SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA-' rating on the following Los Angeles County Sanitation District Districts Financing Authority (District No. 14), California sewer revenue bonds:
-- $170.5 million subordinate revenue bonds series 2005B.
The Rating Outlook is Stable.
The bonds are secured by net wastewater revenues, including connection fees.
KEY RATING DRIVERS
ADEQUATE FINANCIAL PERFORMANCE: The district's financial performance has weakened due to a sharp decline in connection fee revenues. Debt service coverage remains adequate, averaging 1.7x over the three fiscal years ended June 30, 2012.
STRONG LIQUIDITY, STABLE REVENUES: Liquidity remained extraordinarily strong with 851 days cash on hand at the end of fiscal 2012. The district's inherent revenue stability is an important credit strength as the majority of charges are fixed per household versus volumetric based.
DISCIPLINED RATE SETTING: The district's board has approved a series of large rate increases, averaging 17% annually over the past five years, to provide adequate financial coverage as the district invested heavily to improve and expand treatment capacity. Rates have been approved through 2015.
STRONG, CENTRALIZED MANAGEMENT: The district is managed by the Los Angeles County Sanitation Districts' centralized staff, which oversees 23 sewer agencies providing services to more than 5 million Los Angeles County residents, giving the district access to significant financial and operational management expertise.
HIGH DEBT BURDEN: The debt burden is high at $5,419 per customer, but likely to slowly decrease with amortization. The district has no further debt issuance plans and quite manageable capital needs after its recent treatment plant upgrades.
WEAK LOCAL ECONOMY: The district's local economy is limited and dominated by a nearby military base. Unemployment is chronically elevated and was well above state and national levels at 14.4% in August.
COVERAGE WEAKNESS: Fitch is likely to downgrade the rating if the district's debt service coverage ratio dips below current levels on a sustained basis or the district's liquidity position falls to more typical levels for the rating category.
District 14 provides wastewater treatment services to a diverse residential, commercial and industrial customer base centered on the city of Lancaster in eastern Los Angeles County. The district owns the area's treatment plant and sewer trunk lines, and local governments own the collection system. The district has recently completed a major sewerage treatment plant upgrade that will provide a very high level of treatment and provide adequate capacity for growth.
ADEQUATE FINANCIAL PERFORMANCE
The district performed well through a period of intense economic stress that reduced flows and connection fee revenues during the recession, but is just growing into the increased debt service incurred to upgrade its treatment plant. All-in debt service coverage declined to 1.4x in 2012 from 1.6x in 2011. Unaudited actual results show a decline to 1.3x in 2013.
Coverage is significantly below the 1.8x median for 'AA-' rated water-sewer credits. Fitch believes coverage is adequate for the rating category because the issuer's revenues are more stable than the typical credit (primarily based on fixed per household sewer fees) and because the cash flows provide adequate funds to invest in the system. Free cash-to-depreciation was a very strong 195% in 2012, while capital expenditures have consistently exceeded depreciation in recent years.
The district projects all-in coverage of just 1.25x over the next five years with debt service rising due to borrowing for its new treatment plant. Fitch expects the utility to outperform this particularly conservative forecast, which assumes no meaningful connection fee revenues, tax revenues below historical collections and quite elevated expense growth. With some outperformance of the forecast, coverage is likely to remain adequate for the rating category.
The district's liquidity position is very strong with days cash significantly in excess of 'AAA' medians. Ample reserves allow some period of lean coverage as the utility grows into its new debt service.
GOOD RATE DISCIPLINE
The district has raised rates in a disciplined manner to prepare for the increased debt service for the new treatment plant. Rates have more than doubled in recent years. Rates reached Fitch's 1% of median household income (MHI) affordability metric in the current fiscal year, suggesting decreased rate flexibility. Sewer fees are collected on local property tax bills, providing a high degree of compliance. Rate increases have been approved through 2015.
HIGH DEBT BURDEN
The district's main credit weakness is its very high debt burden related to the recent treatment plant improvements. The district's debt burden is among the highest in Fitch's water and sewer portfolio. While debt levels weigh on the rating, the recent capital improvements provide a solid basis for future operations and growth, and the district has implemented adequate rate increases to afford the new debt service. Completion of the treatment plant upgrades will leave the district with very manageable future capital needs and no further debt issuance plans.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the 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' (June 3, 2013);
-- 'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);
-- '2013 Water and Sewer Medians', dated Dec. 5, 2012;
-- '2013 Outlook: Water and Sewer Sector', dated Dec. 5, 2012.
Applicable Criteria and Related Research:
2013 Outlook: Water and Sewer Sector
2013 Water and Sewer Medians
U.S. Water and Sewer Revenue Bond Rating Criteria
Revenue-Supported Rating Criteria