Fitch Rates Rancho California Water Dist Fin Auth, CA's Rev Bonds 'AA+'; Outlook to Positive
--$114.76 million revenue bonds, series 2016A, refunding revenue bonds, series 2016B, and refunding revenue bonds, series 2016C (taxable).
Proceeds of series 2016A will fund various capital improvements to the district's water delivery facilities. Proceeds of series 2016B and 2016C will be used to advance refund a portion of the outstanding principal amount of the refunding revenue bonds, series 2002A and series 2008A.
In addition, Fitch has affirmed the ratings on the following outstanding obligations issued on behalf of the district at 'AA+':
--$185 million revenue bonds, series 2002A, 2005C, 2008A, 2010A, and 2011A;
--$44.6 million revenue bonds, series 2008B (variable rate) underlying long-term rating and bank bond rating.
The Rating Outlook has been revised to Positive from Stable.
The bonds are issued by the authority and are payable from installment payments made by the district from net revenues of the water and sewer system (the system), including ad valorem taxes and assessments. The district's obligation to make installment payments is absolute and unconditional as governed by the installment purchase agreement between the district and the authority. The series 2016A, 2016B, and 2016C and 2010A and 2011A bonds do not have debt service reserve funds.
KEY RATING DRIVERS
IMPROVEMENT IN FORECAST COVERAGE: Debt service coverage (DSC) is expected to increase to a minimum of 2.7x over the next five years due to in part to the defeasance of nearly $60 million in debt related to the wastewater treatment plant (WWTP).
FAVORABLE FIXED REVENUE STRUCTURE: The district receives significant revenues from property taxes and assessments, collected by the Riverside County tax collector, which equal about 2x the district's fixed debt service costs. In addition, the district's overall rate structure is weighted toward fixed charges that amount to more than 70% of a total monthly water customer bill and provide a high degree of revenue stability.
ABOVE AVERAGE DEBT: Debt metrics on a per customer and per capita basis are high due in part to the district's large agricultural presence. Amortization of principal is slow, but debt is expected to decline over time given lack of additional borrowing plans.
EXCEPTIONALLY STRONG RESERVES: The district's liquidity position remains very strong, with cash levels including the board designated funds totaling over 1,000 days operating cash.
IMPORTED WATER SUPPLY DEPENDENCE: Local water supplies account for around 40% of supply at a stable cost. Imported water purchases provide the balance of supply. As water demand has decreased due to drought related conservation, the district has reduced its water purchases.
ACHIEVEMENT OF FORECAST FINANCIALS: Demonstration of results in line with the financial forecast, assuming a continued trend of declining debt levels, would likely result in positive rating action.
The district provides water and wastewater services to a population of approximately 150,000 in southwest Riverside County (the county). The service area encompasses nearly 100,000 acres and includes the city of Temecula, a portion of the city of Murrieta, and unincorporated areas of the county. The district's water service territory is divided into the Rancho Division and the Santa Rosa Division. Wastewater collection and treatment services are provided to just the Santa Rosa division through a small five million gallon per day (mgd) WWTP.
RATE STRUCTURE MITIGATED IMPACT OF DROUGHT CONSERVATION
The district achieved a 29% reduction in water usage from 2013 levels in response to a mandate from the California State Water Board to conserve 32% due to the state's extreme drought. While drought conditions continue, recent regulatory changes have eased conservation requirements. In response, the district recently certified at 0% conservation by demonstrating that it could meet full customer demands given an additional three years of drought conditions. It has experience a rebound in demand thus far of approximately 10%.
The district's financial performance held up very well during the period of mandatory conservation due to its water budget based rate structure, which increased the cost of water as sales volume decreased. The district is able to manipulate various elements of the rate structure when it needs to conserve water, reducing the amount of water allocated to residents at low rates for indoor and efficient outdoor use. The rate structure stabilizes revenues by pushing usage into more expensive tiers, increasing the average price of water sold. The district also benefits from reductions in purchases of expensive imported water as demand declines, allowing the district to meet a greater proportion of needs from local supplies. In addition, the district's rates contain an automatic pass-through of wholesaler rate increases until fiscal 2019.
