Fitch Affirms San Juan Capistrano Pub Fin Auth, CA's Rev COPs at 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings affirms the following rating on San Juan Capistrano Public Financing Authority, CA's (the authority) outstanding revenue certificates of participation (COPs):

--$9.8 million revenue COPs, series 2009 at 'A'.

The Rating Outlook is Stable.

SECURITY

The certificates are secured by installment payments made by the city of San Juan Capistrano (the city) to the authority. Installment payments are a special obligation by the city, secured by a pledge of and first lien on the net water system revenues.

KEY RATING DRIVERS

IMPROVED COVERAGE; NO AVAILABLE CASH: Debt service coverage (DSC) levels have improved over the last several years. The city reasonably projects that DSC will be within the 1.5x to 2.4x range over the fiscal 2015 to 2019 period. Liquidity is expected to remain negligible through fiscal 2017, providing limited operating flexibility.

WATER RESTRICTIONS: Due to California Governor Jerry Brown's executive order to reduce statewide water usage by 25%, the city projects a net revenue loss, albeit manageable, for fiscal 2016. Long-term use restrictions could materially pressure financial operations.

ELEVATED YET DECLINING DEBT BURDEN: The debt profile is above-average but is expected to continue to decline given that the city has no future debt issuance plans. Favorably, debt amortization is above the category 'A' rating medians with principal payout at 46% and 100% in 10 and 20 years, respectively.

RATE PRESSURE AND LITIGATION: Water rates are high at 1.6% of median household income (MHI), exceeding Fitch's affordability threshold of 1% of MHI. Also, outstanding litigation surrounding previously adopted conservation tiered rates, although not expected to materially affect utility financial operations in the event the plaintiffs are successful, potentially raises some concern for Fitch over discontent within the customer base should drought conditions be prolonged.

SOUND ECONOMIC FUNDAMENTALS: Demographics are healthy with high wealth levels and unemployment below state and national averages.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: Declines in financial margins could occur if California's statewide drought continues and water sales fall below the level needed to sustain healthy operations. The city's ability to pass-through rate hikes to offset any drought issues will be important to maintaining the rating.

GOOD DSC KEY: Declining DSC could lead to a lowering of the rating in light of expectations of negligible liquidity through fiscal 2017.

CREDIT PROFILE

The city provides retail water services to an estimated 39,000 people through 11,000 water connections within the city and portions of the city of Dana in Orange County. The water system's customer base is stable, growing at a rate of less than 1% annually over the last five years.

GOOD DSC; VULNERABLE TO MANDATED REDUCTIONS

Financial margins have improved since fiscal 2011 largely due to consistent rate increases. DSC for fiscal 2013 and 2014 totaled 1.7x and 2.1x, respectively. The increase in fiscal 2014 was largely due to higher water sales as a result of a warmer drier year. For fiscal 2014, the city remains at $0 for unrestricted cash. Positive cash balances are not expected until fiscal 2017, which is consistent with prior year projections. The system's cash was depleted in fiscal 2009 and was negative in fiscals 2010-2012 to cover capital expenditures and debt service payments.

Management projects DSC levels to range between 1.5x-2.4x through the fiscal 2019 forecast period, assuming the fiscal 2015 adopted rate plan that includes 5% annual increases through fiscal 2019. Fiscal 2016 DSC projections were recently revised to 1.5x from 1.8x to incorporate the Governor's April 1 executive order mandating a 25% reduction in water use due to the drought. The city's water reduction for that year would have a negative net financial impact of approximately $743,000. While the city's water conservation efforts result in lower purchase costs for imported supply, the decrease in operations and maintenance (O&M) does not fully offset the city's reduced revenue from water sales. However, Fitch believes that the 1.5x DSC for fiscal 2016 is still adequate for the rating category. If the drought persists, it is likely that the city will have to further revise its projections and DSC could be lower than what is currently forecast.

The city recently discussed possible ways to recover from the projected net loss due to reduction in water use including implementing an increased number of recycled water conversions, which would transfer potable landscape customers to the non-potable system, surcharges and penalties to recover lost revenue and help pay for the recycled water conversions and other conservation measures. In addition, education and outreach programs will also be implemented, targeting users that would need the most assistance in reaching conservation goals. If the state's severe drought persists, continued/future restrictions on water usage could pressure operations.

