Fitch Rates San Diego County Water Authority, CA's $50MM Extendable CP 'F1+'

AUSTIN, Texas--()--Fitch Ratings assigns its 'F1+' rating to the following commercial paper (CP) program of the San Diego County Water Authority, CA (SDCWA):

--$50 million extendable CP notes, series 1.

Proceeds of the CP notes will refund outstanding CP notes, series 6 and the liquidity facility associated with the series 6 program will not be renewed. The series 1 notes are expected to price on June 19, 2014.

In addition, Fitch affirms the following outstanding ratings:

--$686.13 million outstanding water revenue certificates of participation (COPs), series 1998A, 2004A, 2005A, and 2008A at 'AA+';

--$624.63 million water revenue bonds, series 2010A and series 2010B (taxable) issued by the San Diego County Water Authority Financing Agency (the agency) on behalf of the authority at 'AA+';

--$526.78 million water revenue bonds, series 2011A, 2011B and 2013A at 'AA+';

--$86.6 million subordinate lien water revenue refunding bonds, series 2011S-1 at 'AA'.

The Rating Outlook on all bonds is Stable.

SECURITY

The CP notes have a subordinate lien on net water system (the system) revenues of the authority. The CP notes are on parity with the series 2011S-1 bonds and subordinate in payment to the authority's outstanding COPs and series 2011A, 2011B and 2013A bonds as well as the agency's bonds.

KEY RATING DRIVERS

PRUDENT AND STABLE FINANCIAL MANAGEMENT: The authority adheres to prudent financial management practices and engages in comprehensive long-term planning aimed at securing a diverse and reliable future water supply. Sound oversight has produced relatively stable financial results even with the significant declines in water sales experienced in previous years.

BROAD SERVICE AREA: The authority provides wholesale water service to 24 member agencies across a large service area in San Diego County (the county).

WATER SUPPLY DIVERSITY: Water supplies have been diversified as a result of significant capital investments made in the last two decades, improving water supply reliability.

MEMBER SUPPORT FOR RATES: Fitch anticipates that continued member support for costs associated with supply diversification will facilitate rate increases to preserve financial margins at consistent levels.

RATE STRUCTURE STABILITY: The structure of the authority's revenues, with a high use of fixed charges, provided stability through a recent period of significant water sales declines.

HIGH DEBT: Capital spending has been substantial in recent years, primarily funded by debt. As a result, the authority's debt levels are high and amortization slow.

SHORT-TERM RATING: The 'F1+' rating on the extendible CP is based on SDCWA's long-term credit quality.

RATING SENSITIVITIES

RATE PRESSURE: The authority's ability to continue to achieve timely cost recovery through rates is key to the rating. Fitch views community rate support as favorable for the authority's strategic direction. But rate fatigue and corresponding decreases in financial margins as costs continue to increase would likely put pressure on the rating.

PRESSURE FROM STATEWIDE DROUGHT: Pressure on financial margins could occur if water sales fall below assumed levels, which could occur in a multi-year water rationing scenario. Sustained decline in financial margins and reserve levels below management's targeted levels could put pressure on the rating.

CREDIT PROFILE

SDCWA provides wholesale water service to an estimated population of 3.2 million, almost all of the county. It sells water to 24 wholesale members that, in turn, either serve retail customers directly or sell to other wholesale providers. The customer base has been relatively stable. However, water sales declined 37% between fiscals 2007 and 2011, which is consistent with other regional utilities as a result of the economic recession, mandatory curtailments related to the drought, ongoing conservation programs, and variable weather conditions. Water sales recovered modestly in fiscals 2012 and 2013 but not to prior levels. SDCWA has adapted its financial planning model to incorporate lower expected water sales. Growth in water demand is only estimated at around 1%-2% annually.

PURSUIT OF WATER SUPPLY DIVERSIFICATION

SDCWA's long-term business strategy has pursued water supply investment and diversification over the past two decades. Following the drought in California in the late 1980's, SDCWA's governing board laid out a plan to achieve water supply diversification and reduce risk related to a sole supplier (at the time Metropolitan Water District of Southern California [Metropolitan] accounted for 95% of SDCWA's water supply). SDCWA has made investments to receive water directly from Imperial Irrigation District, invested in the development of recycled water and conservation programs, added regional water storage, and invested heavily in the refurbishment of its own facilities to improve efficiency. The addition of purchased water from the Carlsbad desalination plant, beginning in less than two years, will round out the diversification plan. SDCWA anticipates that only 30% of its supply will come from Metropolitan by 2020.

