Fitch Affirms Sonoma County Water Agency, CA's Revs at 'AA+'; Outlook Stable
SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA+' rating for the following Sonoma County Water Agency, California debt:
--$21.5 million water transmission system revenue bond.
The Rating Outlook is Stable.
The bonds are secured by net revenues of the agency's water transmission system. Net revenues exclude property taxes, various capital cost payments from wholesale customers, Russian River Project funds and Marin Municipal Water District payments for firm water supply.
KEY RATING DRIVERS
STRONG SERVICE AREA: The utility is a wholesale provider of essential water services to a large, diverse and economically healthy service area with limited alternative supply options.
SOUND FINANCIAL PERFORMANCE: Debt service coverage (DSC) averaged a very strong 3.9x over the three fiscal years ended June 30, 2013. Liquidity is strong with 514 days cash on hand at the end of 2013.
LOW DEBT BURDEN: The debt burden is very low and expected to remain low even with the issuance of as much as $27 million of additional debt over the next five years.
ADEQUATE SUPPLIES, DROUGHT RESILIENCE: The agency has significant supply redundancy and stored water reserves, allowing it to avoid rationing in all but severe droughts. It has thus far avoided mandatory cutbacks in the current severe California drought but would probably have to ration supplies if the drought continued through 2015.
SOLID MANAGEMENT, RATE DISCIPLINE: Management is professional and experienced. Elected officials have shown solid rate discipline. Financial, water supply and capital planning are conservative and thorough.
LIQUIDITY, DEBT BURDEN KEY: The rating is sensitive to shifts in fundamental credit factors, particularly the district's debt burden and its liquidity position. The rating would come under downward pressure if the district drew reserves down significantly and/or regulatory concerns forced a major increase in the debt burden.
PRESSURE FROM STATEWIDE DROUGHT: The current drought could put downward pressure on the rating if water sales and financial margins fell below expectations due to severe, multi-year water rationing.
The Sonoma County Water Agency is a component unit of Sonoma County (implied general obligation (GO) rating of 'AA+' with a Stable Outlook) and the local sponsor of the U.S. Army Corps of Engineers' Russian River Project. The agency sells project water primarily to eight prime contractors - the cities of Santa Rosa, Petaluma, Sonoma, Rohnert Park (implied GO rating of 'AA-' with a Negative Outlook), Cotati, the Town of Windsor, the Valley of the Moon Water District, and the North Marin Water District - and the Marin Municipal Water District (water revenue bonds rated 'AA+' with a Stable Outlook by Fitch).
SOUND FINANCIAL PERFORMANCE
Financial performance has been consistently sound and jumped to very strong levels over the past few years as an improving economy and dry weather boosted sales. DSC jumped to 5.6x in 2013 from 3.9x. Free cash-to-depreciation has averaged a solid 140% over the past three years. The utility's revenues and overall financial performance vary with weather, supply and economic conditions because its rate structure is almost entirely volumetric, exposing it to significant revenue volatility.
Recent years have been particularly strong but the utility also experiences periods with fairly narrow coverage during droughts and recessions. The utility budgets to meet a coverage target of at least 1.5x, typically beating the target by a healthy margin except during droughts and recessions. Such volatility is not a major credit concern because the district has quickly adjusted rates to rebuild financial performance during periods of weak demand and maintains solid reserves to offset short-term revenue misses.
Liquidity has been consistently strong with unrestricted cash and investments averaging about 450 days of operating cash over the past five years. Cash rose to a particularly strong $34.5 million in 2013, equaling 514 days cash. The district's reserve policies require it to maintain at least 3 months of operating cash in the water transmission fund, and the utility has regularly beaten that low benchmark. Fitch expects the district to maintain a robust cash position, a key mitigant to revenue volatility. Sustained liquidity at the low policy level would put downward pressure on the rating.
Pledged revenues exclude various sub-charges to wholesale customers for capital and other costs. The district therefore excludes associated expenditures, historically greater than sub-charges, from coverage calculations. Fitch considers coverage on an all-in basis as the true cost of operations. Nonetheless, the agency does have substantial flexibility to delay or defer the spending on the projects funded by the sub-charges in any given year.
GOOD RATE DISCIPLINE; REVENUE REQUIREMENT BUDGETING
The agency has raised rates as needed to maintain solid financial performance. Conservative budgets are built around reasonable demand assumptions that generally assure results that beat the agency financial targets. The district raised rates for water delivered through its Santa Rosa Aqueduct by an average of 5.3% annually over the five years that ends with fiscal 2015. Rates are built around a revenue requirement specified in the district's 2006 Restructured Water Supply Agreement with contractors, which expires in 2040.
