Fitch Affirms San Juan Water District, CA's COPs at 'AA+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings affirms the following San Juan Water District, CA (SJWD) debt ratings at 'AA+':

-- $30.1 million San Juan Water District revenue certificates of participation (COPs), series 2009A;

-- $12.1 million San Juan and Citrus Heights Project revenue COPs, series 2012A.

The Rating Outlook is Stable.

SECURITY

The COPs are secured by payments to the San Juan Suburban Water District Financing Corp. from the SJWD and the Citrus Heights Water District (CHWD). Each district's proportionate payments are secured by a separate installment purchase agreement that is backed by an absolute and unconditional pledge of net water revenues.

KEY RATING DRIVERS

STRONG FINANCIAL PERFORMANCE: SJWD has delivered consistently solid financial results with debt service coverage (DSC) averaging a solid 2.2x over the three fiscal years (FY) ended 2013. Liquidity was very strong with unrestricted cash and investments averaging 657 days of operating expenses over the period.

STRONG RATE DISCIPLINE: The SJWD Board of Directors has consistently and gradually raised rates to maintain strong financial performance, and rates remain very affordable on both the wholesale and retail level.

STRONG DEBT PROFILE: SJWD's debt burden is very low at about $862 per underlying retail customer. Amortization is slow, but the district has no further borrowing plans, which will allow the debt burden to decline gradually.

SURFACE WATER DEPENDENT: SJWD's primary water supply comes from high-priority rights to the American River water. The utility maintains significant excess water rights, but the current California drought has exposed the vulnerability of the concentrated supply position and yielded significant mandatory water use reductions.

HEALTHY SERVICE AREA: SJWD provides essential services to a sizeable suburban service area as a retail and wholesale water provider. The broader Sacramento metropolitan economy is still recovering from a deep recession, but the district's affluent service area continues to outperform the region.

WEAKEST LINK APPROACH: The San Juan and Citrus Heights Project rating of 'AA+' is based on a weakest-link analysis because the COPs are secured by a joint but not several obligation of the two water districts. The rating is based on the credit quality of San Juan Water District, which will be responsible for about 90% of debt service payments and which Fitch judges to be the weaker of two strong obligors.

CITRUS HEIGHTS SLIGHTLY STRONGER: The CHWD, although a smaller, less affluent part of the SJWD service area, is the stronger obligor because of its extraordinarily low debt burden, very stable revenue structure, higher debt service coverage ratios and solid liquidity.

RATING SENSITIVITIES

DROUGHT RISKS: Fitch believes SJWD is well-positioned to maintain financial performance through a period of water supply scarcity. A deepening of the current drought that yielded greater rationing or failure to adjust rates in a timely manner to stabilize revenues in the face of declining sales could put downward pressure on the rating.

CREDIT PROFILE

The San Juan Water District provides retail and wholesale water services to about 180,000 residents in a 46-square-mile suburban service area about 25 miles northeast of downtown Sacramento. SJWD provides retail services to 10,441 accounts and wholesale services to the Citrus Heights Water District, Fair Oaks Water District, Orange Vale Water Co., and the city of Folsom. The district's service area is largely residential and nearly fully built out.

DROUGHT FORCES CONSERVATION

SJWD's supply position is generally strong. It maintains high priority water rights significantly in excess of demand on the American River, which feeds Folsom Lake, California's ninth largest reservoir. However, the current, severe California drought has highlighted the risks of the agency's surface water dependence. Declines in Folsom Lake levels early in 2014 threatened to draw water levels below intakes that serve San Juan and would have required the U.S. Bureau of Reclamations to use water pumping barges to serve the agency. Late winter rains raised lake levels, pushing lake levels to about averting an immediate crisis. San Juan's water intakes are at about the 100,000 acre feet level of the lake, and rains have refilled the lake to almost 500,000 acre feet. The reservoir is now about half full, and the Bureau of Reclamation no longer expects it to fall to the level that would threaten San Juan's intakes in the upcoming dry season. San Juan is proactively managing supply risks. A 25% water usage reduction program is currently underway and the imposition of drought rates should stabilize revenues (allowing for moderate use of rate stabilization funds) in the face of conservation.

Water rationing and conservation are common during droughts in arid regions. The 'AA+' rating is unlikely to come under pressure during typical droughts for which water managers have planned. Indeed, SJWD has previously shown greater drought resiliency than California peers, avoiding rationing in the more typical 2007-09 drought. However, the current severe drought could put downward pressure on the rating if the district's board fails to fully adjust rates to maintain healthy financial performance as it absorbs a period of reduced supply.

