SAN FRANCISCO--()--Fitch Ratings assigns an 'AA+' long-term rating and an 'F1+' short-term rating to the following Eastern Municipal Water District (Riverside County), California (the district or the utility) debt:
--$54.6 million water and sewer revenue bonds series 2013A, SIFMA index notes.
The notes will refund the district's 2008B variable rate certificates of participation. The notes are scheduled to sell via negotiation on or about March 12.
In addition, Fitch affirms the following ratings:
--$50 million outstanding SIFMA index notes at 'AA+'/'F1+';
--$627.7 million outstanding water and sewer revenue bonds and certificates of participation at 'AA+';
--$197.2 million bank certificates associated with series 2008C, 2008D, 2008E, and 2008G at 'AA+' in the event that any certificates of the series are converted to bank certificates in the future;
--$43.1 million Western Riverside Water and Wastewater Financing Authority revenue bonds (Eastern Municipal Water District improvement district general obligation (GO) bond financing) at 'AA'.
The Rating Outlook is Stable.
The revenue bonds and outstanding COPs are secured by a first lien on net water and sewer system revenues, including rate stabilization fund transfers and connection fee revenues, after payment of operating and maintenance expenses. They are parity debt issued under the same master indenture.
The GO bonds are supported by a pledge of unlimited ad valorem property tax revenues and a second lien on net system revenues.
KEY RATING DRIVERS
FINANCIAL PERFORMANCE REMAINS HEALTHY: The utility's financial performance and all-in DSC remain healthy at an average of 1.6-times (x) over the three years ended fiscal 2012. Coverage excluding connection fees averaged a just adequate 1.3x over the period. Liquidity remains exceptionally strong and somewhat offsets concerns about volatility in coverage.
DIVERSE REVENUES, RISING RATES: Operating revenues have held up well in the face of variable demand for water due to significant rate increases and very stable performance of sewer revenues. Significant property tax revenues also provide some stability.
CONNECTION FEE EXPOSURE: The utility remains heavily reliant on connection fees, which are volatile and have been particularly weak in recent years. Fitch expects all-in coverage excluding connection fees to remain adequate.
LARGE SUBURBAN SERVICE AREA: The district provides essential water and sewer services to a large and diverse service area in western Riverside County. The region is emerging from a deep cyclical downturn due to the collapse of the local housing market.
MANAGEABLE DEBT BURDEN: Debt levels are above average and amortization is slow, but a slowdown in population growth has reduced capital needs to more manageable levels. The debt profile is somewhat complicated with high levels of variable-rate debt and some derivatives exposure, but financial management is experienced and capable.
MARKET ACCESS SOLID: The 'F1+' rating on the 2013A SIFMA index bonds reflects Fitch's expectation that the highly-rated district will maintain the market access necessary to remarket the debt as necessary.
GO BOND RATING: The 'AA' rating on the GO bonds reflects a subordinate lien on net revenues, as well as an unlimited ad valorem property tax pledge from a number of small improvement districts with concentrated tax bases.
COVERAGE WITHOUT CONNECTIONS: A decline in all-in DSC excluding connection fees would put downward pressure on the rating.
CONNECTION FEE WEAKNESS: Connection fee revenues appear to be improving, but the rating could come under downward pressure if connection fees are consistently weak and below the utility's forecast.
Eastern Municipal Water District provides water service and sewer service to 768,000 people, or about a third of Riverside County's population, through retail and wholesale accounts. The service area covers 550 square miles and includes the cities of Temecula, Murrieta, Moreno Valley, Hemet, San Jacinto and Perris, as well as unincorporated areas. The formerly agricultural region suburbanized rapidly over the past two decades and is close to both Orange and San Diego Counties.
SOLID FINANCIAL PERFORMANCE
The utility has performed well in a very difficult operating environment in recent years amid significant increases in imported water costs, declines in water usage and very weak connection fee revenue performance. Fitch calculated all-in DSC (which includes the district's general obligation bond revenues and debt service, as well as accrual of other post-employment liabilities (OPEB)) declined from well above 2.0x through most of the last decade to 1.6x over the past three years and 1.5x in 2012. All-in DSC is forecast to average better than 1.5x over the next five years.
