Fitch Rates Elsinore Valley Municipal Water District, CA's Revs 'AA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned an 'AA' rating to the following Elsinore Valley Municipal Water District, California (EVMWD) debt:
--Approximately $73.3 million water revenue refunding bonds series 2016A issued by the EVMWD Financing Authority.

The bonds are scheduled to sell via negotiation on or about March 15, 2016. Proceeds will refund the district's outstanding 2007A and 2008A certificates of participation (COPs) and pay cost of issuance.

In addition, Fitch affirms the following EVMWD ratings at 'AA':
--$219.7 million outstanding bonds and COPs at 'AA';
--$71.4 million bank bonds associated with series 2011 and 2008B.

The Rating Outlook is Stable.

SECURITY

The bonds and COPS are payable from a pledge of net water and sewer revenues.

KEY RATING DRIVERS

SUBURBAN RIVERSIDE SERVICE AREA: The district provides essential services to a fast growing suburban Riverside County, California service area. The service area has a diverse payer mix and a fundamentally sound but development-dependent economy.

STRONG FINANCIAL PERFORMANCE: Debt service coverage (DSC) has averaged a strong 2.2x over the past three fiscal years despite a severe drought. Liquidity is extraordinarily strong with 1,235 days cash on hand at the end of fiscal 2015.

MANAGING DROUGHT WELL: State regulators have ordered the district to implement steep cuts in water use to combat California's multiyear drought. The district has continued to perform well financially due to drought rates that lessen revenue losses and offsetting reductions of purchases of imported water.

CONNECTION FEE VOLATILITY: Revenues and debt service coverage are more volatile than typical for a water-sewer utility due to significant connection fee revenues, but underlying water, sewer and property tax revenues provide a solid financial base even without connection fee revenues.

SOLID RATE DISCIPLINE: The utility's board has approved rate increases as necessary to maintain sound financial performance and has implemented drought rates to stabilize revenues in the face of declining demand. Rates remain affordable despite rate increases.

HIGH DEBT BURDEN: Debt levels are high at $3,000 per customer. Debt is projected to dip temporarily as the district uses excess reserves to reduce principal on the current refunding transaction, but debt will rise again over the next five years if the district completes its growth-driven CIP as currently projected.

RATING SENSITIVITIES

UNEXPECTED DROUGHT PRESSURES: The rating could come under downward pressure if the current drought further reduces sales without offsetting rate increases and/or expense reductions. Such an outcome appears unlikely given a strong track record on rate setting and the district's ability to reduce water purchases as sales decline.

CREDIT PROFILE

EVMWD provides water and sewer services to about 140,000 residents of western Riverside County who live in and around the city of Lake Elsinore. The customer base is primarily residential. The payer mix is reasonably diverse with the top 10 customers providing 10.5% of revenues in fiscal 2015.

FINANCIAL PERFORMANCE REMAINS STRONG

The district has maintained strong financial performance despite periods of economic stress and drought. All-in DSC averaged a strong 2.2x over the three fiscal years ended June 30, 2015. Free cash to depreciation averaged 93% over the period, providing funds to invest in the system after payment of both operating expenses and debt service. Coverage remained quite healthy at 2.1x in fiscal 2015, despite a 9% reduction in the volume of water sold. The district also benefits from an expense structure in which declining water purchases somewhat offset declining sales volumes. For instance, water sales revenues fell $3.6 million in fiscal 2015, while water purchases fell $1.6 million, offsetting about 45% of the revenue loss.

Water charges provided about half of total revenues in 2015 with sewer charges (26.5%), property taxes (10.4%) and connection fees (7.7%) adding a degree of diversity to the revenue mix. A fixed meter fee provides about a quarter of water revenues. Development-related connection fee revenues vary with economic cycles, creating relatively wide swings in overall financial performance, but underlying financial performance has remained strong across business cycles. DSC excluding connection fees averaged a solid 1.7x over the past three fiscal years.

Liquidity remains extraordinarily strong with significant capital reserves providing a healthy cushion to withstand periods of decreased development activity. The district had $186.4 million of unrestricted cash and investments available at the end of fiscal 2015, equivalent to a very strong 1,235 days of operating cash.

SOLID RATE DISCIPLINE

The district's board has a track record of solid rate discipline with underlying non-drought water rate increases averaging 6% over the five years through 2015 and sewer rate increases averaging a modest 0.9%. The board has also imposed additional drought rates to offset recent conservation. Underlying rates remain moderate at 1.8% of median household income under Fitch's affordability calculations, which assume water use of 7,500 gallons per month and considers combined bills of less than 2% of MHI to be affordable. Fitch's standard demand assumption is below actual water use in this arid area and does not include temporary drought surcharges, suggesting somewhat less rate flexibility. However, rate flexibility is judged to be adequate with rates comparing favorably to other Southern California retailers of imported water and no history of rate controversy.

SIGNIFICANT BUT DECLINING DEBT BURDEN

The district's main credit risk is an elevated debt burden of $229.6 million at the end of fiscal 2015. Debt was about 160% of the median for rated water and sewer systems at $3,000 per customer at the end of fiscal 2015. Debt-to-net plant assets was more typical at 39% as was debt-to-funds available for debt service at 6.9x.

EVMWD plans to pay down outstanding principal by about $53 million as it completes the current transaction, but the reduction is likely to be transitory with the district planning to borrow $137.3 million over the next five years to fund its growth-driven capital improvement plan. Debt is projected to rise to about $3,400 per customer in five years, as new issuance outpaces amortization. Debt amortization will be rapid after the current sale with 51% of principal paid down in 10 years and 100% in 20 years.

REGULATORY DROUGHT PRESSURES

The district's water supplies can be constrained during periods of prolonged and severe drought, and state regulatory action has required greater than expected conservation. EVMWD imports almost 60% of its water from the Metropolitan Water District of Southern California (Metropolitan; rated 'AA+' by Fitch) via the Western Municipal Water District (rated 'AA' by Fitch). Metropolitan procures water from the Sacramento-San Joaquin River Delta via the California State Water Project (SWP) and from the Colorado River. Both river systems have been affected by drought in recent years.

The California State Water Board has ordered the district to reduce water use 28% from 2013 levels. Recent regulatory changes are likely to reduce the conservation requirement closer to 24%. The utility appears well positioned to withstand the revenue pressures associated with either of the standards due to the district's drought rates, healthy revenue diversity and the ability to reduce water purchases.

CYCLICAL SERVICE AREA ECONOMY

The service area is currently growing at a solid pace, but the fast growing area is quite dependent on housing development. The economy has largely recovered from a deep recession during the housing downturn. The city of Lake Elsinore's unemployment rate was only moderately above average at 6.5% in December 2015 and has dropped to less than half its recessionary highs. Median household income remains solid at about 118% of the national level. While the economy was clearly hard hit by the recession, it appears to have reasonable long-term prospects due to the availability of developable land within commuting distance of major Southern California employment centers, a continuing comparative advantage in trade and logistics industries, and continuing population gains.

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
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000044
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94103
or
Secondary Analyst
Shannon Groff
Director
+1-415-732-5628
or
Committee Chairperson
Kathryn Masterson
Senior Director
+1-512-215-3730
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94103
or
Secondary Analyst
Shannon Groff
Director
+1-415-732-5628
or
Committee Chairperson
Kathryn Masterson
Senior Director
+1-512-215-3730
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com