AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned its 'AA+/F1+' rating to the following bonds issued by the Metropolitan Water District of Southern California (Metropolitan):
--Approximately $189 million special variable rate water revenue bonds, series 2015A-1 and series 2015A-2 (self-liquidity).
Bond proceeds will refund outstanding fixed and variable rate bonds as self-liquidity variable rate bonds. Bonds are expected to price June 30, 2015.
In addition, Fitch affirms the following ratings:
--$3.4 billion outstanding water revenue bonds and term bonds at 'AA+';
--$566.3 million SIFMA index mode bonds, series 2009A-2, 2011A1-A4 and 2012B1-B2; term mode bonds, series 2012E2, and flexible index mode bonds, series 2013E at 'AA+'/'F1+';
--$167.2 million special variable rate water revenue refunding bonds, series 2013D and 2014D (self-liquidity)at 'AA+'/'F1+';
--$110.4 million waterworks general obligation (GO) bonds at AAA'.
The Rating Outlook is Stable.
Bonds are payable from net water revenues of the district. The series 2015A bonds do not have a liquidity facility to support the weekly tender but instead rely on Metropolitan's own liquidity in the event of a failed remarketing. The GO bonds are payable from an unlimited ad valorem tax on all property within the district.
KEY RATING DRIVERS
WHOLESALE SUPPLIER: Metropolitan is the supplemental wholesale water supplier to 18.4 million people in southern California. Revenues are provided from 26 member agencies that rely on water purchased from Metropolitan to supply their retail customers although there are no minimum annual purchase or payment amounts.
WATER SUPPLY FLUCTUATIONS: Water is provided from two independent supply sources. Supply fluctuations occur on the in-state water supply, the State Water Project (SWP). The Colorado River supplies, banking arrangements, and Metropolitan's substantial storage facilities help balance this risk. Consequently, Metropolitan has sufficient supplies to meet customer demands despite statewide drought concerns.
FLEXIBLE FINANCIAL PROFILE: Financial performance exhibits cyclicality linked to hydrological and weather conditions in the state given Metropolitan's role as the supplemental supplier and its highly volumetric rate structure. Financial margins in the past two years have been stronger given higher water sales.
RATE FLEXIBILITY: Metropolitan's revenue flexibility is evident in the 75% cumulative rate increases between 2008 and 2013, although rate sensitivity is likely heightened given the magnitude of those rate actions. Higher rates improve the economics of a variety of local water supply investment options for Metropolitan's members that will reduce future sales.
GO BONDS: Metropolitan's GO rating of 'AAA' is based on its ability to levy unlimited ad valorem taxes on its $2.3 trillion tax base, with the property tax revenues restricted to be used only for debt service on the remaining GO bonds and capital costs related to the SWP.
PRESSURE FROM STATEWIDE DROUGHT: Pressure on financial margins could occur if water sales fall below already low budgeted levels in fiscals 2016 and projected levels in 2017. Metropolitan will be spending down reserves on conservation programs but reserves are expected to remain healthy and above internal minimum targets.
Metropolitan is a wholesale water supplier in southern California to 26 member agencies, many of whom have some form of local water supply. The largest three members (55% of water revenues in 2014) include the San Diego County Water Authority (senior lien revenue bonds rated 'AA+' by Fitch), Orange County Water District (revenue bonds rated 'AAA'), and Los Angeles Department of Water and Power (water bonds rated 'AA').
Significant developments to water supply sources and the demand profile from members have occurred since the beginning of California's last drought in 2007-2009. Greater variability and uncertainty exists on Metropolitan's in-state water supply, the SWP. Demand level from members has declined from pre-recession levels although it continues to exhibit a high degree of annual variability. Finally, reliability considerations and Metropolitan's significant rate increases have prompted regional investment in new local supplies that will reduce future demand for water sold by Metropolitan.
Metropolitan's members are not required to buy minimum amounts of water from Metropolitan but instead use the imported water supply to supplement their other sources. However, Metropolitan's role in the region is crucial in that it supplies 40%-60% of Southern California's water supply. Fitch expects Metropolitan to remain a key water supplier although over the long term there may be further pressure on demand.
