OREANDA-NEWS. Fitch Ratings has assigned the following ratings to San Antonio, TX's water system junior lien bonds, issued for the benefit of the San Antonio Water System (SAWS):

--$170.8 million water system junior lien revenue refunding bonds, series 2016A (no reserve fund), rated 'AA',
--$45.5 million water system junior lien revenue refunding bonds, taxable series 2016B (no reserve fund), rated 'AA'

The bonds will be sold via negotiation the week of February 2. Approximately $145 million will be used to refund the outstanding obligations of the district special project (DSP) for financial integration as well as debt service savings. The remaining $71 million will refund a portion of senior lien series 2007 bonds for debt service savings.

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

--$1.16 billion in outstanding water system revenue bonds (senior lien) at 'AA+';
--$1.4 billion in outstanding water system junior lien revenue bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

Repayment security of the water system senior lien revenue bonds is provided by a pledge of net revenues of SAWS's water and wastewater system (the system). The junior lien revenue bonds are paid subsequent to the senior lien bonds. The series 2016A&B bonds will be issued without a reserve fund.

KEY RATING DRIVERS

ADEQUATE FINANCIAL PERFORMANCE: All-in debt service coverage (DSC) ranged from 1.6x to 1.7x over the last four years despite severe drought conditions. Preliminary 2015 results point to a modest decline in DSC due to the extreme wet weather that ended the long drought. Fitch expects that SAWS's strong financial planning, as well as recent and future rate increases, will continue to support adequate coverage levels over the long term while keeping pace with ongoing capital needs.

STRONG MANAGEMENT WITH EXTENSIVE PLANNING: SAWS maintains strong management practices, including a 20-year long-range financial and rate forecasting model that incorporates future capital investment and related rising operating expenditures.

HIGH DEBT / SUBSTANTIAL CIP: The system is expected to remain highly leveraged for the rating category given its large capital plan. The system's $1.5 billion capital improvement program (CIP) over the next five years (2016 - 2020) is driven by wastewater needs to comply with regulatory standards, as well as requirements to secure future diverse water supplies. Fitch believes credit concerns regarding the system's sizeable CIP are somewhat offset by the system's planned use of available reserves and rate increases, as well as a gradual decline in CIP spending beyond 2021 as reflected in SAWS's 20-year projections.

COSTLY SUPPLY DIVERSIFICATION EFFORTS: SAWS's water supply diversification efforts continue to introduce new non-Edwards aquifer sources to its water supply inventory; however, at a materially higher cost.

COMPETITIVE RATES: The system's rates are competitive compared with area and state-wide peer systems. A comprehensive rate study was recently completed and, despite planned rate hikes to support the system's substantial capital needs, Fitch believes rates will remain competitive and affordable relative to area wealth levels.

STRONG AND DIVERSE SERVICE AREA: The growth trend of San Antonio's overall economic activity and diversification remains stable, with the softening in residential building activity partially offset by steady commercial and military construction.

RATING SENSITIVITIES

MAINTENANCE OF ADEQUATE FINANCIAL PROFILE: Failure to increase rates as planned would result in weakening financial performance, given the system's growing water supply costs, substantial capital program and growing leverage ratios, especially as compared to the medians of similarly rated credits.

PROJECTED DECLINE IN CAPITAL SPENDING: The rating reflects Fitch's expectation that the capital improvement plan (CIP) and resulting debt levels will be manageable until the CIP declines beyond 2021. Material increase to the CIP projections from the system's current 20-year plan could exert financial pressure inconsistent with the current rating.

CREDIT PROFILE
SAWS is the predominant service provider to about 1.6 million residents of Bexar County, serving about 386,000 water and 427,000 wastewater retail and wholesale customers. SAWS is governed by a seven-member board of trustees and rate changes are approved by the city council. SAWS's main challenges continue to be the development of supplemental water resources given the projected doubling of population for the area by the year 2050 and the ongoing sewer system maintenance program.