Fitch believes the utility's extraordinarily strong reserves allow for greater volatility in coverage than might otherwise be seen at this rating level, allowing it to offset connection fee variability. Connection fee revenues are coming in well ahead of expectations in the current fiscal year. The financial forecast assumes a resumption of development in the service area and a gradual increase in connection fees. While the assumptions underlying this forecast appear reasonable (with new connections staying well below their long-term averages), some downside risk remains to the forecast.
Fitch is also closely monitoring performance excluding connection fees. All-in DSC excluding connection fees is a key indicator of the utility's underlying performance. The coverage ratio fell to 1.2x in 2012 and is not forecast to improve from that level over the near term. Fitch believes that management's financial forecast is somewhat conservative. Improving demand conditions, lower-than-forecast interest expense, unbudgeted revenues from new customers, and conservative expense assumptions suggest the utility will somewhat outperform the forecast, as it historically has.
Liquidity, including unrestricted cash and investments, remains very strong with $334.8 million, or 668 days of operating cash on hand at the end of fiscal 2012, positioning the utility well to withstand any misses in its financial forecast. Days cash has declined from 852 days in 2010 due to capital spending, but the utility has consistently maintained solid reserves over time.
ADEQUATE RATE FLEXIBILITY
The district raised rates significantly in recent years to cover increased wholesale water costs from its wholesale supplier, the Metropolitan Water District of Southern California (MWD, water revenue bonds rated 'AA+'/Stable by Fitch). Annual water rate increases have averaged 7.1% over the past five years and have helped stabilize operating revenues despite a drop in the volume of water sales. Sewer revenues have grown steadily with rates increasing an average of 4.6% a year over the period.
The district's current rate package runs through fiscal 2018 and allows rates to be increased to pass through any MWD rate increases plus a local inflation factor to support operating costs. This formula could lead to some erosion in underlying performance over time, with operating expenses outpacing inflation, but Fitch believes management has adequate rate flexibility to reverse the trend if needed to maintain solid financial performance. Combined water and sewer rates are currently affordable at just 1.5% of Riverside County's median household incomes.
AFFORDABLE DEBT BURDEN
Due to its high growth over recent decades, the district's debt burden was slightly above average for the rating level at $2,373 per customer or $1,142 per capita at the end of fiscal 2012. Fitch expects debt levels to remain above average amid gradual amortization of debt and continued borrowing via low-interest state loans. The district plans to fund $166 million, or 43%, of its $385.2 million 2013-17 capital improvement program with state revolving fund loans whose repayment is on parity with outstanding revenue bonds and senior to the outstanding GOs.
Debt per customer is forecast to fall to about $2,200 in 2017 but remain slightly above the median for rated water and sewer utilities. Amortization is improving with the shorter, 20-year term of the state revolving fund loans and is now close to average at 34% in 10 years and 76% in 20 years.
The district's debt portfolio requires active management of liquidity renewals and interest rate risk because 28.7% of the district's outstanding debt ($250 million) was in unhedged variable-rate debt at the end of fiscal 2012. This proportion is likely to decline over time, as the district takes on more fixed-rate state loans, and Fitch believes the district has ample financial flexibility and expertise to manage such products.
The series 2013A bonds will refund the district's 2008B variable rate demand obligations with SIFMA Index bonds. The new structure reduces the district's exposure to liquidity providers, but also requires active management, as the bonds must be rolled every three to nine months. The rating on the bonds is based on Fitch's belief that the district's high credit quality should provide adequate market access to refinance the bonds, given a structure that allows a six-month window for remarketing or refinancing the securities each year.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was informed by information from CreditScope and IHS Global Insights.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 12, 2012;
--'U.S. Water and Sewer Revenue Bond Rating Criteria', dated Aug. 3, 2012;
--'2012 Water and Sewer Medians', dated Dec. 8, 2011;
--'2012 Outlook: Water and Sewer Sector', dated Dec. 8, 2011.
Applicable Criteria and Related Research
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2013 Water and Sewer Medians
2013 Outlook: Water and Sewer Sector