Average daily water production for fiscal 2014 was 7.7 million gallons per day (mgd) and consists of a blend of imported and local groundwater with a total capacity of approximately 19.7 mgd. This supply does not include the 3.6 mgd of emergency imported water supply. During fiscal 2014, the city obtained approximately 57% of its water supply from the Metropolitan Water District of Southern California (MWD) through the Municipal Water District of Orange County. The remaining 43% was derived from groundwater supplied by city-owned local wells.

MWD recently supported the Governor's April 1 mandate and voted to restrict water purchases for its member agencies. The city is now subject to a 15% reduction in water supplies effective July 1, 2015. Management previously anticipated MWD's allocation reduction, with the city's original forecast (prior to the governor's mandate) reflecting imported water demand to be well below MWD's required allocation.

LIMITED RATE FLEXIBILITY

Water system rates consistently have been increased since fiscal 2010. The city recently completed a new rate study and approved 5% rate increases for five years beginning in fiscal 2015. With a monthly water bill of around $104, rates are high at 1.6% of MHI and exceed Fitch's affordability threshold of 1% of MHI, assuming average monthly usage of 7,500 gallons per month. Actual monthly usage could be higher than the national average of 7,500 gallons per month due to many larger lots for residential customers. On a combined system basis, rates are currently at Fitch's 2% affordability threshold. With system rates rising 5% annually over the next four years, affordability will be further constrained despite the city's above average wealth levels.

LEGAL CHALLENGE TO TIERED RATES

Another concern with regards to the city's rate flexibility is litigation over previously adopted rates filed by a group of taxpayers in April 2012. In 2013, the California superior court declared that the city's water rate structure was invalid and violates California's Constitution because fees were imposed on parcels of property that exceeded the proportional cost of the service attributable to those parcels. Specifically, the city charged certain ratepayers for recycled water that they did not actually use and that was not immediately available to them. The lawsuit sought prospective relief from the water rates set in February 2010. The city has since flattened its tiered charges to more directly align with actual water costs.

The city appealed the case in September 2013, and awaits a decision from the appellate court, expected in April 2015. The city has been allowed to charge its current rates until the appeal is resolved. The most recent rates adopted in June 2014 have not been challenged in any court and are not an issue in the pending case. However, credit concerns could arise if additional ratepayer pushback emerges, particularly if rate adjustments beyond those currently contemplated are necessary to offset the drought's effects on revenue levels.

ELEVATED DEBT BURDEN; MANAGEABLE CAPITAL NEEDS

The city's current five-year capital improvement plan totals $11.4 million. Capital needs are anticipated to be funded from pay-go resources (i.e. system rates and developer impact fees). With the projected net revenue loss from water conservation efforts and no available cash reserves, certain projects may need to be deferred. The city has no future debt plans so above-average debt ratios (debt per customer of $2,859 and debt per capita of $913) are expected to continue to decline over the next five years.

AFFLUENT SERVICE AREA

The water system serves approximately 11,376 customers, including about 1,000 users outside of the city limits. Customer growth has been modest at approximately 1% annually over the past five years. San Juan Capistrano (general obligations rated 'AAA' with a Stable Outlook) is a wealthy municipality located in southern Orange County midway between Los Angeles and San Diego. The city is noted for the historic Mission of San Juan Capistrano as well as gated master planned residential communities with an equestrian focus capitalizing on the city's commitment to open space (44% of the city's land). The city is largely a residential, suburban community with residents commuting to jobs in the Orange County, San Diego, and Los Angeles areas. Area wealth levels are 20% and 40% above state and national levels, respectively, and the 3.9% unemployment rate as of December 2014 is below state (6.7%), county (4.4%), and national (5.4%) levels.

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:

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

2015 Outlook: Water and Sewer Sector

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983317

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Contacts

Fitch Ratings
Primary Analyst
Adrienne M. Booker, +1-312-368-5471
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Adrienne M. Booker, +1-312-368-5471
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com