant is piped to an outfall channel that eventually flows to the South San Francisco Bay and the remaining 20% flows to the recycling program's system. The city replaced its old cogeneration facility in 2021 with a new 14-megawatt cogeneration facility. As one of the largest cogeneration facilities in the U.S., it produces approximately 60% of the electric power required to operate the treatment plant. In addition, the city maintains emergency diesel generators which the city estimates are able to provide up to 48 hours of continuous power without refueling during a catastrophic or prolong power outage.

The city is responsible for operating the treatment plant and determining operating and capital costs as the administering agency under the 1959 Sewage Treatment Plant Agreement between the city and Santa Clara, and under separate agreements among the respective tributary agencies. The agreements outline various contracted capacity for each of the tributary agencies for the discharge of wastewater into the treatment plant as follows: Milpitas 8.5%, West Valley Sanitation District 7%, Cupertino Sanitary District 4.7%, County Sanitation District 2-3 0.6%, and Burbank Sanitary District 0.2%.

The balance of the treatment capacity is shared between the City of Santa Clara and the City on a pro rata basis determined on an annual basis by the ratio of each city's annual assessed valuation to the sum of both cities' assessed valuation, which may change from year to year but is currently 63.6% city and 15.4% Santa Clara.

Under the agreements, each tributary agency is required to make contributions on a quarterly basis to pay for a portion of the operations and maintenance (O&M) costs and capital expenditures of the treatment plant. The remaining costs for O&M and capital are shared between the city and the city of Santa Clara based on their assessed property value relative to the total assessed values.

The agreements require a Treatment Plant Advisory Committee (TPAC) advise the city and Santa Clara on the operation, maintenance, repair, and improvement of the treatment plant and related programs and policies. The TPAC meets monthly and consists of nine appointed members, including three from the San José City Council, two from the Santa Clara City Council, one from the San José Manager's Office, and one each from Milpitas, Cupertino Sanitary District, and the West Valley Sanitation District.

���������ֳ� considers the system to be a related entity to the city for rating purposes given the city's oversight of the system, including the authority to establish rates for the collection system. The credit quality of the city does not currently constrain the bond rating. However, as a result of being a related entity, the issue ratings could become constrained by a material decline in the general credit quality of the city.

KEY RATING DRIVERS

Revenue Defensibility

Strong Rate Flexibility Supported by Affluent Service Area

The revenue defensibility assessment reflects the system's independent legal ability to set rates, which are affordable for the vast majority of the population. All system revenues are derived from its monopolistic business lines. Median incomes are well above the national average and unemployment is typically low, reflecting the very favorable service area.

Operating Risks 'aa'

Very Low Cost Burden, Manageable Capital Needs

The operating cost burden is very low averaging $5,363 per million gallons (mg) in the five years ended fiscal 2021. Its life cycle ratio has been relatively unchanged at 41% over the last five years despite high capital investment relative to depreciation. Planned capex in upcoming years should keep the life cycle ratio low.

Financial Profile 'aaa'

Very Low Leverage

Leverage over the last five years has been exceptionally low but is expected to rise modestly over the next five years with additional capex and borrowing yet remaining under 2.0x and supportive of the assessment. Liquidity is very strong, albeit neutral to the assessment.

Asymmetric Additive Risk Considerations

No asymmetric additive risk considerations affected this rating determination.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--The rating is at the highest level on ���������ֳ�'s scale and cannot be upgraded.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

--A sustained increase in the operating cost burden to over $6,500 per mg or higher;

--Sustained leverage above 5.0x through ���������ֳ�'s base and stress case scenarios.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit /site/re/10111579.

SECURITY

The bonds are secured by installment payments made to the authority by the city from net system revenues including rents, rates, fees, charges and subsidies but excluding revenues related to the recycling program.

Revenue Defensibility

Revenue defensibility is considered very strong, reflected by the 'aa' assessment. All system revenues are derived from monopolistic sources, and the system benefits from a very favorable service area. Growth is stable with a five-year CAGR of about 0.8% reflecting the mostly built out nature of the bay area. Income levels have consistently trended at least 70% above the U.S. median, outpacing the national growth over the last few years. Unemployment has historically trended well under the national levels, and remained even with the U.S. unemployment during pandemic-related government lockdowns. As of September 2022, it stood at 2.2%.

