Correction: Fitch Rates Los Angeles County Sanitation Dist. No. 20, CA's Revs 'AA-'; Outlook Stable

SAN FRANCISCO--()--(This is a correction of a release originally published Oct. 4, 2016. It corrects the period for which rates have been approved, the use of proceeds and description of DSC.)

Fitch Ratings has assigned a 'AA-' rating to the following Los Angeles County Sanitation District's (LACSD) Financing Authority (District No. 20), California sewer revenue bonds:

--Approximately $162.8 million subordinate lien revenue refunding bonds series 2016A.

The proceeds will be used to refund outstanding subordinate lien debt, including revenue bonds and possibly state revolving fund loans, and to pay costs of issuance. The bonds are scheduled to sell via negotiation the week of Oct. 10.

In addition, Fitch has affirmed the following ratings:

--$151.6 million subordinate revenue bonds series 2005A and 2007A at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are backed by a subordinate lien of net wastewater revenues (including connection fees) within LACSD's District No. 20 (the district).

KEY RATING DRIVERS

ADEQUATE FINANCIAL PERFORMANCE: Debt service coverage (DSC) is narrow but adequate for the rating level given extraordinarily stable revenues and strong liquidity. Revenues are dominated by flat per household residential service charges collected on property tax bills, making them very predictable. Capital needs are limited, suggesting little need for excess revenues.

DISCIPLINED RATE SETTING: The district's board approved a series of large rate increases to provide adequate financial coverage as the district invested heavily to improve and expand treatment capacity. Rates have been approved through fiscal 2019, and approved rates should gradually provide a wider coverage cushion over the next five years.

STRONG, CENTRALIZED MANAGEMENT: The district is managed by LACSD's centralized staff, which oversees 24 sewer agencies providing services to more than 5 million Los Angeles County residents, giving the district access to significant financial and operational management expertise.

VERY HIGH DEBT BURDEN: The debt burden is very high but likely to slowly decrease with incremental principal amortization. The district has no further debt issuance plans and minimal capital needs after its recent treatment plant upgrades.

ESSENTIAL SERVICE PROVIDER: The district provides essential wholesale wastewater treatment services to a sizeable service area that covers most of the city of Palmdale in northern Los Angeles County. Defense and aerospace industries dominate local economic activity. Unemployment and poverty rates trend higher than the national average.

RATING SENSITIVITIES

COVERAGE WEAKNESS: The rating could come under downward pressure if the Los Angeles County Sanitation District No. 20's debt service coverage does not improve as expected or liquidity falls to more typical levels.

DEBT PRECLUDES UPGRADE: The rating is unlikely to move higher due to very high debt levels.

CREDIT PROFILE

The district serves a 41-square mile residential, commercial and industrial customer base centered on the city of Palmdale in the Antelope Valley. The service area is somewhat weak economically. The non-seasonally adjusted unemployment rate remained elevated at 7.1% in August 2016. The individual poverty rate is also above the national average at 17.8% in 2015. Median household income is 92% of the national level and 82% of the state median. The region's major employers are related to the defense and aerospace industries, including Edwards Air Force Base, the China Lake Naval Air Weapons Station, Lockheed Martin, the Mojave Air & Spaceport, and Northrup Grumman.

The district owns the area's sewage treatment plant and 45 miles of sewer trunk lines; local governments own the network of smaller collector sewers. The district has recently completed a major sewerage treatment plant upgrade that will provide a very high level of treatment and provide adequate capacity for growth. The customer base is diverse in terms of payers with residential customers accounting for more than 80% of sewerage flows. Concentration is low with the top 10 customers providing about 6% of operating revenues.

WEAK COVERAGE TO IMPROVE

The district is just growing into the debt service burden incurred to upgrade its treatment plant. All-in DSC excluding rate stabilization fund (RSF) transfers rose to 1.2x in fiscal 2015 and held at that level in 2016 (unaudited results). The district used one year of RSF transfers to deliver coverage of 1.1x as it built up to full debt service on the bonds in 2014. Fitch expects coverage excluding RSF transfers to rise to solidly above 1.25x over the next five years, as debt service falls with the current refunding and the utility continues to impose small rate increases in most years.

The district's conservative financial forecast shows coverage rising gradually to 1.3x across the 2017-2021 forecast horizon, and Fitch expects the utility to outperform the forecast somewhat. The forecast assumes connection fee revenues remain near recessionary lows at about a quarter of the average over the past five years. Property taxes are assumed to come in below recent experience, and the forecast does not assume new revenues from recycled water sales that are likely to begin in the next few years.

The rating could come under downward pressure if the utility fails to raise coverage to over 1.25x. However, Fitch views significant improvement in coverage above 1.25x as unnecessary given the stability of district revenues (primarily based on fixed per household sewer fees) and minimal additional capital spending needs following the recent rebuilding of the district's primary assets.

The district's liquidity position is very strong with unrestricted cash and investments above the 'AA' median at 496 days as of June 30, 2015. Ample reserves allow a period of lean coverage as the utility grows into its debt service.

SOLID RATE DISCIPLINE

The district has raised rates in a disciplined manner to prepare for increased debt service for the new treatment plant, and the rates necessary to improve coverage to a more comfortable range have already been approved by the district's board. Rates have more than doubled in recent years, and they are slightly above average at about 1% of median household income in fiscal 2015. Sewer fees are collected on local property tax bills, providing a high degree of compliance. Rate increases have been formally approved through fiscal 2019. Debt service savings from the current transactions will reduce expenditures and allow a more gradual increase in rates, and the district's financial forecast assumes the approved rates will be sufficient through 2021.

ELEVATED DEBT BURDEN

The debt burden related to the recent treatment plant improvements has pushed debt ratios to a very high level. Debt per customer was twice the median for 'AA' rated water and sewer utilities at $4,857 at the end of fiscal 2015, the last audited fiscal year. Debt to net plant assets is also very high at more than 88%. While debt levels weigh on the rating, the utility is well placed within its capital cycle. Recent capital improvements provide a solid basis for future operations and growth, and the district has implemented adequate rate increases to afford the new debt service. Completion of the treatment plant upgrades leaves the district with very manageable future capital needs and no further debt issuance plans. Average age of plant is extremely low at five years. The new plant treats wastewater to tertiary standards, allowing effluent to be used for irrigation purposes and reducing prior concerns about regulatory compliance.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/site/re/869223

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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012703

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012703

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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
Alan Gibson
Director
+1-415-732-7577
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
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
Alan Gibson
Director
+1-415-732-7577
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com