The contract unconditionally obligates contractors to pay agency costs regardless of water deliveries. In addition, it provides that a failure to pay by one or more customers would have to be covered by the others. In practice, the agency sets its budget annually with water rates based on the revenue requirement and expected demand (dividing the revenue requirement by the lower of the average demand over the prior three years, the prior year's deliveries or requested deliveries).
The formula is a credit strength because it has generally led to customer and elected policymaker consensus around rates. It also provides revenues comfortably above the revenue requirement during typical periods of gradually rising water demand. The formula yields manageable, transitory revenue misses in periods of declining demand such as 2009 when a combination of drought and recession reduced deliveries sharply.
The supply agreement allows the district to quickly recoup lost revenues, while forcing demand assumptions lower and rates higher in subsequent years. The agency's revenue requirement and fiscal 2015 rates were built around requested deliveries that are 20% below estimated fiscal 2014 deliveries. This conservative approach suggests the agency will be able to meet financial targets even with a 20% drop in demand.
SOLID SUPPLY POSITION TESTED BY DROUGHT
The agency's supply position is solid with adequate storage capacity in Lake Sonoma and Mendocino (the two main Russian River Project reservoirs) allowing the district to avoid rationing in all but the worst droughts. The agency's combined water rights total 75,000 acre-feet (AF) per year, compared to 2013 demand of 54,247 AF. The agency believes capacity is sufficient through at least 2027. The district uses its 367,500-AF of storage rights in the two federal reservoirs to offset the supply fluctuations inherent in its surface water dependence in a region with extremely variable rainfall.
Agency supplies have thus far been adequate to avoid mandatory rationing in the current severe California drought. However, the agency recently asked customers to voluntarily cut use by 20% and could impose mandatory rationing if the drought remains severe in 2015. The agency currently has about 178,000 AF (72.6% of capacity or more than three times 2013 water use) stored in Lake Sonoma, its main reservoir. Mandatory 30% supply cutbacks would go into effect if the level of storage fell below 100,000 AF before July of a given year, which Fitch does not expect in 2014 or 2015.
LOW DEBT LEVELS, MANAGEABLE CAPITAL PLANS
The agency's debt burden is expected to remain low over the next five years. The district currently has $30.8 million of debt outstanding, including the rated bonds and parity state revolving fund loans. Per capita debt is very low at just $62, about a quarter of the median for 'AAA' rated water and sewer systems. Debt is also extraordinarily low at 26% of net plant assets and just 1.0x equity (unrestricted net assets). The debt portfolio is uncomplicated with only fixed-rate, fully amortizing obligations outstanding. Amortization is rapid with 58% of debt repaid in 10 years and 96% repaid in 20.
Debt will remain very low even with a planned $27 million of borrowing in fiscal 2016 to fund about a third of the agency's $79.5 million five-year capital improvement plan. The borrowing would increase the debt burden to just $111 per capita.
The agency's manageable current capital needs focus on environmental regulatory compliance, earthquake hazard mitigation and improvements to its south transmission pipeline. The biggest capital needs relate to compliance with a biological opinion issued by the National Marine Fisheries Service in 2008 governing operations on the Russian River related to fish protection measures. The agency could face significant additional capital demands if current work to fish that spawn in the watershed fails to meet regulatory goals. The current rating could come under downward pressure if the agency were forced to make capital improvements that pushed the district's debt burden significantly above average.
STRONG SERVICE AREA
The service area is very strong economically with high incomes and very low unemployment rates. The agency and its contractors provide water to the most heavily populated areas of central and southern Sonoma County and Marin County (implied GO rated 'AAA' with a Stable Outlook). Median household income is solid at about 120% of the national level in Sonoma County (the core of the service area) and very strong at 170% of the national average in Marin County. The unemployment rate was well below the national average at 5.3% in Sonoma in April 2014 and 3.9% in Marin.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was informed by information from CreditScope and IHS Global Insights.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 3, 2013);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013);
--' 2014 Water and Sewer Medians'(Dec. 12, 2013);
--'2014 Outlook: Water and Sewer Sector'(Dec. 12, 2013).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
2014 Water and Sewer Medians
2014 Outlook: Water and Sewer Sector