HIGH FIXED COST RECOVERY
The district's revenue structure is heavily weighted toward fixed-rate base charges in the water rates and property taxes and assessments, which provide more than 40% of total district revenues. The district receives a share of the county's 1% property tax revenues and levies its own property assessments on land value within the district. The district's property assessments existed prior to 1996 and are grandfathered under California's Proposition 218 amendments regarding voter authorization of such charges. The district does not participate in the county's Teeter plan, taking the full risk and reward of collections, which it has found to be beneficial.
The base water charge amount to more than 75% of the district's fixed costs and the first tier of usage recovers the remaining fixed costs. Rates over the next five years depend on the level of demand recovery, with higher rates expected if usage increases to offset higher purchased water costs.
IMPROVED FINANCIAL METRICS & FORECAST; STRONG LIQUIDITY
Despite a decline of 27% in water sales from 2014 to 2016, Fitch-calculated DSC improved from 1.3x in fiscal 2014 to 1.5x in 2015 and 2.2x in 2016 (compared to an expected 1.7x). Further, management's financial forecast indicates that DSC will range between 2.7x and 2.9x through fiscal 2021 primarily as a result of a decline in debt service payments with the defeasance of the WWTP debt and this refinancing.
DSC had historically been strong at above 2x through fiscal 2010 but narrowed through fiscal 2014 with increasing debt service from new debt and increasing imported water costs. Water sales have fluctuated considerably over the past decade ranging from a high of 87,639 acre-feet (af) in 2007 to the low of 52,577 af in 2016.The district's projections assume an 8% increase in sales in fiscal 2017, followed by annual increase of about 5% reaching 66,062 af in fiscal 2021. Following the dip in 2014 DSC, the district refined its structure to match revenues more closely with variable imported water costs.
Combined unrestricted and board-designated reserves have equaled more than 1,000 days cash for at least the last six years. Unrestricted cash totaled $45.6 million, or 266 days operating cash, at the end of fiscal 2016. However, the district had another $178 million in board-designated reserves collected through the district's share of 1% of property taxes and other property assessments. The funds can be legally used for any purpose at the board's discretion.
IMPORTED WATER DEPENDENCE
Metropolitan Water District of Southern California (MWD, revenue bonds rated 'AA+'/Stable Outlook), the regional wholesale provider of imported water, provides much of the district's supply through contracts with Eastern Municipal Water District and WMWD. In typical years, treated water purchased from MWD provides around 40% of the district's water supply while another 15% - 20% in untreated water purchased from MWD is recharged into the local water basin and extracted from the aquifer for later use. The purchase contracts for imported water do not require a minimum amount or a fixed payment, so the district is able to reduce or increase its purchases in response to customer water demand.
ABOVE-AVERAGE DEBT BURDEN
The district will defease approximately $60 million in WWTP debt with funds provided by the Santa Rosa Regional Resources Authority (SRRRA), formed by the district, Elsinore Valley Municipal Water District, and Western Municipal Water District (WMWD). The SRRRA plans to utilize state loan proceeds expected in December 2016 to purchase the WWTP. The district originally issued the WWTP debt and received payments from the partner agencies to cover their share of debt and capital costs. Going forward the district will pay the SRRRA its share of debt via operating expenditures.
Debt levels will decline with the defeasance of the WWTP debt but still remain high relative to the number of customers and population due in part to the large agriculture component of the district's service area. However, Fitch's concern about the debt metrics are somewhat mitigated by the district's very high reserve levels. Debt per customer based on the combined system will be about $5,200 post-defeasance, which is equal to about 2.5x Fitch's median for the 'AA' rating category and about 5x the 'AAA' median. Debt to net plant assets of 45% post-defeasance is in line with 'AA' medians. The district's existing debt has a slow amortization with only 28% of debt maturing in the next 10 years and 68% in 20 years.