SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the following Eastern Municipal Water District Financing Authority debt:
--Approximately $80 million subordinate lien water and sewer revenue bonds series 2015B.
The bonds are scheduled to sell via negotiation on or about June 3, 2015. The proceeds will be used to fund the ongoing capital improvement program of the Eastern Municipal Water District, CA (the district) and to pay cost of issuance.
In addition, Fitch affirms the following ratings:
--$427.7 million senior water and sewer revenue bonds and certificates of participation (COPs) at 'AA+';
--$104.6 million senior water and sewer revenue bonds series 2012A and 2013A (the SIFMA bonds) at 'AA+/F1+';
--$104.4 million bank certificates and bonds associated with series 2008C and 2008G at 'AA+' in the event that any certificates of the series are converted to bank certificates in the future;
--$148.6 million bank bonds associated with series 2014A, 2014B and 2014C at 'AA' in the event that any certificates of the series are converted to bank certificates in the future;
--$35.5 million Western Riverside Water and Wastewater Financing Authority revenue bonds (Eastern Municipal Water District improvement district general obligation (GO) bond financing) at 'AA'.
The Rating Outlook is Stable.
SECURITY
The outstanding senior revenue bonds and COPs are payable from a first lien on net water and sewer revenues, including rate stabilization fund transfers and connection fee revenues. The subordinate bonds are payable from a second lien on net revenues.
The GO bonds are payable from net system revenue pledge after payment of revenue bonds, available reserves and ad valorem property taxes. The 'AA' rating reflects the net revenue pledge.
KEY RATING DRIVERS
FINANCIAL PERFORMANCE REMAINS HEALTHY: The utility's financial performance and all-in DSC remain healthy. Liquidity remains exceptionally strong. Operating revenues exhibit a high degree of stability.
MANDATORY DROUGHT CONSERVATION: State regulators have ordered the district to drastically reduce water usage in response to a statewide drought. The district is well positioned to offset financial declines from lower water sales through its allocation based rate structure.
CONNECTION FEE EXPOSURE: The utility remains reliant on economically sensitive connection fee revenues. Fitch expects all-in coverage excluding connection fees to remain adequate.
STRONG MANAGEMENT PRACTICES: Management's planning practices include active and thorough water supply, capital and financial planning processes. Budgeting is generally conservative with actual results regularly exceeding projections and corrective action taken quickly to restore performance during past periods of weakness. Elected officials have shown strong rate discipline.
SOLID SUBURBAN SERVICE AREA: The district provides water and sewer services to a large and diverse service area in western Riverside County. The region has emerged from a deep cyclical downturn due to the collapse of the local housing market and remains fundamentally sound.
SIGNIFICANT DEBT BURDEN: Debt levels are above average and expected to remain elevated with slow amortization and $233 million of additional borrowing planned over the next five years. The debt profile is complex with high levels of variable-rate debt and derivative exposure.
RATING SENSITIVITIES
PRESSURE FROM STATEWIDE DROUGHT: The rating could come under downward pressure if financial margins fall more than expected due to severe or multi-year water rationing related to the current severe California drought. The Stable Outlook reflects Fitch's belief that this is unlikely due to the district's diverse revenue base, self-stabilizing allocation based rate structure and ample rate flexibility to respond to any unexpected declines in financial performance.
CREDIT PROFILE
Eastern Municipal Water District provides water service and sewer service to 785,000 people, or about a third of Riverside County's population, through retail and wholesale accounts. The service area covers 550 square miles and includes the cities of Temecula, Murrieta, Moreno Valley, Hemet, San Jacinto and Perris, as well as unincorporated areas. The formerly agricultural region suburbanized rapidly over the past two decades and is close to both Orange and San Diego Counties.
POSITIONED TO WITHSTAND STATE'S EMERGENCY WATER CUTS
On May 5, as a response to the Governor's recent executive order to reduce annual water usage in the state by 25%, the State Water Resource Control Board (SWRCB) adopted rules requiring mandatory reductions in water usage for all of California's water providers. The district's required reduction is 28% over 2013 levels. To achieve this, Eastern enacted Stage 4 of its drought management plan, which reduces water allocations across its water usage tiers, including a 10% initial reduction in outdoor watering allocations. The district has also asked users to voluntarily reduce outdoor watering by 50%.
The district's allocation based rate structure is designed to recoup lost revenues as drought measures push sales volumes lower. When the district needs to conserve water, policymakers declare a higher drought stage, which reduces the amount of water allocated to residents at low rates for indoor and efficient outdoor use. The rate structure stabilizes rates by pushing use into more expensive tiers, effectively recovering the district's full costs despite lower sales.
The impact on net revenues is expected to be modest, despite the large reduction in water sales. The district will reduce purchases of its most expensive imported water supplies as consumers reduce usage. Some erosion in revenues is possible if users react to price signals by conserving enough to stay in their reduced water budgets and avoiding higher cost wasteful use tiers.