SAWS took over operations of the former Bexar Metropolitan Water District (BMWD) on Jan. 28, 2012 and has been operating the system, District Special Project (DSP), as a separate component unit. SAWS serves approximately 102,000 water connections under the DSP. Approximately $145 million of the bond proceeds will be utilized to refund the outstanding debt of the DSP. Upon closing, the DSP will be dissolved and the financial operations will be consolidated into SAWS. The consolidated DSC and liquidity are expected to remain in line with SAWS metrics prior to consolidation. Debt per customer levels will rise modestly due to the higher leverage position of the DSC, but the rapid connection growth in the service territory somewhat mitigates concerns.

IMPROVED COVERAGE SUSTAINED

All-in DSC ranged from 1.6 to 1.7x from 2011 to 2014 despite the prolonged drought. However, given the extreme wet weather that brought an end to the four-year drought, the preliminary results for 2015 point to modestly reduced DSC at 1.5x. The 2016 budget conservatively reflects lower water sales and a 7.5% rate increase that took effect Jan. 1, 2016.

SAWS has developed and annually updates a multiyear financing plan that includes expected capital and operational costs and incorporates its planned rate increases. The five-year projections for fiscal years 2016 to 2020 reflect all-in coverage ranging from 1.6x to 1.8x. Moreover, SAWS has recently revised its all-in DSC target to 1.75x from the previous 1.5x. Fitch views the higher DSC target favorably, given the high leverage position of the system and expected debt issuance over the next five years.

HIGHLY LEVERAGED WITH LARGE CAPITAL NEEDS

Outstanding long-term debt per customer is high at over $3,300 compared with the 'AA' category median of nearly $2,000. This has been largely driven by the system's need to reduce sanitary sewer overflows in compliance with a U.S. Environmental Protection Agency consent decree, and invest in capital projects necessary to secure future water sources.

SAWS 2016-2020 five-year CIP totals a large $1.5 billion. About 52% of the CIP will address wastewater infrastructure improvements, with the remainder addressing long-term supply and delivery projects. The system's effort to increase the target cash funded CIP level to roughly 50% from 35% is considered favorable. Accordingly, the sources of funding include 46% pay-go monies derived from service revenue and impact fees and 54% future debt issuance.

SUPPLY DIVERSIFICATION

Historically SAWS has relied on the Edwards Aquifer for the vast majority of water supply. Environmental concerns with the aquifer habitat and recharge resulted in pumping restrictions and led to substantial efforts to diversify the area's water supplies. SAWS began adding several modest non-Edwards Aquifer water sources to its portfolio in 2002. The water supply projects included in the CIP are expected to increase the composition of non-Edwards Aquifer water over time. Fitch believes that water diversification will be a long-term positive to the system despite the significant cost, which is expected to be incrementally absorbed through rate adjustments.

OFF-BALANCE-SHEET WATER SUPPLY PROJECT

In addition to the CIP, SAWS has entered into a contract with the Vista Ridge Consortium to construct a 140-mile pipeline that will deliver 50,000 acre feet (AF) annually to SAWS's intake point from the Carrizo and Simsboro aquifers by 2020. This is projected to be the largest non-Edwards Aquifer water source in its supply portfolio. The pipeline project will be treated as an operating expense (prior to all debt service per the flow of funds) at an estimated cost of $2,200 per AF. This will result in an increase of an estimated 20% in operating expenditures in 2020 when the project is expected to begin water deliveries. The term of the contract is for 30 years (from completion of the project), at which time the pipeline is turned over to SAWS and is expected to have a useful life of 30-50 years remaining.

The project is currently in the development phase, financial close is pending the resolution of legal matters. Certain contract provisions protect SAWS from significant financial exposure during the development phase.

AFFORDABILITY SOMEWHAT MITIGATES COST PRESSURES

SAWS has recently completed a rate study and adopted a new rate structure geared to recover a higher percentage of cost at base service tiers, while maintaining a low life-line rate for water use under 3,000 gallons per month. The new rate structure also has 8 water tiers instead of 4, enabling SAWS to recoup base cost at lower tiers and sending conservation signals sooner than the previous rate structure. A 7.5% rate increase for the average residential connection took effect January 2016. Planned rate hikes for total water and wastewater service from 2017-2020 average about 9.1% annually. The average monthly residential bill currently totals $59 (including pass through fees), which is lower than all other Texas urban systems except El Paso, affording the system significant rate flexibility, an important credit strength.\