SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings assigns an 'AAA' rating and a Stable Rating Outlook to $70 million of reimbursement obligations (the bank bonds) associated with Orange County Water District, California's (the district) commercial paper certificates, 2015 series A (tax-exempt) and series B (taxable), should the certificates ever be held by the liquidity provider.
The district expects to execute a letter of credit (LOC) and reimbursement agreement effective Nov. 19, 2015 with Sumitomo Mitsui Banking Corporation (the bank, rated 'A-'/Stable Outlook by Fitch) providing liquidity support for the certificates. The rating is assigned to the bank bonds but will only become applicable if the certificates cannot be remarketed and are purchased by the bank.
In addition, Fitch has affirmed the following obligations of the 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.
SECURITY
The bank bonds, bonds and COPs 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. Indenture compliant debt service coverage (DSC) has remained strong, though DSC has more recently declined when including larger than expected water purchases.
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. Costs related to a potential desalination water agreement are expected to be paid through water purchases and not additional debt. Final expansion of the GWRS capacity is at least five years out.
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.
PRESSSURE FROM STATEWIDE DROUGHT: The current drought could put downward pressure on Orange County Water District's rating if financial margins or liquidity levels fall significantly below expectations due to severe, multiyear water rationing. However, the Stable Rating Outlook reflects Fitch's belief that the district's revenue and expenditure flexibility sufficiently mitigate impacts from expected lower water sales.
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 through 19 major groundwater producing agencies, including Anaheim (water revenue bonds rated 'AAA' Stable Outlook by Fitch) and Irvine Ranch Water District (COPs and revenue bonds rated 'AAA', Stable Outlook by Fitch). Created by the state legislature in 1933, the district operates under the direction of an elected and appointed 10-member board of directors.
BANK BOND TERMS
Based on a review of the terms governing bank bonds specified in the LOC and reimbursement agreement, Fitch believes that the incremental risk associated with the bank bonds do not have a material impact on the district's long-term credit rating. Legal provisions are standard with a three-year amortization period beginning after six months and a maximum interest rate of 12% on any bank bonds.
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 $322 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.
As a wholesaler, the district is not subject to the mandatory conservation requirements established in May 2015 by the State Resources Water Control Board. However, it is still exposed to the requested 25% statewide cutbacks through the individual conservation mandates required of its customers. Most of its customers are reportedly meeting or are close to their mandates, and water deliveries are estimated to decline 13% in fiscal 2016.
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.
Unaudited fiscal 2015 results indicate Fitch-calculated senior lien DSC of 2.1x and all-in DSC of just 1.4x as result of larger than estimated water purchases combined with a decline in replenishment assessment revenues due to the ongoing drought. DSC less the water purchases is estimated at 2.9x. Fiscal 2016 projections indicate all-in DSC of 1.7x assuming water purchases of 55,000 af; however, DSC is expected to be somewhat higher as management expects water purchases to be lower at approximately 25,000 af. Projections show an increase in DSC in fiscal 2017 and through at least fiscal 2021. Assumptions include planned rate increases, water purchases of 65,000 af/year, and a return to higher levels of water consumption. Lower water consumption than anticipated in the out years, though somewhat mitigated by reduced water purchases, could pressure financial margins barring additional offsets.
The basin is primarily recharged with water from the Santa Ana River watershed, but the district also purchases water from MWD. The district's practice had been to build up reserves and purchase the replenishment water when available. However, MWD's replenishment program was discontinued in 2013.
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 declined to approximately 550 days in fiscal 2015 due to the cash defeasance of revenue COPs, series 2005B during the year and are expected to remain at this level in fiscal 2016 as water sales remain low. Fitch expects liquidity to begin to trend upwards as sales increase in future years, 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 fiscal-year end 2015 at $70.5 million), an operating budget reserve ($19.7 million), a toxic cleanup reserve ($4 million), a general contingency reserve ($3 million), a pay-go fund ($13.8 million) and a water fund for purchase of replenishment water, which has been drawn down to $2.3 million 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 signed a term sheet with Poseidon Water 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. However, the cost would be an O&M expense, payable prior to debt service. As such, it could be a credit negative if the costs pressure margins and coverage of debt obligations.
Recent capital needs have focused on the district's $482 million GWRS completed in 2008, and its $137.5 million expansion, completed in spring 2015. The recharge capacity of the GWRS increased from 72,000 af/yr to 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.
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 approximately 306,000 af in fiscal 2015 and is expected to decline to about 280,000 af in fiscal 2016 due to drought-related conservation. It had previously expected to increase to about 350,000 af 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, at 4.5% as of August 2015, have historically been lower than the region, state, and nation. 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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994263
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994263
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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