Fitch Rates San Diego County Water Authority, CA's Sr/Sub Water Revs 'AA+'/'AA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has assigned the following ratings to bonds issued by the San Diego County Water Authority, CA (SDCWA or the authority):

--Approximately $115 million water revenue refunding bonds series 2016A (Green Bonds) 'AA+';

--Approximately $185 million water revenue refunding bonds, series 2016B 'AA+';

--Approximately $86.6 million subordinate lien water revenue refunding bonds, series 2016S-1 'AA'.

Proceeds of the 2016A and 2016B bonds will advance-refund a portion of outstanding series 2008A and 2010A bonds for interest savings. Proceeds of the series 2016S-1 bonds will refund certain outstanding commercial paper notes. The bonds are expected to price the week of June 6, 2016 via negotiation.

In addition, Fitch affirms the following outstanding ratings (pre-refunding):

--$424.2 million outstanding water revenue certificates of participation (COPs), series 1998A, 2005A, and 2008A at 'AA+';

--$564.2 million water revenue bonds, series 2010A and series 2010B (taxable) issued by the San Diego County Water Authority Financing Agency (the agency) on behalf of the authority at 'AA+';

--$690 million water revenue bonds, series 2011A, 2011B, 2013A and 2015A at 'AA+';

--$86.6 million subordinate lien water revenue refunding bonds, series 2011S-1 at 'AA';

--$50 million extendable commercial paper (ECP) notes at 'F1+'.

The Rating Outlook on all bonds and COPs is Stable.

SECURITY

The water revenue bonds and COPs are payable from the authority's water system net revenues. The series 2016S-1 bonds are on parity with the series 2011S-1 bonds and ECP notes, and have a subordinate lien on net revenues.

KEY RATING DRIVERS

PRUDENT AND STABLE FINANCIAL MANAGEMENT: The authority adheres to prudent financial management practices and engages in comprehensive long-term planning aimed at securing a diverse and reliable future water supply.

BROAD SERVICE AREA: The authority provides wholesale water service to 24 member agencies across a large service area in San Diego County (the county).

WATER SUPPLY DIVERSITY: Water supplies have been diversified as a result of significant capital investments made in the last two decades, improving water supply reliability and drought-resiliency.

MEMBER SUPPORT FOR RATES: Fitch anticipates that continued member support for costs associated with supply diversification will facilitate rate increases to preserve financial margins at consistent levels.

HIGH DEBT: Capital spending has been substantial in recent years, primarily funded by debt. As a result, the authority's debt levels are high and amortization slow.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: Pressure on San Diego County Water Authority's financial margins could occur if water sales fall below already low forecasted levels in fiscals 2016 and beyond. The authority plans to use reserves in its rate stabilization fund to offset lower water revenues and rising costs in fiscals 2017-2018 but reserves are expected to remain healthy and above internal minimum targets.

CREDIT PROFILE

SDCWA provides wholesale water service to an estimated population of 3.1 million, or almost all of San Diego County (Fitch Issuer Default Rating of 'AAA'). SDCWA sells water to 24 member agencies that provide retail service to the region. The customer base has been stable. However, water sales have fluctuated significantly, consistent with other regional utilities, as a result of the mandatory curtailments related to the drought, ongoing conservation programs, economic recession and variable weather conditions.

WATER SUPPLY AVAILABILITY AND THE CALIFORNIA DROUGHT

Over the past two decades, SDCWA has pursued water supply investment and diversification. Following the drought in California in the late 1980s, SDCWA's governing board laid out a plan to improve water supply diversification and reduce risk related to a sole supplier (at the time Metropolitan Water District of Southern California [Metropolitan] accounted for 95% of SDCWA's water supply). As a result, SDCWA now has water supply sources that include purchases of Colorado River water from Imperial Irrigation District, recycled water and conservation programs, increased local storage capacity and desalination. Significant investments in supply diversification have allowed SDCWA to continue to meet water demands in its service area during the current drought.

