AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings assigns its 'AA+' rating to the following bonds being issued by the East Bay Municipal Utility District, CA (EBMUD or the district):
--Up to $135 million, water system revenue refunding bonds, series 2014A;
--Up to $215 million, water system revenue refunding bonds, series 2014B;
--Up to $75 million, water system revenue bonds, series 2014C.
Proceeds of the series 2014A bonds will advance refund fixed rate bonds for uniform savings and pay costs of issuance. Proceeds of the 2014B bonds will refund outstanding variable-rate bonds with fixed rate debt, pay swap termination fees, and pay costs of issuance. Proceeds of the 2014C bonds will fund part of the district's ongoing capital program. The bonds will not have debt service reserve funds. The 2014A & B bonds are expected to price on May 20, 2014 and the 2014C bonds are expected to price on June 17, 2014.
Fitch also affirms the following outstanding EBMUD ratings:
--$1.76 billion water system revenue bonds, series 2005A, 2007A, 2007B, 2010A, 2010B, 2012A, 2012B, and 2013A at 'AA+';
--$82.07 million water system SIFMA bonds, series 2009A-1 and 2009A-2 at 'AA+/F1+';
--$372.9 million outstanding subordinate lien extendible commercial paper (CP) notes at 'F1+'.
The Rating Outlook is Stable.
Bonds are payable from net revenues of the water system. Tax receipts are not pledged to bondholders but must be used to pay operating expenditures. The CP notes have a subordinate lien on net water revenues.
KEY RATING DRIVERS
STRONG SERVICE AREA: EBMUD provides retail water supply to a service area with strong economic diversity and a population of approximately 1.3 million in Alameda and Contra Costa counties. Growth in population is anticipated to be offset by increased water conservation and efficiency with modest net growth in water demand.
LOWER WATER SALES: Debt service coverage declined between 2008 and 2012 due to lower water sales, the economic recession and escalating debt service. While water sales have remained at lower levels, financial recovery is occurring due to cost cutting and adopted rate increases.
RATE FLEXIBILITY: EBMUD rates are competitive for the region. Rate flexibility and the EBMUD Board of Directors' willingness to raise rate rates to recover costs was demonstrated by the Board's adoption of 9.75% and 9.5% rate increases in fiscals 2014 and 2015, respectively.
WATER SUPPLY DIVERSITY AND REDUNDANCY: Water supply reliability was improved by completion of the Freeport Regional Water Project (Freeport) in 2011. Investment in the project drove the increase in debt levels in recent years but is providing valuable dry water year supply in the current statewide drought.
HIGH DEBT LEVELS: Debt levels will likely remain high for some time, even with the district's planned shift to a higher use of pay-as-you-go capital funding.
LONG-TERM PLANNING PRACTICES: Long-term financial, capital and water supply planning practices at the district provide a strong enhancement to credit quality.
SHORT-TERM RATINGS: The 'F1+' ratings on the series 2009A index bonds and extendable CP are based on EBMUD's long-term credit quality.
PRESSURE FROM STATEWIDE DROUGHT: Pressure on financial margins could occur if water sales fall below assumed levels if severe multi-year water rationing were to be implemented. Sustained decline in financial margins and reserve levels below management's targeted levels could put pressure on the rating.
EBMUD provides retail water service to approximately 1.3 million people residing in Alameda and Contra Costa counties, with around two-thirds of district customers residing in the cities of Alameda, Berkeley, Oakland, San Leandro, Richmond, and Walnut Creek. The customer base of around 380,000 has been relatively stable. However, water sales declined around 15% between the years 2008-2012, which is consistent with other regional utilities as a result of the economic recession, conservation efforts, and variable weather conditions. Water demand recovered modestly in 2013 with an uptick of 4% to 168.4 million gallons per day (mgd). Growth in water demand is estimated to remain at around 1%. Customer concentration is modest with the largest five customers accounting for 6.2% of revenues.
EBMUD WELL POSITIONED TO HANDLE CURRENT DROUGHT
The district's primary water supply is provided by its water rights in the Mokelumne River watershed (90%), although a small portion also comes from streams within the district. Historically, these supplies (around 364,000 acre feet [af]) exceeded customer demands in normal hydrological conditions but could be strained in drought conditions. Following the drought in the late 1980's, EBMUD evaluated its long-term water supply outlook and began planning Freeport as well as various conservation and recycling programs.