CARLSBAD DESALINATION PROJECT

Investment in desalination represents an effort to further diversify supply and develop water supplies that are drought-tolerant, locally generated, and do not rely on State Water Project or Colorado River hydrology. When construction is complete and the plant produces quality drinking water, the authority is required to purchase 48,000 acre-feet (af) annually, which would provide around 7% of the authority's water supply.

The cost of the project water, estimated at around $2,000 per af, is significantly higher than water purchases from Metropolitan whose current tier 1 treated water rates are $890 per af. However, SDCWA views the regulatory and hydrological uncertainty of Metropolitan's imported supply as providing a high risk to its customers. The authority has indicated to its member agencies that a rate increase of 10%-12% is anticipated to be necessary to fund the incrementally higher cost of the Carlsbad project once it comes on line, which is expected to occur in fall 2015.

HIGH CAPITAL INVESTMENT; HIGH DEBT

The authority invested $1.9 billion in capital over the past decade. The authority expects future capital spending to be more modest at around $445 million over the next five years. Spending in the next few years will relate primarily to the Carlsbad desalination project, relining and replacement of water mains, and completion of the San Vicente dam raise.

As a result of the historical capital investment, debt levels are high at 78% debt to net plant and $770 debt per capita. But debt levels are comparable in the region where water supply investments are capital intensive and considerable investments have been made in recent years. The debt also reflects the high point in the authority's capital lifecycle; capital spending to depreciation has ranged between 200%-800% for the past five years as compared to the Fitch median of 148% for 'AA' rated water and sewer utilities.

RATE FLEXIBILITY; COMMUNITY SUPPORT

The authority has implemented sizable rate increases in recent years in response to lower water sales and increasing water supply and debt service-related costs. The 3.5% rate increase implemented in calendar 2014 was much lower than the 10%-18% annual increases experienced in the prior five years.

Fitch views rate flexibility as good, despite the cost escalation in recent years, based on strong member support for the strategic direction. Customer surveys continue to reflect the broader population's appreciation for the authority's business strategy of diversification and the willingness to pay the cost associated with the acquisition of alternative water supplies.

FINANCIAL MARGINS STABLE

Financial performance in fiscals 2013 and 2012 improved from prior years with SDCWA posting senior lien debt service coverage (DSC) as calculated by Fitch of 1.54x and all-in DSC of 1.45x. Fitch's calculations include the authority's share of the county's 1% property tax receipts as revenues, along with the authority's fixed charges received through the infrastructure access charge and water standby availability charge.

Cash reserves are healthy, with operating reserves and rate stabilization funds providing $130 million or 115 days cash at the end of fiscal 2013. This level of reserves is considered adequate for the authority's wholesale agency risk profile. These reserve levels do not include another $73 million that the governing board has designated for purchasing water to fill San Vicente Reservoir over the next three to five years. This cash is unrestricted but designated and is not included in Fitch's days operating cash calculation.

NEW EXTENDABLE COMMERCIAL PAPER PROGRAM

SDCWA has authorized a new subordinate lien extendable CP note program (the series 1 notes) for up to $50 million in aggregate. The notes are extendable municipal commercial paper with original maturities from one to 120 days from the original issuance date of each note. However, the authority has the right to extend the maturity to up to 270 days from the original issuance date. If the notes are extended, the interest rate is reset to the greater of SIFMA plus a fixed number of basis points or a fixed interest rate, both of which are determined based on the CP credit ratings at the time. However, the reset rate shall not exceed a maximum interest rate of 12% per annum.

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:

--'Revenue Supported Rating Criteria' (June 2013);

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

--'Rating U.S. Public Finance Short-Term Debt' (Dec. 2013);

--'California Drought Impact on Utilities' (March 2014);

--'Peer Review: California Water and Sewer Credits' (Dec. 2013).

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830982

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Contacts

Fitch Ratings
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Andrew DeStefano
Director
+1-212-908-0284
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Andrew DeStefano
Director
+1-212-908-0284
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com