AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A+' rating to the following Westlands Water District, CA (WWD or the district) bonds:
--Approximately $50.25 million refunding revenue bonds, series 2016A.
The bonds are scheduled to sell the week of Oct. 26, 2016 via negotiation. Proceeds, combined with $52 million in district cash, will be used to refund all of the district's series 2005A certificates of participation (COPs) and 2012A bonds and all of the series 2007A and 2008A COPs. The district will prepay a portion of its 2012A bonds from proceeds of land sales.
Fitch has also downgraded to 'A+' from 'AA-' the rating on the following district obligations:
--$96.5 million (pre-refunding) revenue COPs, series 2005A, 2007A, 2007B and 2008A;
--$10.8 million (pre-refunding) revenue COPs, series 2008A (bank bonds);
--$67.7 million (pre-refunding) revenue refunding bonds, series 2012A.
In addition, Fitch downgrades to 'A+' from 'AA-' the rating on the following San Luis & Delta Mendota Water Authority, CA (SLDMWA) bonds:
--$29.8 million refunding revenue bonds (Delta Habitat Conservation and Conveyance Project), series 2013A.
The Rating Outlook has been revised to Stable from Negative.
SECURITY
WWD CERTIFICATES AND BONDS: COPs and bonds are secured by a first lien pledge on net revenue of the district's water system.
SLDMWA REVENUE BONDS: The SLDMWA revenue bonds are secured by an unconditional contractual obligation from WWD, payable as an operating and maintenance expense of the district. Although there are multiple participants in the project, WWD provides a 100% guaranty of the full payment, including the amounts that are expected to be paid by the eight other participating water districts.
KEY RATING DRIVERS
DOWNGRADE ON CHALLENGES TO FUNDAMENTALS: The downgrade reflects Fitch's view that district operations face increased pressure over time. Despite improvements to the district's debt profile following this transaction and potentially lower leveraging related to a drainage settlement with the U.S. than previous estimates, the prospect of ongoing escalation in district charges coupled with probable declines in irrigated acreage heightens concentration risk and affordability concerns.
LARGE BUT CONCENTRATED SERVICE AREA: The district is the largest water district by acreage in the nation, encompassing 614,700 acres in Fresno and Kings Counties in the San Joaquin Valley, but serves a highly concentrated base of approximately 900 customers, most of which are agricultural. Concentration concerns are somewhat offset by the high value of crop production within the service territory (over $2 billion annually in 2015), which enhances economic viability.
WATER SUPPLY CONSTRAINTS: The district faces increasing supply risk. Despite ample water entitlements from the U.S. Bureau of Reclamation's (USBR) Central Valley Project (CVP), environmental rulings, application of state and federal laws, and drought have reduced deliveries of CVP water to de minimis levels in recent years and are expected to limit future deliveries. In addition, the district is facing heightened competition with other state-wide users for water resources.
CURRENTLY SOUND FINANCIAL POSITION: The district's financial position is generally stable following the adoption of fixed-rate land based charges in fiscal 2011. Debt service coverage (DSC) on senior lien debt has been 1.6x or higher since 2011. District cash balances have continued to climb, growing to over $100 million for fiscal 2016 (unaudited), up from just $40 million in fiscal 2010.
DEBT PROFILE IMPROVING: The current transaction and cash defeasance reduces the district's presently high debt levels considerably. However, debt levels may escalate over the medium term to address requirements of the proposed drainage settlement.
RATING SENSITIVITIES
CHALLENGES TO FISCAL PERFORMANCE: Westlands Water District's Stable Outlook reflects Fitch's expectation that anticipated resource and operational challenges are manageable. However, additional unanticipated challenges to the district's resource base and/or a weakening in district financial results from historical norms could lead to downward rating pressure.
RISING LEVERAGE: Material changes to the district's projected debt profile as a result of implementation of the proposed drainage settlement agreement or debt taken on by the district on behalf of other agencies, such as the San Luis & Delta Mendota Water Authority, would be viewed negatively.
CREDIT PROFILE
LARGE, UNIQUE IRRIGATION DISTRICT
The district is governed by a nine-member board of directors elected from district land owners and is responsible for district governance and policies. The district maintains full independent rate-setting authority as well as the ability to place a lien on property if water bills are unpaid. The district covers 614,700 acres in Fresno and Kings County on the west side of the San Joaquin Valley of which about 565,000 is irrigable. However, in 2016, the district estimates only 357,000 acres were being irrigated. It is the largest irrigation district in the U.S. by acreage and responsible for administering the delivery of water from the USBR CVP.
CONCENTRATION OF AGRICULTURAL CUSTOMERS
The district serves a small concentrated customer base comprised of approximately 700 connections for agricultural irrigation service and another 200 municipal and industrial connections. Irrigation water sales accounted for 80% of the district's operating revenues, land based charges 17% and municipal and industrial revenues accounted for just over 2% of operating revenues in fiscal 2015. Offsetting the ratepayer concentration risk somewhat is the high value of the cash crops farmed in the district (about $2 billion in calendar 2015).
DRAINAGE SETTLEMENT COULD PRESSURE DISTRICT
In September 2015 the district entered into a settlement with the U.S. to resolve decades of litigation surrounding the USBR's failure to provide contractually required drainage service within the district. The settlement, which has been signed by the U.S. and the district, still requires Congressional authorization. Fitch views favorably the provisions in the settlement providing for the district's receipt of a permanent water contract (albeit with a reduced delivery entitlement) and relief from $295 million (present value) in obligations to the U.S. However, Fitch is concerned with the additional responsibilities taken on by the district for drainage management and the related costs and liability that could be incurred.
