Fitch Upgrades Lake Arrowhead Community Service District, CA COPs to 'AA+'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has upgraded its rating on the following certificates issued by the Lake Arrowhead Community Services District, CA (the district):

--$20.7 million in outstanding certificates of participation (COPs), series 2009 to 'AA+' from 'AA'.

The Rating Outlook is revised to Stable from Positive.

SECURITY

The COPs are secured by a pledge of net water and wastewater system (the system) revenues.

KEY RATING DRIVERS

UPGRADE REFLECTS IMPROVING FINANCIALS: System financial results have been strong and are expected to become even more robust over the next couple of years as debt costs drop significantly and borrowing needs remain muted.

LIMITED DEBT NEEDS: Significant infrastructure-related capital spending funded in part by the series 2009 COPs have greatly reduced the system's near- and intermediate-term capital needs. Projects in the district's five-year capital improvement plan (CIP) are expected to be cash funded.

ADEQUATE SUPPLY: Although drought pressures remain, the district's access to a variety of water sources is expected to keep water supply adequate.

RATE FLEXIBILITY LIMITED: Despite recent significant rate increases, some flexibility remains as combined water and wastewater rates remain below Fitch's affordability threshold. However, factoring in fees and charges collected on customers' tax rolls, rates are likely near Fitch's affordability threshold.

LIMITED SERVICE AREA: Fitch believes that the current rating of 'AA+' is likely capped given the limited size of the service area coupled with the area's economic reliance on tourism.

RATING SENSITIVITIES

CONTINUED SOUND FINANCIAL PERFORMANCE: Financial forecasts point to sustained liquidity levels and improving all-in debt service coverage (DSC). Given lack of capital pressures, rating stability is expected

CREDIT PROFILE

The district provides service to 8,300 water customers and 10,600 wastewater customers in a number of unincorporated communities surrounding Lake Arrowhead in the San Bernardino Mountains. The Lake Arrowhead area is a resort community primarily serving residents of Los Angeles, Orange, San Bernardino, and Riverside counties. More than half of the homes in the service area are second homes.

STRONG FINANCIAL PERFORMANCE EXPECTED TO CONTINUE

The system finished fiscal 2013 with all-in DSC of 2.2x, which was an improvement over the previous year's result of 1.9x and at the high end of Fitch's 'AA' median. The effect of recent rate increases combined with the scheduled maturity of the series 2002 revenue bonds should lead to continued improvements in the system's already sound financial profile. Management's latest financial forecast anticipates DSC improving to an exceptionally strong 4.1x in fiscal 2015, with further gains in the years immediately following.

The system's available liquidity has also been very strong over the past five years. Inclusive of restricted cash reserves available for certain operational costs, fiscal 2013 finished with the cash equivalent of 783 days of operational costs, well above Fitch's 'AA' median level. Given budgeted pay-go spending for capital projects, liquidity levels may decline somewhat but should remain very strong over next several years. In addition, management's implementation of a new cash reserve policy in fiscal 2012 requiring, among other things, a minimum three months of budgeted operating expenses should ensure liquidity levels remain robust.

RATE INCREASES EXPECTED TO TAPER

After a significant rate increase in 2011 followed by a few moderate increases in subsequent years, management expects future rate changes to be more modest. Current rates are affordable at about 1.7% of median household income, below Fitch's affordability threshold of 2% (assuming Fitch's standard average monthly usage of 7,500 gallons per month). In addition to rate revenues, pledged revenues include an ad valorem tax and a 15-year supplemental water supply fee that was enacted in August 2004, both of which are collected on the county of San Bernardino tax rolls. The tax and supplemental water supply fee are budgeted at 17% and 11% of gross revenues, respectively, for fiscal 2014. The supplemental fee as a percentage of gross revenues has declined over the past few years as such supplemental rates were lowered while primary service fees increased. Factoring in fees and charges collected on customers' tax rolls, rates are likely above Fitch's affordability threshold.

MODEST CAPITAL IMPROVEMENT PLAN, MANAGEABLE DEBT RATIOS

The district's five-year CIP is predominantly allocated for repair, maintenance, and replacement projects. The total cost is expected to be approximately $24 million. Leverage ratios are fairly low, with debt per customer at $1,489, below Fitch's 'AA' category median of $1,828. However, amortization is somewhat slow at 36% and 66% in 10 and 20 years, respectively. Management has indicated to Fitch that near- and intermediate-term capital expenditures will be paid with cash, eliminating the need for new debt and supporting the likelihood of higher DSC levels.

ADEQUATE WATER SUPPLY

The district's primary water source is provided by Lake Arrowhead. Due to severe drought conditions at the time, the State Water Resources Control Board (SWRCB) issued an order in 2006 that limits lake withdrawals to 1,566 acre-feet per year. The district has also entered into a memorandum of understanding (MOU) with the Lake Arrowhead Association to maintain lake levels at no lower than 5,100 feet.

The district now derives its water from a combination of lake (77%), recycled (12%), well (7%) and imported water (1%). While conservation and recessionary pressures have led to dramatic decreases in water usage, current drought conditions continue to pressure lake supply. However, given the variety of sources, the district expects supply to be sufficient to meet at least medium-term demand.

Imported water usage by the district has been on the decline. In 2004, imported water accounted for 10% of total supply, but in 2012 and 2013, imported supply was down to 4% and 1% of total supply, respectively. Fitch believes that the district is financially positioned to absorb at least some costs associated with increased purchases of expensive imported water, if necessary. But if drought conditions continue, such costs could lead to some erosion of DSC.

LIMITED ECONOMY

The district benefits from its proximity to San Bernardino and Los Angeles, which are about 23 and 75 miles away, respectively. Tourism is the main economic driver in the area, with populations nearly tripling during holiday weekends. Economic prospects for the district appear favorable due to the above-average wealth levels and low poverty rates of the area's permanent residents. Additionally, although small, there is no significant user concentration in the service area.

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

In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2014);

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

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Outlook: Water and Sewer' (December 2013).

Applicable Criteria and Related Research:

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=844355

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Contacts

Fitch Ratings
Primary Analyst
Major Parkhurst
Director
+1-512-215-3724
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Scott Monroe
Director
+1-415-732-5618
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Major Parkhurst
Director
+1-512-215-3724
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Scott Monroe
Director
+1-415-732-5618
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com