The city has the independent ability to set rates without external approval, subject only to the provisions of Proposition 218. The city's sewer service and use charges comprise about 80% of operating revenues, with most of the remainder made up of O&M charges from partner agencies. Approximately 95% of the city's sewer service and use charges are collected on the property tax bill through the county's Teeter Plan, under which the county provides full payment to the system and keeps any penalties or late charges related to delinquencies. These include residential customers and commercial, institutional and light industrial users discharging less than 25,000 gallons per day or a uniform strength of sewage. The remaining 5% of charges are non-residential users discharging more than 25,000 gallons of sewage per day or sewage of widely varying strength and are billed directly by the city. The city's annual delinquency rate for non-Teeter Plan sewer service and use charges averaged 0.8% over the five fiscal years ended 2022.

The system's total monthly bill to residential customers was about $41.64 as of fiscal 2021, which is considered affordable for about 90% of the service area's population. The city implemented rate increases of 3%-4% on average on a combined basis for all customer categories for fiscals 2019 to 2021, no adjustment in fiscal 2022 due to coronavirus considerations, and 9% in fiscal 2023 in order to recoup the lost 2022 revenues. The city estimates rate increases of about 4% annual for fiscal years 2024-2028.

Operating Risks

The system's operating risk profile is assessed at 'aa'. The operating cost burden is very low at $5,941 per mg in fiscal 2021 with a five-year average of $5,636 per mg. Annual flows ranged from 101 million gallons per day (mgd) to 109 mgd from 2017 to 2020 before declining 6.4% in fiscal 2021 to 97.3 mgd and another 9.6% in fiscal 2022 to 88 mgd. According to management, these declines were due to conservation and impacts from the coronavirus pandemic. Given modest projected overall increases in operating spending and historically higher levels of flows, ���������ֳ� expects the operating cost burden to remain under the 'aa' threshold of $6,500 per mg for at least the next several years.

The system has moderate investment needs with a life cycle ratio of 40-41% in each of the last five years despite average capital spending relative to depreciation of 405%. Average annual capital spending is expected to increase over the fiscal 2022-2026 time period to $174.2 million from $122.6 million the five years ending fiscal 2021.

Current fiscal 2022 to 2026 capital spending is estimated at $871 million, with approximately $343 million in overall debt added to the balance sheet over that time. This includes the current issuance as well as planned draws from the subordinate wastewater note revolver. The capital improvement projects in the collection system CIP consist mostly of sewer rehabilitation projects for older neighborhoods in the city with structural deterioration or changes in flow patterns and capacity improvement projects.

The city completed a Treatment Plant Master Plan in 2013 that recommends $2 billion in capital improvement projects over a 30-year timeframe. The city is implementing the first phase with a ten-year $1.5 billion CIP focused on critical rehabilitation needs and operational reliability, improved process performance, and regulatory compliance.

Financial Profile

The financial profile is exceptionally strong and is assessed at 'aaa'. Leverage has been negative the last five years with cash balances greater than the system's combined debt and pension liability. Leverage stood at negative 0.3x in fiscal 2021 with a five-year average of negative 1.2x. The liquidity profile is healthy, albeit neutral to the assessment, with current days cash on hand at 949 in fiscal 2021 and coverage of full obligations (COFO) of 7.9x. ���������ֳ� calculated all-in debt service coverage was 8.2x.

���������ֳ� Analytical Stress Test (FAST)

The FAST considers the potential trend of key ratios in a base case and a stress case. The stress case is designed to impose capital costs 10% above expected levels and evaluate potential variability in projected key ratios.

The FAST base case is informed by management's current forecast which assumes the adopted rate increase of 9% for fiscal 2023 (no rate increase was implemented in fiscal 2022) and rate increases of about 4% per year for each of fiscal years 2024 through 2026, which have not yet been adopted. Operating cost increases are based on salary adjustments and inflationary factors, increases in energy costs and chemicals, changes in costs related to operational changes (including a new mechanical digested sludge dewatering facility), and one-time remediation costs of legacy lagoons estimated at $26 million in fiscal 2024. In addition, management provided projected capital contributions from tributary agencies for fiscal year 2022 to 2026 ranging from $30.8 million to $67.2 million.

Based on these assumptions, leverage increases annually to 1.2x in fiscal 2026 of the base case and follows a similar trajectory reaching 1.7x in the stress case the same year. The liquidity profile is expected to remain neutral to the assessment with COFO of at least 5.9x.

Sources of Information

In addition to the sources of information identified in ���������ֳ�'s applicable criteria specified below, this action was informed by information from Lumesis.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on ���������ֳ�'s ESG Relevance Scores, visit

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