However, given the extreme severity of the drought state-wide, California's governor issued an executive order calling for an emergency regulation in May 2015. The order mandated individual conservation standards ranging from 4% to 36% for all retail utilities, including for authority members. Savings by authority members have averaged 21% from June 2015-March 2016 and are expected to lead to a 16% overall reduction in SDCWA water sales for fiscal 2016.

With drought conditions easing in the state in recent months, the state recently adopted an emergency regulation on May 18, 2016 that replaced the specific state-wide water conservation requirements with one based on local supply conditions. The new regulation requires local water agencies to demonstrate the ability to meet an additional three dry years consistent with 2012-2015 or implement conservation standards sufficient to meet the shortfall differential. Based on the new regulations and the amount of local supplies in the region, SDCWA anticipates little if any additional conservation from its members will be necessary, although the authority projects that water sales for fiscals 2017-2020 will see little increase year-over-year and will remain below fiscal 2012 levels.

Strong available balances of $115.4 million (fiscal 2015) in the rate stabilization fund (RSF) should allow SDCWA to mitigate any drought-related pressures and keep rate increases manageable over the next few years. The authority currently forecasts using a moderate $37 million in RSF draws in fiscals 2017-2018 and then gradually adding back to reserves in the last two years of the forecast. The overall proposed treated water rate increase for calendar 2017 is 5.9%, with future expectations through 2020 generally in the same range under a 'high-rate' scenario. Water sales could exceed SDCWA's conservative estimates, which would reduce the need to rely on RSF transfers and/or temper forecasted rate adjustments.

CARLSBAD DESALINATION PROJECT

The Carlsbad Desalination Project (the project) became commercially operational in December 2015. SDCWA is required to purchase 48,000 acre-feet (af) annually from the project, which will provide around 10% of the authority's total water supply. The cost of the project water, estimated at around $2,300 per af, is significantly higher than water purchased from SDCWA's wholesale provider - Metropolitan (revenue bonds rated 'AA+') - whose current tier 1 treated water rates are $942 per af. However, SDCWA views the regulatory and hydrological uncertainty of Metropolitan's imported supply as providing a high risk to its customers. The authority also expects Metropolitan charges will become more in line with project water costs over time.

LARGE CAPITAL INVESTMENTS AND DEBT

The authority invested a significant $2 billion in capital over the past decade. As a result of the investment, debt levels are high at 71% debt-to-net plant and roughly $700 per capita. However, debt levels are comparable to other utilities in the region where water supply investments are capital intensive and considerable investments have been made in recent years. Debt levels have also been trending downward as the authority transitions to an asset maintenance mode from constructing new facilities. Debt issuance over the next five years is expected to be relatively modest (around $50 million to $100 million) to fund a portion of the much more manageable $393 million five-year capital improvement plan.

FINANCIAL MARGINS EXPECTED TO REMAIN HEALTHY

Financial performance in fiscal 2015 was strong as reduced water purchases offset a 5% decline in sales from the prior year. Senior debt service coverage was 1.73x from all revenues, or around 1.5x after $28.5 million in revenues was transferred to the RSF. Fitch's coverage calculations include the authority's share of the county's 1% property tax receipts as revenues along with the authority's fixed charges received through the infrastructure access charge and water standby availability charge.

Senior coverage in fiscal 2016 is expected to be favorable as well (around 1.55x) despite a 16% decline in sales for the year. The solid performance is expected to allow the authority to deposit an additional $6 million in the RSF and still meet its 1.5x senior lien coverage target.

Cash reserves are healthy, with operating reserves and rate stabilization funds providing $123.6 million or 99 days cash on hand at the end of fiscal 2015, up from $109.6 million at the end of fiscal 2014. This level of core reserves is considered adequate for the authority's wholesale agency risk profile. The authority also maintained another $103 million in reserves at the end of fiscal 2015 related to equipment replacement and water purchases to fill San Vicente Reservoir over the next couple of years. Including these additional balances, days cash was a solid 181 days.

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

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

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005099

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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
Doug Scott
Managing Director
+1-512-215-3725
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Shannon Groff
Director
+1-415-732-5628
or
Tertiary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
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
Doug Scott
Managing Director
+1-512-215-3725
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Shannon Groff
Director
+1-415-732-5628
or
Tertiary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com