STRONG STARTING POSITION

SJWD's financial performance has been strong in recent years, despite a deep economic recession and variable water sales. All-in DSC was a solid 2.1x in FY 2013. With debt service declining sharply in FY 2013, coverage is likely to improve despite some revenue weakness during the drought.

The district's operating revenues have grown gradually in recent years despite variable weather conditions and lingering economic weakness. Rising water rates and a significant fixed component of both wholesale and retail charges have largely offset variable demand fluctuations. The district also gets about 10% of revenues from relatively stable property taxes.

Revenues are likely to decline noticeably with rationing, but not to a degree that would put pressure on the rating unless the drought worsens and/or lasts for an unusually long time. The district estimates that the current stage three drought reductions would cost its retail system a manageable $313,500 in fiscal 2014 (about 3.7% of 2013 retail sales). SJWD's estimate for a full year cost is $500,000, netting out reduced sales revenues, drought rate increases and related declines in expenses. Similar reductions will be felt on the district's wholesale system. Taken together, the revenue losses are likely to yield a manageable and transitory decline in financial performance that is not inconsistent with the current strong rating.

The retail system's 2013 sales were $8.5 million. SJWD has significant financial reserves to withstand expected variability in revenues. Unrestricted cash and investments equaled a robust $14.4 million, or 635 days cash, at the end of FY 2013, exceeding of the 427 day median for 'AAA' rated utilities.

SOLID RATE FLEXIBILITY

SJWD raised retail rates by a moderate 2.5% on average over the five years ended FY 2014. The district's board of directors has issued a Proposition 218 notice of increases in volumetric water rates to offset the impact of the current drought. Rate increases would be phased in as water rationing intensified with the current stage three 'water warning' requiring a 10% increase and a stage five 'water crisis' requiring a 60% increase.

Base retail water rates appear very affordable with 10 hundred cubic feet (HCF) of water costing $40.47 a month, or 0.4% of median household income. Wholesale rates appear competitive compared to other wholesale water providers in the state of California. Actual water use is much higher than the national average used in Fitch's affordability calculations, suggesting somewhat less rate flexibility. However, the public's awareness of the drought, the district's solid track record of imposing necessary rate increases, and the retail service area's very high incomes suggest that the district is likely to have adequate flexibility to deal with consumption declines.

STRONG DEBT PROFILE

The debt burden is quite low at $43.7 million, or $862 per customer. That's well below the median of $1,213 per customer for 'AAA' rated utilities. With no further borrowing planned, the debt ratios will fall to less than $800 per customer in five years. Amortization of the district's outstanding debt is slow with just 23% repaid in 10 years and 63% repaid in 20 years.

The district has regularly maintained and improved its infrastructure with minimal borrowing. Capital expenditures averaged a solid 291% of depreciation over the past five years. Future capital plans are driven by the need to maintain the district's aging pipe system, but SJWD's debt appears to be quite manageable with no further borrowing planned.

SOLID SUBURBAN SERVICE AREA

The district benefits from its location in the large Sacramento metropolitan statistical area. However, the regional economy is currently recovering from a deep cyclical downturn due to a sharp contraction in the residential real estate market and a period of state budget weakness. The region's unemployment rate was significantly above the national average at 8.3% in January 2014.

SJWD's service area includes several cities with very high median household incomes and likely very low unemployment rates, although full income and employment data do not exist for the district as a whole. The city of Citrus Heights, which has income levels close to the national median, is one of the less affluent areas of the district and had an unemployment rate of 5.7% in January, well below the national average.

SMALLER, STRONGER OBLIGOR

CHWD (obligor for about 10% of the San Juan and Citrus Heights Project COPs) is the largest of San Juan's wholesale water customers. CHWD serves the suburb of Citrus Heights and small areas of adjacent communities.

The district's debt burden is well below all rating category medians at just $343 per customer. Debt levels are expected to decline rapidly because the district has no further borrowing plans and amortization of outstanding debt is very rapid with 70% of principal repaid in the next 10 years. Financial performance is solidly above the medians for all rating categories with debt service coverage averaging 5.7x over the three years ended Dec. 31, 2012 and unrestricted cash and investments equal to 544 days cash at the end of 2012.

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

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' (June 3, 2013);

-- 'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);

-- '2014 Water and Sewer Medians' (Dec. 12, 2013);

-- '2014 Outlook: Water and Sewer Sector' (Dec. 12, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826896

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Andrew Ward, +1-415-732-5617
Director
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings, Inc.
Primary Analyst
Andrew Ward, +1-415-732-5617
Director
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com