Fitch Affirms Irvine Ranch Water District, CA COPs, Rev Bonds, and Notes at 'AAA'; Outlook Stable
--\$61.3 million certificates of participation (COPs), series 2010 at 'AAA';
--\$175 million revenue bonds, (Build America Bonds), series 2010B at 'AAA';
--\$91 million refunding index tender notes, series 2011A-1 and 2011A-2 at 'AAA/F1+'.
The Rating Outlook is Stable.
All series have a parity lien on pledged net water and wastewater system revenues. The series 2010 COPs are payable from net system revenues after payment of operations and maintenance expenses.
The series 2010B revenue bonds are secured by a net revenue pledge of the district and voter-approved ad valorem assessments on land value that are collected within the six improvement districts contained within the district's service territory.
The series 2011A-1 and 2011A-2 index tender notes are secured by a net revenue pledge of the district and the consolidated several unlimited general obligations of four improvement districts (ad valorem assessment collected on land value) within the district.
KEY RATING DRIVERS
STRONG FINANCIAL PERFORMANCE: Financial performance is very strong, characterized by solid debt service coverage 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. The district is 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, and amortization is 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 2010B revenue bonds and series 2011 index tender notes are also secured by certain ad valorem assessments, the ratings solely reflect the net revenue pledge of the district.
SHIFTS IN FUNDAMENTALS: The rating is sensitive to shifts in fundamental economic, financial, debt and management credit factors. The Stable Outlook indicates that Fitch views such shifts are unlikely.
The district provides retail water and wastewater services to an estimated 370,000 people through 105,320 water and 100,967 sewer connections within the city of Irvine and portions of five other cities and unincorporated areas in Orange County (implied general obligation (GO) rated 'AA+'/Stable Outlook by Fitch).
VERY STRONG FINANCIAL PERFORMANCE
The district's financial performance has been strong and consistent. All-in debt service coverage (DSC) increased to 2.3x and 2.7x in fiscals 2013 and 2014, respectively, from approximately 2x the prior few years. Management's five-year forecast through fiscal 2019 shows coverage of at least 1.8x, or 1.4x less connection fees. Fitch's analysis focuses on all-in DSC, which includes the consideration of outstanding GO bonds and other subordinate lien obligations.
Although the GO bonds are secured by ad valorem taxes assessed by the district, the district uses its net revenues to support a portion of the GO debt. In addition, it has liquidity facilities in place with four banks to support the variable rate GO debt.
Reserves are high, with 934 days cash on hand at fiscal year-end 2014, which is equal to the five-year average. The district uses its significant cash reserves to balance interest rate risk. Reserves include operating reserves and a sizable replacement fund with a balance of \$163 million, or over 50% of total cash, as of Nov. 30, 2014. 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 \$566.8 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 notes does not reduce the district's overall variable rate exposure, but it does mitigate liquidity facility risk. Index tender notes 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 notes. The notes were successfully remarketed in February 2015.
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+'/Stable Outlook); local groundwater, managed by Orange County Water District (OCWD; COPs rated 'AAA'/Stable Outlook); and recycled sources from the district's wastewater treatment facilities. The district has made progress towards the development of new water supplies. However, it continues to have exposure to rapid cost escalation of imported water from MWD, which accounted for approximately 23% of its supply in fiscal 2014. The district expects its purchases from MWD to decline to about 17% in fiscal 2015 due to the drought as well as additional groundwater generated by completion of wells 21 and 22.
The district provides wastewater treatment to about 71% of its wastewater flows. The remaining wastewater is treated by the Orange County Sanitation District (COPs rated 'AAA'/Stable Outlook). The district is in the process of expanding its wastewater treatment facilities to provide 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 \$40.72 per month, or just 0.5% of median household income, versus Fitch's affordability threshold of 2%, due in part to property tax revenue receipts. The district has increased water rates by an average of 6.5% per year and sewer rates by 10% per year over the past decade. A portion of the rates is reserved for the replacement fund.
ELEVATED DEBT LEVELS
Debt ratios are high compared to Fitch medians, with per capita debt at \$1,792, and amortization of principal is slow. Debt levels are projected to increase to about \$2,195 per capita by fiscal 2019 given borrowing plans. The district's five-year capital plan includes about \$409 million in spending on project such as the Michelson Water Recycling Plant Expansion and biosolids handling (\$146 million), water supply and reliability including water banking facilities and Baker Treatment Plant improvements (\$77 million), and development-related expansions (\$107 million). The district expects to fund approximately 73% of the plan through additional GO borrowing of \$150 million in each of fiscals 2016 and 2019.
AFFLUENT SERVICE AREA
The district serves a diverse and wealthy economic base with county and city of Irvine median household incomes 48% and 71% above national averages, respectively. City and county unemployment rates of 3.7% and 5.0%, respectively, as of November 2014 were 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.