Metropolitan absorbs much of the regional demand variability as the 'high-cost' resource, due to conservation and efficiency investments as well as weather conditions. The swing in annual demand can exceed 200,000 acre-feet (AF). With Metropolitan's primarily volumetric rate structure, the district must operate with a strong financial cushion to absorb the revenue implications of demand variations, such as lower sales expected to occur in fiscal 2016.
POSITIONED TO MAINTAIN CREDIT QUALITY DURING DROUGHT
MWD has made substantial investment in its physical storage facilities and inter-agency water storage agreements in the past 20 years. Storage capacity is nearly four times what it was in 1994. Metropolitan currently has 5.93 million acre-feet (MAF) in storage capacity. Stored water was used in the last drought of 2007-2009 but stronger hydrological conditions recently allowed Metropolitan to add to its stored water in 2011-2013. Storage reached a high point of 3.37 MAF on Jan. 1, 2013 before falling to 1.73 MAF as of Jan. 1, 2015. Metropolitan's substantial stored water position allowed it to meet the water demand of members during the initial years of the drought without triggering any mandatory cutbacks.
In April 2015, Metropolitan moved to Stage Three of its allocation plan that requires its members to reduce their purchases from Metropolitan by 15% in fiscal 2016. This action is consistent with statewide efforts to reduce water usage and the Governor's emergency order to retail utilities to curtail water sales. Metropolitan's conservative rate-setting and fiscal 2016 budget, which is based on 1.75 MAF water sales (compared to 2.04 MAF in fiscal 2014) should continue to preserve healthy financial operations.
HIGHER SALES IN 2013 and 2014 PRODUCED STRONG FINANCIAL MARGINS
Dry conditions for the past four years (prompting a drought declaration by the Governor in January 2014) led to strong water sales for Metropolitan in the initial years of the drought, given lower availability of the members' local supplies and stored water levels at Metropolitan. Water sales were 1.86 MAF in fiscal 2013 and 2.04 MAF in fiscal 2014. These results exceed the 1.7 MAF budget target that Metropolitan adopted in 2011 for fiscals 2013 and 2014 after water sales declined to just over 1.6 MAF in 2011 and 2012. Wetter conditions and economic recession in those prior years resulted in lower purchases from members.
Financial performance of Metropolitan is highly dependent on actual water sales as compared to budget. Financial performance in fiscal 2014 exceeded budget expectations and debt service coverage equaled 2.5x. The additional revenues bolstered reserves that exceed maximum reserve targets established by the board. While excess reserves can be remitted to members, this has not occurred since 2009.
STRONG FIXED-CHARGE COVERAGE
Fixed-charge coverage increased to 2.1x in fiscal 2014 from 1.8x the prior year, in excess of Metropolitan's internal target for rate-setting of 1.2x. Fitch uses fixed-charge coverage as the key financial metric for Metropolitan (a proxy for total debt service coverage) and the district uses this calculation for internal rate-setting as well. The fixed-charge calculation includes the amount of SWP costs that are a capitalized expense as if they were paid as debt service. This expense is paid to the state for SWP expenses and is a cash outflow, much as principal on debt-financed assets is paid but not considered an 'operating expense' of the system.
CASH RESERVES MITIGATE RISK
Metropolitan's reserves provide a strong degree of financial flexibility. As of June 30, 2014, there was $1 billion in unrestricted cash including the operating and maintenance fund, or 389 days of operating cash. However, reserves are used to mitigate other risks, such as providing self-liquidity for $356 million in variable-rate bonds.
Metropolitan has approved the use of $450 million in reserves to fund conservation programs in fiscals 2015 and 2016. This represents a spend down of most reserves in excess of Metropolitan's minimum targets but is viewed as reasonable given Metropolitan's strong reserves, the extreme nature of the current drought and the 15% allocation that requires each member to reduce its purchases.
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.
Rating U.S. Public Finance Short-Term Debt (pub. 07 Jan 2015)
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 31 Jul 2013)
Dodd-Frank Rating Information Disclosure Form