Fitch Rates Anaheim Housing & Pub Improv Auth, CA's Water Revs 'AAA' & Affirms Outstanding
--$34.9 million revenue bonds, series 2016-A (water system project).
Bond proceeds will finance various projects related to the city's water system (the system), including rehabilitation and replacement service reliability projects and projects that will improve and augment the system's water supply and delivery capabilities. Bonds are expected to price on or around Sept. 27, 2016 via negotiated sale.
In addition, Fitch affirms the 'AAA' rating on the following outstanding obligations issued on behalf of the city's system, payment of which is on parity with the authority bonds:
--$95.1 million California Municipal Finance Authority, CA revenue bonds, series 2015-A;
--$35.3 million Anaheim Public Financing Authority, CA water revenue bonds, series 2004, 2008, 2010-A and 2010-B (Build America Bonds).
The Rating Outlook is Stable.
The authority bonds and outstanding system obligations are secured by purchase payments made by the city in accordance with the installment purchase agreement. Payments from the city to the authority are absolute and unconditional. Payments are required to be made only from net revenues of the city's system. The rating therefore reflects the credit quality of the system.
KEY RATING DRIVERS
STRONG FINANCIAL PERFORMANCE: The water system enjoys a strong financial position, with debt service coverage (DSC) expected to remain above 2.0x and adequate liquidity levels given revenue stability.
FAVORABLE RATE STRUCTURE: The water rate structure includes a unique direct pass-through of purchased water costs and debt/capital costs, providing strong and timely cost recovery from ratepayers. It maintains rate flexibility due to its very low water rates as compared with other regional providers and Fitch's affordability threshold.
STABLE SOURCE OF SUPPLY: Approximately three-quarters of the utility's supply is provided by the Orange County Water District (OCWD), whose rates are much lower than the utility's other source, Metropolitan Water District of Southern California (MWD), providing the city with relative cost stability compared with much of Southern California.
ELEVATED DEBT LOAD: Recent and planned issuances have pushed debt to above-average levels relative to Fitch medians.
STABLE CUSTOMER BASE: The customer base is stable in a service territory that is largely developed.
SUSTAINED FINANCIAL METRICS AMID INCREASING DEBT: Maintenance of strong debt service coverage and liquidity commensurate with the high rating level is essential to the rating, given the incremental rise of capital needs and planned debt issuance over the intermediate term.
The water system serves the city of Anaheim (Issuer Default Rating of 'AA+'/Stable Outlook) as well as a small portion of the unincorporated area outside the city. The system currently serves a population of approximately 350,000 and has sufficient supply to serve the anticipated build-out population of 400,000. The system has a diverse mix of customers, with residential users accounting for 59% of revenues and usage. The top 10 commercial and industrial customers comprise about 9% of sales revenues and the top four public agencies accounted for 5%. Customer growth has been moderate, averaging 0.2% annually over the past five years.
STRONG FINANCIAL PERFORMANCE
Fitch views the system's financial profile as strong. Coverage levels of all obligations have been greater than 2.0x over the past six audited fiscal years through 2015. DSC equaled 2.2x in fiscal 2015. Estimated DSC for fiscal 2016 of 2.1x, which includes the use of $2 million in rate stabilization funds, is lower than previously projected due primarily to drought-related conservation. The city's original state-mandated conservation standard was 20% and it achieved a 23.5% reduction in water usage through June 2016 as compared with usage in 2013. However, the city recently certified with the state at a 0% conservation level as a result of a stress test on local supplies. Projected DSC through fiscal 2020 is anticipated to remain at least equal to the city's target of 2.0x.
Liquidity has declined over time from a high $31 million, or 285 days cash, in fiscal 2009 to $18.6 million, or 131 days at the end of fiscal 2015. This is in part due to capital outlays and a one-time transfer of $4 million to the electric utility in fiscal 2015 to cover the water system's share of costs associated with implementation of a new customer information system. However, preliminary fiscal 2016 results indicate an increase of $2 million in reserves followed by continued rising cash balances through fiscal 2021. In addition, the utility has access to a $14 million revolving credit agreement with Wells Fargo expiring in 2021 that can be used for any purpose; it currently has no outstanding balance. Days cash including the credit agreement would be about 230. Fitch views reserves as adequate given the revenue stability provided by the system's rate structure.
STABLE SOURCE OF SUPPLY; EXPOSURE TO MWD COSTS
The city of Anaheim's water supply is derived primarily from the OCWD (revenue certificates of participation rated 'AAA'/Stable by Fitch), which despite fluctuations in availability is a strong credit positive given its low cost. Anaheim received between 67%-76% of its water supply from OCWD over the last five years. OCWD has incrementally increased the proportion of pumping allowed from the basin in each of the past four years.
Anaheim pays OCWD a per acre-foot charge that covers the cost of capital improvements at the district and the purchases of replenishment water. The city's remaining supply - about 25% - is provided by the MWD (revenue bonds rated 'AA+'/Stable by Fitch). The cost of untreated MWD water is more than double that received from OCWD. As such, the system faces ongoing cost pressure related to the MWD's water supply. The city entered into a 10-year purchase agreement with MWD effective January 1, 2015. The agreement guarantees purchases at lower cost Tier 1 rates for a cumulative ten-year maximum amount that averages 7,960 million gallons per year compared actual purchases averaging 5,634 million gallons over the last five years.
FAVORABLE RATE STRUCTURE AND RATE FLEXIBILITY
Fitch views the system's rate structure as a strong credit positive, as it provides for automatic increases not subject to further City Council approval to recover capital and debt service costs as well as direct pass-through of purchased water costs. The system has four rate components: a customer charge, base commodity charge, a water commodity adjustment to recover actual cost of purchased water from MWD and OCWD along with electricity charges for pumping, and a water system reliability adjustment for capital cost recovery.
Despite recent rate increases, including an increase in the flat customer charge to $9.90 from $5 effective Feb. 1, 2016, Anaheim's water rates are low for the region and when compared to Fitch's affordability threshold, reflecting its access to OCWD's water supply in a region predominately served by the MWD. The city implemented various phases of its Water Reduction Plan, established by ordinance, in order to adjust to the ongoing drought and conservation mandates.
GROWING CAPITAL PLAN
While the system has historically had very little debt, recent issuances have been used to fund the majority of the system's capital needs, more than doubling debt from 2010 levels. The system's five-year capital plan has an estimated cost of $139 million and will be funded with roughly 70% debt and 30% pay-go. The city plans to issue an additional $30 million in parity bonds in fiscal 2020, which will push debt per customer to a high $2,914 in the next five years, which is triple the median for Fitch's 'AAA' rated water utilities. However, debt on a per capita basis is more in line with medians. Continued escalation in the system's debt profile beyond the capital plan period, without offsetting strengths in other key metrics, could apply pressure to the current rating.