Fitch Affirms Orange County Water District, CA Rev Bonds and COPs at 'AAA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the following obligations of Orange County Water District, CA (the district) at 'AAA':

--$53 million revenue refunding bonds, series 2013A;

--$286.4 million revenue certificates of participation (COPs).

The Rating Outlook is Stable.

In addition, Fitch Ratings has withdrawn its ratings for the following Orange County Water District (CA) obligations due to prerefunding activity:

--Revenue certificate of participation series 2003B (all maturities);

--Revenue refunding certificate of participation series 2007A (all maturities).

The updated rating history for the above maturities is now reflected on Fitch's web site at 'www.fitchratings.com'.

SECURITY

The bonds are payable from revenues of the district, net of all district operations and maintenance (O&M) costs but excluding the basin equity assessment and water purchase costs.

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE: The district's financial performance is exemplary, marked by strong financial policies, limited fixed expenditures, and a history of increasing rates in line with operating and capital costs.

SUBSTANTIAL RATE FLEXIBILITY: The district maintains substantial rate flexibility relative to competing supplies from the Metropolitan Water District of Southern California (MWD; water revenue bonds rated 'AA+'/Stable Outlook by Fitch).

STABLE REVENUES: District revenues are derived primarily from annual assessments on groundwater users and property taxes, both of which have proven stable over time.

MANAGEABLE CAPITAL PLANS: Capital plans are manageable and focus on expansion of capacity.

DIVERSE SERVICE AREA: The service area is broad and diverse and is characterized by high income levels and low unemployment.

RATING SENSITIVITIES

SHIFTS IN FUNDAMENTALS: The rating is sensitive to shifts in fundamental economic, financial, debt and management credit factors. The Stable Outlook indicates that Fitch views such shifts as unlikely.

CREDIT PROFILE

The district is located in the northern half of Orange County, CA (the county, implied general obligation debt rated 'AA+'/Stable Outlook by Fitch), encompassing approximately 350 square miles. It helps provide the majority of the water supply demand for more than 2.3 million people. Created by the state legislature in 1933, the district operates under the direction of an elected and appointed 10-member board of directors.

SUBSTANTIAL RATE FLEXIBILITY

The district's primary role is management of the Orange County Groundwater Basin (the basin), which is a primary drinking water source for numerous water purveyors in the county. The basin's groundwater supplies 19 municipal and 110 private groundwater producers that pump and deliver water to their customers and pay replenishment assessments (RAs) and additional replenishment assessments (ARAs) to the district based on groundwater extracted from the basin.

The district maintains substantial rate flexibility based on its limited yet key role in regulating, protecting, and resupplying basin groundwater. Competition is mitigated by the scarcity of alternative water sources and relatively inexpensive price of groundwater supplies compared to imported MWD water. Currently, MWD water is around $923 per acre-foot (af) for local purveyors, while the cost of district basin water (not including utility costs) is about $294 per af. Assessments are expected to increase 16% and 17% in fiscals 2016 and 2017, respectively, to fund increased debt service costs associated with the Groundwater Replenishment System (GWRS) expansion before moderating at about 4% each of the following two years. Groundwater assessment delinquency rates are very low.

STRONG FINANCIAL PROFILE

District financial metrics are healthy. Approximately 67% of revenues are derived from the assessments and 16% from property taxes, which have been quite stable. Fitch calculated debt service coverage (DSC) has typically exceeded 2.0x on a senior lien basis and a minimum of 1.4x for all debt obligations. DSC fell in fiscal 2012 to 2.2x on a senior basis and 1.4x on an all-in basis, primarily due to the purchase of a large quantity of available MWD low-cost replenishment water (versus untreated full service MWD water). Discretionary purchased water costs, which are treated as an O&M expense for Fitch coverage calculations, nearly doubled for 2012, rising to $29 million, well above the prior five-year average of $11 million. Less these costs, as per the indenture, all-in coverage for fiscal 2012 was 2.5x. Senior and all-in DSC for fiscal 2014 were a still healthy 2.4x and 1.5x respectively, despite $45 million in purchased water costs due to basin overdraft as a result of the drought and availability of supplemental water from MWD. Less these costs, all-in coverage for fiscal 2014 was 3.4x.

The basin is primarily recharged with water from the Santa Ana River watershed, but the district also purchases water from MWD when available for replenishment purposes. The district's practice is to build up reserves and purchase the replenishment water when available. Projections show a return to historical coverage levels beginning in fiscal 2015 and through at least fiscal 2019.

Liquidity is substantial as a result of the district's conservative fiscal management and prudent reserve policies. Cash and working capital remained in excess of 880 days over the past six years, only dipping to still very high levels of over 600 days in fiscals 2012 and 2014 when the district made large MWD water purchases. Cash levels are expected to increase to historical norms going forward, only dropping in years in which higher than average amounts of MWD water is purchased.

The district prudently maintains its board-approved policies to sustain reserves for various purposes. These consist of a replacement and repair reserve (balance as of 12/31/14 at $76.9 million), an operating budget reserve ($19.7 million), a toxic cleanup reserve ($4 million), a general contingency reserve ($3 million), and a water fund for purchase of replenishment water ($10.5 million), which has been drawn down from about $59 million over the last few years due to large MWD water purchases.

MANAGEABLE CAPITAL NEEDS

Future capital needs are manageable and generally serve to expand the district's ability to provide additional supplies, enhancing its revenue base. The five-year CIP through fiscal 2019 totals $241 million and focuses on both expansion and rehabilitation. Capital concerns are minimal and relate primarily to continued protection of the basin from groundwater contamination, which the district aggressively pursues. The district recently entered into negotiations with Poseidon regarding possible construction of a desalination plant to produce an estimated 50,000 acre-feet per year (af/yr). While financing is uncertain at this point, management does not anticipate bearing the debt burden and as, such, the project is not expected to have a negative impact on the district's debt profile.

Recent capital needs have focused on the district's $482 million GWRS completed in 2008, and its $137.5 million expansion, estimated to be completed in spring 2015. Upon completion, the recharge capacity of the GWRS will reach 103,000 af/yr, allowing for more groundwater pumping from the basin. Over the long-term, management plans to ultimately expand the capacity to 130,000 af/yr at an estimated cost of $100 million.

Despite the costs, the incremental increases to assessments to fund the GWRS project are relatively minor and are not expected to affect the district's cost competitiveness. Basin production was more than 331,156 acre-feet of water in fiscal 2014 and is expected to remain at about this level through fiscal 2019. It had previously expected to increase to about 350,000 af by 2016 due to the GWRS expansion, but the drought has been longer and more severe than anticipated.

DIVERSE AFFLUENT SERVICE AREA

The county benefits from a large, diverse, and wealthy economic base as well as its proximity to Los Angeles, Riverside, and San Diego. Unemployment rates have historically been lower than the region, state, and nation and continue to be low at 5% in November 2014. Wealth indicators, as measured by median household income, are high at 123% and 143% of the state and nation, respectively.

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 2014);

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

--'2015 Water and Sewer Medians' (December 2014);

--'2015 Outlook: Water and Sewer Sector' (December 2014).

Applicable Criteria and Related Research:

2015 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410

Revenue-Supported Rating Criteria

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

U.S. Water and Sewer Revenue Bond Rating Criteria

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

2015 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=979060

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Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Andrew Ward
Director
+1-415-732-5617
or
Committee Chairperson
Douglas Scott
Managing Director
+1-512-215-3725
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Andrew Ward
Director
+1-415-732-5617
or
Committee Chairperson
Douglas Scott
Managing Director
+1-512-215-3725
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com