SOLID FINANCIAL PERFORMANCE
Financial performance remained solid during very difficult operating environments in recent years, including periods of surging imported water costs, drought and very weak connection fee revenue performance. Fitch calculated all-in DSC - which includes the district's general obligation bond revenues and debt service - was solid at 1.8x in each of the past two years. Senior lien DSC was strong at better than 2x in the past two fiscal years and is expected to rise gradually as connection fee revenues grow and debt is refinanced into the subordinate working lien.
Coverage varies more with economic cycles and connection fee revenues, but has remained consistently healthy. Connection fees rose to $30.2 million in 2014, about three times the level seen at their recent low in 2011. Coverage excluding connection fees was narrow at 1.4x in 2013 and 1.2x in 2014, suggesting continued dependence on growth-related revenues. Non-connection fee revenues are fairly diverse and stable with flat rate sewer fees, significant fixed water meter charges and stable property taxes providing about 40% of revenues.
Management's financial forecast shows all-in coverage averaging a strong 2.1x over the next five years. The forecast assumes compliance with state regulatory mandates and continued increases in development. The utility's very strong financial reserves mitigate concerns about coverage volatility in the near-term. Unrestricted cash and investments equaled $212 million, or 400 days of operating expenses, at the end of fiscal 2014, providing ample resources to offset short-term revenue misses. The utility also maintains significant restricted capital reserves, which totaled $75.5 million at the end of 2014.
STRONG MANAGEMENT PLANNING, SIGNIFICANT SUPPLY INVESTMENTS
The district's management practices are strong with a long track record of delivering better than forecast financial results, investing to increase the reliability of supplies and raising rates as needed to maintain financial performance. For example, the district began investing in water recycling long before most California water agencies and now produces a very significant 33% of supplies from relatively drought-proof, highly treated waste water. The district's supply investments do not exempt it from mandatory statewide rationing, but they suggest that the district will be better positioned than others if the drought is prolonged.
Local supply investments have modestly reduced the district's exposure to supply curtailments of imported water in a prolonged or severe drought. Eastern imports about half of its water from the Metropolitan Water District of Southern California (Met Water, revenue bonds rated 'AA+'/Stable Outlook by Fitch), down from about 60% in 2002.
Fitch generally views reliance on imported water as a credit weakness that reduces supply security and increases the cost of water. However, Met Water's significant investments in water storage in recent years have paid dividends in the current drought, allowing Southern California and Eastern to avoid rationing in the early stages of the dry spell. The regional wholesaler has curtailed deliveries by 15% this year, suggesting local water managers believe they have less need to conserve than state regulators have required.
SOLID RATE DISCIPLINE
The district has raised rates as needed to maintain healthy financial performance, including significant hikes to cover increased water costs from its wholesale supplier, the Metropolitan Water District of Southern California (MWD, revenue bonds rated 'AA+'/Stable Outlook by Fitch). Eastern's rate increases have slowed in the most recent period, but have been healthy with a three-year average of 3.9% for water and 4.3% for sewer. Rates also compare favorably to other local jurisdictions, and rate increases have not generated significant controversy among ratepayers or elected policymakers.
ABOVE AVERAGE DEBT BURDEN
The district's debt burden is somewhat above average with borrowing increasing again now that growth has resumed in the service area. The district's $929.8 million debt burden at the end of fiscal 2014 was about 125% of the median for 'AA' category water and sewer utilities at $2,462 per customer. Fitch expects debt to rise to about $2,800 per customer as the district borrows $254 million to fund 52% of its $487 million 2015-19 capital improvement plan (CIP). Capital needs are roughly evenly divided between projects related to growth and renewal of existing infrastructure, providing some opportunity to adjust capital spending if growth fails to materialize as forecast. Expansions of the recycled water system and sewer system improvements dominate the CIP, accounting for about 68% of spending.
The district invested heavily in maintaining its infrastructure with capital expenditures to depreciation averaging 180% over the past five years. Investments have been driven by spending of capital reserves built up during boom years and debt because operations have not thrown off sufficient cash flows to fund much of the capital plan. Free cash to depreciation has averaged a weak 44% over the past five years. Free cash to depreciation is not expected to rise to more typical levels until development activity resumes at a more robust pace.
The district's debt portfolio is more complex than the typical municipal water and sewer utility with $350.7 million, or 31.5% of the district's outstanding debt, as short-term and variable rate debt. About $102.3 million of the debt is hedged with interest rate swaps, lowering the percentage of pure variable rate exposure to 22.3%. Fitch expects variable rate exposure to slowly decrease as a percentage of the debt portfolio as the district plans to utilize significant amounts of fixed-rate state revolving fund loans to fund capital over the next few years.
Debt amortization is slow with 62% of bonds repaid in 20 years versus a 'AA' median of 81%; however, much of the current CIP's future borrowing will be done through state revolving fund loans with 20 year terms, improving amortization rates somewhat.
GO BONDS
The GO bonds are payable from an unlimited ad valorem property tax revenues from a number of small, concentrated improvement districts. The district does not levy the full legally permissible debt service levy for the GO bonds, choosing instead to pay some GO debt service from net revenues. The 'AA' rating on the bonds reflects the stronger revenue pledge of subordinate net system revenues.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was informed by information from CreditScope and IHS Global Insights.
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);
--'California Water Credits May Struggle With New Rules' (May 8, 2015).
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=985187
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