Fitch Affirms Oro Valley, AZ's Water Revs at 'AA-'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings affirms the following rating on the town of Oro Valley (the town) bonds:

--$13.5 million senior lien water project revenue refunding bonds, series 2012 at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a first lien on the net revenues of the town's water system (the system), including connection and development impact fees.

KEY RATING DRIVERS

ROBUST LIQUIDITY, ADEQUATE COVERAGE: The financial position of the water system includes strong liquidity and sound all-in debt service coverage (DSC); however, the system shows some reliance on connection fee revenue to generate satisfactory coverage levels.

ELEVATED BUT DECLINING DEBT BURDEN: The system's debt load is elevated with key debt ratios significantly weaker than the 'AA' category median, but debt amortizes rapidly providing future debt capacity.

AMPLE WATER SUPPLY: The system has ample long-term water supply from the state's Central Arizona Project (CAP) water allocations and direct access to 2,000 acre feet (af) of its 10,305 af allotment via an agreement with the city of Tucson. The town also utilizes groundwater and reclaimed water sources.

RATE FLEXIBILITY REMAINS: Rates are slightly higher than surrounding area providers, but the town maintains sufficient rate flexibility relative to Fitch's affordability benchmark and has demonstrated a willingness to raise rates as necessary.

FAVORABLE ECONOMIC PROFILE: The town participates in the larger Tucson area economy. Resident wealth levels are above average and area unemployment is also below state and national averages.

RATING SENSITIVITIES

DECLINE IN CONNECTION FEE REVENUE: The rating on the Oro, AZ water revenue bonds is sensitive to shifts in connection fee revenue. A significant reduction in connection fee revenue, without offsetting increases in user charges, could negatively affect the system's financial profile and therefore pressure the rating.

CREDIT PROFILE

The system provides potable water to approximately 19,300 customers, primarily residential, within the town limits as well as a small number of customers within the unincorporated area of Pima County. The town (rated 'AA-', Stable Outlook) is located six miles north of Tucson in southern Arizona. Population has grown from 581 persons in 1970 to over 42,000 in 2014. Build-out is estimated to be in 2040 with a population of approximately 55,000.

SUFFICIENT WATER SUPPLY - UPDATES TO LONG-TERM WATER ACCESS PLAN

The town's water supply is obtained from groundwater wells, reclaimed water and direct access to 2,000 acre feet (af) of its CAP water allocation. CAP water is an essential component of the state's water supply developed in order to preserve groundwater supply. The town's total allocation of CAP water is 10,305 af, which it accesses via recharge and underground storage credits. System demand for potable and reclaimed water in 2015 was the lowest in 10 years at just 2,866 million gallons or the equivalent of 8,795 af, comfortably under the town's CAP allotment.

Direct access to CAP water is achieved via a five-year intergovernmental agreement with the city of Tucson, which started in 2012. The agreement with Tucson allows for the town to take up to 4,000 af of water. The CIP includes plans to access an additional 1,500 af of CAP water within their service area at a costs of about $13 million under their existing agreement with Tucson. The project, which is dependent on area demand needs, would be financed through development impact fees and is slated to come on line around fiscal 2023. This is a departure from prior plans that indicated full access to all 10,305 af of the town's allotment at a much higher cost of $76 million. The town will consider increasing the amount of water it accesses from Tucson in 2017 when the agreement is up for a five year extension. Water deliveries from Tucson in 2015 totaled 1,992 af at a cost of $995,600.

The town has seen a steady decrease in potable and reclaimed water sales since 2005, despite growth in system connections. This decline in consumption has allowed the town to defer plans for direct access to CAP water. Nevertheless, the town continues to explore low-cost alternatives and partnerships to access CAP water.

SOUND COVERAGE

Financial performance has been sound, with some DSC volatility due to fluctuations in connection fee revenue. Audited results for fiscal 2015 show DSC on an all-in basis is adequate for the rating level at 1.5x but weakens to 1.2x when connection fee revenue are excluded. This is down considerably from the prior fiscal year when DSC registered at with and without connection revenues registered at 2.5x and 1.8x, respectively. Connection fee revenue comprised 24% of operating revenues in fiscal 2014, but that was cut in half the following fiscal year. The fiscal 2014 growth in connection fee revenue related to several commercial/retail and multifamily developments being completed.

The all-in DSC calculation accounts for all system related debt, including parity state loans as well as a portion of several of the town's excise tax bonds which are paid by the system on a subordinate basis. Management projections appear reasonable based on recent permit and demand data. The forecast through fiscal 2020 points to a softening of all-in DSC coverage with levels ranging from 1.2x to 1.4x through fiscal 2020. Forecasts take into consideration growing costs related to accessing additional CAP water and fees paid to Tucson for wheeling CAP water to the town. Historically the system's actual performance has been stronger than forecasts due to conservative budgeting and tight expenditure control.

AMPLE CASH PROFILE

System liquidity remains strong. Liquidity balances, which include connection and development impact fees revenues, average almost 900 days of cash on hand (DCOH) since 2011. Unrestricted cash from rate revenue alone is also very healthy at about $10 million for fiscal 2015, or the equivalent of 441 days of cash on hand.

RATE FLEXIBILITY REMAINS

Historically strong financial results have been driven by a series of moderate rate hikes in recent years coupled with cost cutting measures. Water rates are currently affordable at 0.7% of median household income (MHI, based water consumption of 7,500 gallons), below Fitch's 1% MHI affordability threshold. Rates are reviewed on an annual basis and management is forecasting very small rate increases of about 1% to 2.2% annually through fiscal 2020.

DECLINING DEBT LEVELS

Over the last several years the town has refunded for savings two outstanding bonds issuances. These refundings, coupled with the rapid amortization of outstanding debt, provide additional debt capacity for future CAP related projects if demand were to require them. System debt levels for fiscal 2015 equal $2,391 on a per customer and $1,082 on a per capita basis. These levels are above the 'AA' category medians of $2,050 per customer and $577 per capita.

MANAGEABLE CAPITAL PLAN

Current capital improvement plans (CIP) though fiscal 2020 are a reasonable at $20 million, a decline of about 20% from prior plans. The town anticipates using cash reserves, a $4.5 million debt issuance and existing state revolving loan proceeds to finance the CIP. Future debt that had been anticipated to finance CAP related project has been scaled back considerably, relieving Fitch's concerns about additional leveraging. Current debt ratios levels remain weak compared to Fitch's 'AA' median but should align more closely to median levels in five years.

STABLE ECONOMIC BASE

The local economy is composed of the hotel/motel, retail trade, and government sectors, and is part of the larger Tucson area economy, which is anchored by higher education, defense, and high-tech employment. Town unemployment of 4.6% for December 2015 is favorable compared to the metropolitan area (5%), state (5.5%) and national averages (4.8%). Wealth levels remain high registering at 49% and 39% above the state and national average, 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=1001548

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1001548

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Teri Wenck, CPA
Director
+1-512-215-3742
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Gabriela Gutierrez, CPA
Director
+1-512-215-3739
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Teri Wenck, CPA
Director
+1-512-215-3742
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Gabriela Gutierrez, CPA
Director
+1-512-215-3739
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com