Fitch Ratings has assigned an 'AA' rating to the Orange County Sanitation District, California's (the district) $29.6 million refunding certificates of participation (COPs), series 2008B (the certificates). The certificates will sell on Sept. 4 via competitive sale. Proceeds will refinance the district's 1993 variable rate demand COPs, terminate the swap and fund and maintain the debt service reserve fund. In addition, Fitch has affirmed the 'AA' underlying long-term rating on the district's approximately $1.1 billion of outstanding parity senior lien COPs. The Rating Outlook is Stable.
The 'AA' rating reflects the essentiality of the service provided, healthy finances exhibited by strong liquidity and high debt service coverage levels, and the construction and cost risk inherent in its sizeable capital improvement plan (CIP). In addition, the rating considers the very strong pledged revenue security as service charges are collected on the property tax bill, competitive rate structure, effective financial and capital planning and the district's success in managing its CIP thus far. The district's ability to implement its CIP as planned and budgeted while maintaining good debt service coverage and high cash balances may lead to positive rating considerations in the mid-term.
The district serves the northern and central portions of Orange County (the county), including about 2.5 million people, or 81% of the county population covering over 471 square miles. In addition to the $1 billion already expended, the district's long-term CIP is still sizeable at $1.5 billion through fiscal 2021. The CIP is focused on moving to full secondary treatment for all effluent and assuring treatment and collection system capacity through 2020. In addition, it includes final costs of the groundwater replenishment system which began operation in November 2007 in collaboration with the Orange County Water District. The district plans to fund about 40% of its CIP through fiscal 2021 with additional COPs, including about $200 million during this fiscal year.
Risks associated with rising debt and increasing demands on system revenues for pay-go projects are somewhat offset by the district's strong financial record and current position sustained by historical and adopted rate hikes, including five years of rate increases adopted in February 2008 resulting in a 61% increase from the current annual residential rate. Nonetheless, rates are still competitive with regional and state providers, and will likely remain affordable given the district's high wealth levels. Further enhancing the district's long-term financial stability is the fixed receipt of a proportionate share of the countywide 1% property tax levy, providing about 21% of gross revenue in fiscal 2007. Growth of this revenue source may slow in the near term, but because the county guarantees tax collections, the district would not be affected by tax delinquencies.
Legal covenants are sound, including an additional bonds test of 1.25 times (x) maximum annual debt services (MADS) for senior lien bonds and a covenant to set rates equal to 1.25x annual debt service (ADS). Pledged revenues do not include capital facilities capacity charges (connection fees). Actual debt service coverage has been very strong, averaging 3.0x ADS since 2001, including 3.1x in fiscal 2008 according to unaudited information. By policy, the district sets rates to provide for 2.0x coverage, and projects coverage levels, including planned the planned new money issuance, to range between 2.5x in fiscal 2009, declining to 2.1x for fiscal years 2011 and 2012. The district's exposure to the slowdown in the housing market is moderate, as impact fees have historically provided less than 10% of operating revenue and are not included in the rate covenant or debt service coverage calculations. While an actual decline in assessed valuation would yield a reduction in property tax revenue, the district maintains flexibility to raise volume-based rates.
Note: Fitch issued an exposure draft on July 31 proposing a recalibration of tax-supported and water/sewer revenue bond ratings which, if adopted, may result in an upward revision of this rating (see Fitch research 'Exposure Draft: Reassessment of the Municipal Ratings Framework').
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
