SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has downgraded its rating on the following Marin Municipal Water District Financing Authority, CA (the authority) obligations issued on behalf of the Marin Municipal Water District, CA (the district) to 'AA' from 'AA+':
--$84.68 million subordinate lien water revenue and refunding bonds, series 2012.
The Rating Outlook is Stable.
The bonds are secured by installment payments to the authority from net revenues of the district after payment of senior obligations (senior lien is closed). Net revenues include connection fees.
KEY RATING DRIVERS
LOWER TARGETED COVERAGE; INCREASED LEVERAGE: The downgrade reflects lower than anticipated debt service coverage (DSC) in 2015 (1.2x as calculated by Fitch) and the district's revised rate strategy, which is expected to maintain coverage at a level more consistent with a 'AA' rating. In addition, already high debt levels will rise in the near term given additional anticipated borrowing and very slow amortization of current debt.
AFFLUENT CUSTOMER BASE: The district benefits from its location in the affluent, mature community of Marin County (implied GO rating 'AAA'/Stable Outlook), its primarily residential customer base, and its moderate rates relative to income.
ADEQUATE SUPPLY; LIMITED STORAGE: The district's water supply sources are adequate, with 75% of its supply generated by local sources and 25% purchased from Sonoma County Water Agency (SCWA; rated 'AA+'/Stable Outlook). However, storage is limited, a vulnerability exposed by increased water purchases related to the drought.
SOUND LIQUIDITY: Cash levels are sound at 281 days, though lower than rating category medians. Cash on hand should remain at the current level in the near term as capital requirements will largely be debt funded.
SIGNIFICANT ADDITIONAL LEVERAGE: Adoption of an updated capital investment plan by the Marin Municipal Water District that requires significant additional leverage over the next 10 year period, without offsetting credit strengths, could result in negative rating action.
ADEQUATE COVERAGE; LIQUIDITY: Achieving debt service coverage levels of 1.5x and maintaining sound cash balances are essential to maintaining the rating at the current level.
The district provides water to 185,000 residents over 147 square miles in southern and central Marin County. The district encompasses 80 square miles of watershed lands and operates three water treatment facilities and one recycling facility.
REDUCED COVERAGE AND TARGETS
Fitch calculated all-in fiscal 2015 DSC declined to just 1.2x, including $1.4 million in rate stabilization funds, well-below expectations, after several years above 2.0x. Fiscal 2015 revenues decreased 12.5%, due in part to reduced demand related to the state drought, while purchased water costs remained elevated due to reduced local supply.
For fiscal 2016, the district is meeting the mandatory conservation level required by the State Water Resources Control Board of 20% (as compared with the same period in 2013). It expects to use an additional $3.9 million in rate stabilization funds in fiscal 2016 to meet its rate covenant, leaving a balance of approximately $2 million. As such, fiscal 2016 DSC is forecast at 1.25x.
The district recently completed a rate study and adopted a rate-setting strategy targeting DSC of 1.5x. DSC falls to just 1.4x-1.5x as a result of about $120 million in additional debt contemplated in the study. However, management has indicated only about $50 million in borrowing is planned in the next two years with future debt levels subject to a current CIP update and planned rate study. DSC of 1.5x is notably lower than recent performance and previous forecasts. Projections show DSC of 1.6x-2.6x from fiscal 2017 to 2020 based on current debt service.
AFFLUENT CUSTOMER BASE
The district's location in affluent Marin County is a credit positive. It is essentially a built-out community in the San Francisco metropolitan area, located just north of the Golden Gate Bridge, within commuting distance to the city and benefiting from a sound job base of its own. The district's customer base is primarily residential and its top 10 customers represent less than 5% of total revenues.
AFFORDABLE RATES DESPITE SIZEABLE RECENT HIKES
Effective Jan. 1, 2016, the district implemented a 50% increase to its bimonthly base service charge, added a watershed management fee of $8.45, and increased the tier 1 consumption rate by 1.9%. As a result, total single-family residential rates increased 21.7% to $58.60 for 7,500 gallons of usage per month. This is equal to an affordable at 0.7% of median household income. The monthly bill will rise by an additional 4% in July 2016. The district expects to seek approval for subsequent annual 7% adjustments, subject to another rate study to be undertaken in conjunction with near term borrowing.
Given the relative affordability of current rates, the district likely retains some rate flexibility. However, the district's rate history has been mixed. Rates were held flat over fiscals 2013-2015 versus expectations of annual increases ranging from 3.5% to 6.5%. Previous adjustments included 11.5% in 2010, 4% in 2011, and 6% in 2012.
Cash levels increased over the past five years to $41.8 million, or 281 days, at fiscal 2015 year-end. Prior levels have varied from a high of $45.3 million, equal to 523 days in 2007 to just 67 days in 2010. Capital spending on repair and replacement projects on a pay-as-you-go basis continued during the recession and resultant period of lower water sales. Free cash to depreciation has declined in the past two years to 85% and 14% in fiscals 2014 and 2015, respectively, indicating the district is not generating sufficient cash to cover ongoing maintenance needs.
ADEQUATE WATER SUPPLY
The water system obtains 75% of its water supply from rainfall stored in seven reservoirs with a storage capacity of 79,566 acre-feet (af), equal to two years of demand. The remaining 25% of supply is imported from the Russian River through a contract with the SCWA. The district takes the water through the North Marin Water District's aqueduct pursuant to a long-term contract. Reservoir levels as of mid-March 2016 were at 100% of capacity.
The SCWA contract provides for purchase of up to 14,300 af per year, although, due to pipeline constraints, the deliveries have been limited to 8,500 af. The five-year average of purchases is 6,479 af. However, due to the ongoing drought, the district increased water purchases to 8,236 af and 7,000 af in fiscals 2014 and 2015, respectively.
ELEVATED DEBT TO INCREASE
Debt levels are currently higher than category medians, and are expected to rise. The fiscal 2016-2020 CIP totals $146 million not including projects contingent upon grants or funded with fire flow fees. This is an increase from the last CIP totaling $89 million from fiscals 2014-2018. The district currently has approximately $123 million principal outstanding and anticipates issuing up to an additional $50 million in the next two years. The new borrowing will fund a large storage tank project and seismic upgrades to two treatment plants, among other projects. The district is currently updating its CIP and expects additional borrowing amounts to be identified. Amortization of current debt is very slow with only 48% of principal retired within 20 years.
The series 2012A were issued on subordinate lien to the remaining 2004 certificates of obligation ($1.9 million) and 2010 series A bonds ($31.85 million). The senior lien is closed with no further issuance allowed, including refunding bonds, and rate covenants apply to both senior and subordinate. The series 2012A does not have a debt service reserve, and existing Ambac sureties and cash continue to satisfy the reserve account requirement of the senior lien. Covenants include a 1.25x rate covenant and 1.25x additional bonds test on a projected basis looking out five years.
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.
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
Dodd-Frank Rating Information Disclosure Form