Freeport provides a dry-year water supply of 133,000 af. Freeport came on line in November 2011 and includes the infrastructure and dedicated pumping capacity to withdraw water from the Sacramento River in accordance with EBMUD's contract with the federal Central Valley Project (CVP). The contract extends through 2046 with a subsequent 40 year option to renew by EBMUD. Given the current drought, the allocation for EBMUD (as a north-of-the-San Joaquin Delta municipal contractor) was cut to 50%, so it has access to 66,500 af in the 2014 water year. The magnitude of this cut is not viewed as a credit concern. EMBUD's planning parameters take into account the likelihood of a curtailment to their allocation from CVP in dry years, given the lower availability of water in the CVP.
The district's storage capacity provides additional security through stored water reserves of 472,000 af. This is down from 647,000 af in storage one year ago but still compares favorably to annual water demand of around 200,000 af (168 million gallons per day). The district may use additional storage if 2015 is also very dry but will also add most of the CVP water from 2014 to its storage. Only about 23,000 af of the 66,500 af CVP allocation is expected to be used in April-June 2014.
HIGH DEBT LEVELS SHOULD BE MANAGEABLE
Capital investment over the past decade has been significant. The district invested over $2 billion in capital in the water system, including seismic improvements to various district assets, and the structural hardening of the 90 miles of tunnels and aqueducts. The district's capital needs remain sizable but now largely consist of infrastructure reinvestment. The district expects capital spending to stabilize at around $200 million annually, which will exceed annual depreciation of around $115 million. The majority of the district's $1.03 billion in projected capital spending over the next five years consists of maintenance and reinvestment into existing infrastructure (60%).
EBMUD's debt profile is high, with $7,012 debt per customer and over $1,908 per capita in fiscal 2013. Over the next five years, debt levels are projected to increase with new debt issuance planned and the district's slow principal payout equaling just 21% in 10 years and 55% in 20 years. Consequently, EBMUD's debt burden will remain a long-term credit issue, and it will be important for the district to continue maximizing financial flexibility on the revenue side, given the high fixed costs (debt service accounts for between 35%-40% of revenues). However, given the level of supply diversification and overall improvements that have been made in recent years and management's stated intent to pursue greater capital funding from revenues, Fitch believes future borrowing pressures should be manageable.
RATE INCREASES DESIGNED TO IMPROVE FINANCIAL MARGINS
EBMUD adopts rates for a two-year period concurrently with the adoption of the district's biennial budget. EBMUD's board adopted the fiscal years 2014 and 2015 budget in spring 2013 with 9.75% and 9.5% residential rate increases, respectively. The rate increases are designed to restore the district's financial margins, increase revenues to fund higher staffing levels, and provide revenues to fund a higher percentage of pay-as-you-go capital. The monthly average residential bill is $43 per month or 0.9% of median household income.
FINANCIAL METRICS STABILIZING WITH RATE INCREASES
Financial performance declined between fiscal years 2008 and 2012 as a result of lower water sales, increasing debt service, and a reduction in growth-related connection fees. In response to these factors, the district raised rates, restructured debt payments from 2012-2015 into later years, and cut operating costs.
Fitch-calculated debt service coverage in fiscal 2012 was 1.50x of revenue bonds and 1.42x of all obligations, including subordinate state loans and interest on commercial paper. Fitch's coverage includes amounts transferred in from system capacity charges (connection fees) collected in previous years. All-in coverage in fiscal 2012 without the transferred funds would have been 1.32x. Coverage levels in fiscal 2012 were also boosted by the release of $12 million in reserve fund money from a refunding transaction.
Debt service coverage improved to 1.68x on all obligations in fiscal 2013 without the use of transferred funds or capitalized interest. However, the coverage does reflect lower principal payments in this year as a result of the restructuring done in 2012. All-in debt service will increase from $134 million in fiscal 2014 to $180 million in fiscal 2016, which reflects the full burden debt service associated with existing and planned debt. Financial performance is forecast to exceed management's 1.6x debt service coverage target for all-in coverage even with the additional issuance. Cash levels remained strong throughout the downturn. The district has $303 million in unrestricted cash or 565 days of operating cash.
WEAK LEGAL COVENANTS
EBMUD's outstanding revenue bonds have been issued as subordinate lien but there is no debt outstanding on the senior lien indenture, which was closed in 2010. Legal covenants are weak, including a 1.10x rate covenant and no reserve funds for the series of bonds issued in 2012 and thereafter.
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 additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'Rating U.S. Public Finance Short-Term Debt' (December 2013).
Applicable Criteria and Related Research:
U.S. Water and Sewer Revenue Bond Rating Criteria
Rating U.S. Public Finance Short-Term Debt