Within a year of the settlement's authorization the district would be required to pay $185 million to compensate farmers in drainage affected parts of the district and permanently retire 100,000 acres of land (reducing the irrigable acreage by 17%). The district currently owns 92,500 acres of land and would look purchase or obtain non-irrigation covenants on the additional 7,500 acres. The district anticipates issuing debt to finance these initial settlement requirements. The series 2016A bond offering will reduce the district's overall debt burden (which includes its obligations related to the SLDMWA) by 29%, providing some future debt capacity for the planned financing.
District management of drainage within its boundaries could encompass a variety of options and implementation of the options is at the discretion of the district. Measures identified by the district to manage drainage include conservation, source control, land retirement and collection and reuse of shallow groundwater. Additional capital costs related to drainage management in the district have yet to be determined but could be substantial.
CONTINUED LOW CVP DELIVERIES INCREASES SUPPLY RISK
District water is purchased from the USBR's CVP and sold to users at prices designed to cover cost. CVP allocations have been minimal the last several years, with 0% CVP allocation in 2014 and 2015 and just 5% in 2016. When allocations are low the district is forced to purchase supplemental water on the open market which can be costly. In 2016-2017 the blended supplemental water costs have ranged from $750 per acre foot (AF) to $1,350 per AF compared to $133 per AF for CVP water in 2016 - 2017. With the exception of 2011, CVP allocations to the district have been less than 50% of the district's entitlement for a decade.
Reduced CVP allocations not only lead to higher costs related supplement water purchase, but also results in higher groundwater pumping. The documented safe yield for groundwater pumping in the district's basin is estimated at 225,000 AF, but there are no restrictions on groundwater pumping in years with low CVP allocations. Since CVP allocations have dropped, groundwater pumping by users within the district has averaged 650,000 AF for the last three years, well over the safe yield.
In 2014 the state passed groundwater management legislation. The district has filed notice of intent to be the groundwater sustainability agency for the Westside sub-basin (which includes all lands in the district). The state has set a deadline of 2020 for establishment of groundwater sustainability plans. It is unclear how the legislation will ultimately affect groundwater pumping within the district, but restrictions in groundwater pumping could lead to high costs as the district has to rely on costly supplemental water. It could also lead to the reduction of land used for farming in the district, increasing concentration concerns.
The district is seeking to mitigate some use of groundwater pumping by investing in projects involving aquifer storage and recovery, reuse of municipal and industrial wastewater and reuse of treated drainage water. Costs related to development of these projects are estimated at $10 million to $15 million over the next five years and will be funded from district revenues.
2015 FINANCIAL RESULTS BOOSTED BY LAND SALES
Financial results for fiscal 2015 were strong, boosted by $22 million in additional non-operating revenues from the sale of land. Senior lien and all-in DSC, including land sale proceeds were 3.6x and 2.6x, respectively. Without the land sale proceeds, DSC would have still been healthy at 2.1x and 1.7x, respectively. Unaudited results for fiscal 2016 point to continued healthy coverage of over 2x.
Management-provided forecasts are conservative in the assumption of 0% CVP allocations, with senior lien DSC of 1.4x to 1.6x for fiscals 2017 - 2020. Forecasts assume rates based on 0% CVP water allocations. The district budgets to achieve 1.35x DSC on senior lien debt and its rates are designed to cover the cost of water plus the operational expenses of the district.
CASH BALANCES USED TO PREPAY DEBT
District cash continued an upward trend in fiscal 2015. Cash balances registered $140 million in fiscal year 2015, up sharply from $40 million in fiscal year 2010. However, cash balances saw some decline for fiscal 2016 (unaudited) due to prepayment of debt. The district is also contributing over $50 million cash from land sales as part of this transaction to assist in the refunding and cash defeasance of outstanding debt.
SUPPORT OF CALIFORNIA FIX UNDETERMINED
The district's participation with SLDMWA consisted of initial support of planning and design work related to the Bay Delta Conservation Plan (BDCP), for which environmental impact studies were completed in 2013. The continuation of the BDCP is now referred to as the California Water Fix, a proposed conveyance system to increase reliability of water supplies through the Bay Delta. Public reports now estimate the district's share of future costs of the California Fix at $2.5 billion.
The district has not made a formal decision on whether to continue its participation in the California Fix and no decision is expected until a record of determination is finalized in early 2017. If the district were to continue to participate, they could do so directly, through the SLDMWA or through a joint powers agency. Depending on how they choose to participate would affect how costs are financed; either as operating and maintenance expense (like the current support of the SLDWA activity agreement with the series 2013 SLDMWA bonds) or as debt service payable from district net revenues on parity or subordinate to the series 2016A bonds. Significant further leverage by the district in support of the California Fix could apply downward pressure to the ratings.
COMPLEX RELATIONSHIP AMONG WATER USERS IN STATE
Water use in the state is generally divided into three sectors: 50% environmental, 40% agricultural and 10% urban. With increasing demands on water resources, particularly in situations like the recent California drought, there has and will likely continue to be increased competition over available resources. As the largest agricultural provider in the nation, the district is often heavily invested in discussions about water use in the state.
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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