Fitch Rates Irvine Ranch Water Dist, CA's GOs 'AAA'; Outlook Stable
--$105.9 million general obligation (GO) bonds, series 2016.
Bond proceeds will fund the district's share of Baker Water Treatment Plant (WTP) costs, a portion of the district's biosolids handling project, as well as other capital projects. Bonds are expected to price on Sept. 28, 2016 via negotiated sale.
The Rating Outlook is Stable.
The bonds have a senior lien on pledged net water and wastewater system revenues after payment of operations and maintenance expenses. The series 2016 GO bonds are additionally secured by voter-approved ad valorem assessments on land value that are collected within 13 improvement districts (six water and seven sewer) contained within the district's service territory.
KEY RATING DRIVERS
STRONG FINANCIAL PERFORMANCE: Financial performance is very strong, characterized by solid debt service coverage (DSC) and sizable liquidity balances.
LOW RATES: Utility rates are very low, limiting pressure on the rate base and preserving flexibility.
GOOD SUPPLY DIVERSIFICATION EFFORTS: Long-range capital planning activities are exceptional with the district continually developing new water sources to counter uncertainty over the ongoing reliability and high cost of imported water supplies.
ELEVATED DEBT: Debt levels are above average and expected to remain so over the medium term. Amortization is also slow. Capital spending remains focused on water supply reliability.
AFFLUENT CUSTOMER BASE: The service area is affluent and diverse, benefitting from access to the Los Angeles and San Diego employment areas.
RATINGS BASED ON REVENUE PLEDGE: Although the series 2016 GO bonds are also secured by certain ad valorem assessments, the ratings solely reflect the net revenue pledge of the district.
ADDITIONAL LEVERAGE: Irvine Ranch Water District's rating is sensitive to leveraging beyond that currently contemplated given the already high debt levels relative to rating category medians.
The district provides retail water and wastewater services to an estimated 370,000 people through about 108,000 water and 102,000 sewer connections within the city of Irvine and portions of five other cities and unincorporated areas in Orange County (Issuer Default Rating [IDR] 'AA+'/Stable Outlook).
VERY STRONG FINANCIAL PERFORMANCE
The district's financial performance has been strong and consistent, with Fitch-calculated all-in DSC averaging 2.1x over the last five years. Senior DSC averaged 4.5x over the same period. Management's five-year forecast through fiscal 2021 shows all-in DSC of not less than 2.3x, or 1.8x less connection fees. The district has performed well even during the drought due in part to stability provided by its tax receipts, which make up about 20% of total revenues, and also due to adjustments allowed by its allocation-based rate structure.
Fitch's analysis focuses on all-in DSC, which includes the consideration of outstanding GO bonds and other subordinate loan obligations. Although the GO bonds are additionally secured by ad valorem taxes assessed by the district, the district uses its net revenues to support a portion of the GO debt. The district also has liquidity facilities in place with three banks to support GO-backed debt.
Reserves are high, with 716 days cash on hand at fiscal year-end 2015, which is a bit lower than the five-year average of 900 days due to large capital expenditures for the year. Projections show cash balances at or above the current levels through the forecast period. The district uses its significant cash reserves to balance unhedged interest rate risk. Reserves include operating reserves and a sizable replacement fund with a balance of $167 million, or 67% of total unrestricted cash, as of fiscal year end 2015. Although earmarked for capital, this fund acts as a rate stabilization fund and can be used to pay operating expenditures. The replacement fund provides substantial liquidity when included with the district's operating reserves.
A substantial 58% of the district's outstanding $547.7 million debt burden is in the variable-rate mode. A portion of the debt is synthetically fixed through the use of $130 million in fixed payer LIBOR swaps. The use of index tender bonds does not reduce the district's overall variable-rate exposure, but it does mitigate liquidity facility risk. Index tender bonds have a hard put feature that the district must actively manage in advance of the mandatory tender date. To the extent market demand ever diminishes for the product, the district would be required to facilitate a take-out financing for the bonds. The bonds were successfully remarketed in February 2016.
GOOD PLANNING EFFORTS TO DIVERSIFY SUPPLY
Long-range capital planning activities are exceptional with the district continually developing new water sources to counter uncertainty over the ongoing reliability and high cost of imported water. Water supplies are derived from imported surface water purchased from the Metropolitan Water District of Southern California (MWD; revenue bonds rated 'AA+'/Outlook Stable) through the Municipal Water District of Orange County; local groundwater, managed by Orange County Water District (OCWD; COPs rated 'AAA'/Outlook Stable) and recycled sources from the district's wastewater treatment facilities.
The district has made progress towards the development of new water supplies with recycled water now accounting for 28% of supply. New supply sources also include treated groundwater and water banking projects. However, it continues to have exposure to rapid cost escalation of imported water from MWD, which accounted for approximately 15% of its supply in fiscal 2016, down from 23% in fiscal 2014 due to the drought as well as additional groundwater generated by completion of wells 21 and 22.
The $106 million Baker WTP, the district's share of which will be funded with this borrowing, will treat 28 million gallons per day of imported untreated MWD water upon completion in fall 2016. The WTP will allow the district to reduce its purchases of treated water in line with the increase in lower-cost untreated water, thus reducing overall purchased water costs. The district will own and operate the plant and 76% of capacity will be held by other participating water agencies.
The district provides wastewater treatment to about 80% of its wastewater flows. The remaining wastewater is treated by the Orange County Sanitation District (COPs rated 'AAA'/Outlook Stable). The district is in the process of expanding its wastewater treatment facilities to provide biosolids handling, a portion of which will be funded with this borrowing, and additional recycled water supply for sale to its customers, as well as to control costs on its wastewater treatment services.
LOW RATES PRESERVE FLEXIBILITY
The district's combined water and sewer rates based upon usage of 7,500 gallons are very low at $44.40 per month, or just 0.7% of median household income for the county, versus Fitch's affordability threshold of 2%. The district has increased water rates by an average of 4.4% per year and sewer rates by 5.4% per year over the last five years. A portion of the rates is reserved for the replacement fund.
ELEVATED DEBT LEVELS
Debt ratios are high compared to Fitch's 'AAA' medians, with per capita debt at $1,548. Amortization of principal is also slow. Given borrowing plans, debt levels will increase to about $2,200 per capita by fiscal 2021. The district's five-year capital plan (fiscals 2017-2021) includes about $395 million in spending (versus $409 million for the last CIP) on projects such as biosolids handling ($76.5 million), water supply and reliability including water banking facilities and Baker WTP improvements ($73.5 million), and development-related expansions ($94.5 million).
The district expects to fund approximately 65% of the plan through borrowing, including this 2016 GO issuance and another GO issuance of $75 million planned for fiscal 2019. Escalation in borrowing beyond currently contemplated levels could ultimately pressure the rating given that leverage is already well above the rating category median.
AFFLUENT SERVICE AREA
The district serves a diverse and wealthy economic base with county and city of Irvine median household incomes 42% and 72% above national averages, respectively. City and county unemployment rates are well below state and national levels. Major employers include the University of California, Irvine, and Irvine Unified School District, as well as various private employers in the pharmaceutical/medical and wireless technology fields. The county's proximity to the Los Angeles, Riverside and San Diego areas provides ready access to the substantial southern California economy.