Fitch Ratings affirms the following rating for the Imperial Irrigation District, California (IID) as part of its continuing surveillance:
--$35.8 million revenue certificates of participation (COPs), series 2004, at 'AA-'.
The Rating Outlook is Stable.
Water revenue COPs are secured by net revenues of IID's water system.
KEY RATING DRIVERS
EXCEPTIONALLY STRONG WATER RIGHTS: The district has superior water rights to a very large volume of the state of California's allocation of Colorado River water that is used to serve the region's irrigation needs.
DIVERSIFICATION IN WATER SALES: IID makes water sales outside the traditional service area that are under contract through 2047, resulting in revenue diversity with around half of system revenues provided by IID's traditional irrigation customers and the other half provided by water sales outside the region and falling water charges from IID's power system.
WATER SALES AT FIXED PRICES: The Quantification Settlement Agreement (QSA) provides IID a highly stable and certain revenue stream and a 2009 Settlement Agreement with the San Diego County Water Authority (SDCWA) increased pricing which, over time, is anticipated to offset needed rates from irrigation customer and fund system capital needs.
SIGNIFICANT CAPITAL NEEDS: Fitch anticipates significant capital spending in the next five years to build mandatory conservation projects, which could place strain on the system's resources and financial position.
LIMITED RATE FLEXIBILITY: Very low water rates to the district's irrigation customers at $20 per acre-foot provide the region with a competitive advantage to other agricultural areas in the state. However, IID appears to have very limited rate flexibility given strong customer protest voiced in 2009.
IMPROVED AND ADEQUATE FINANCIAL POSITION: The financial position became strained over the past few years with reliance on one-time sources to meet rate covenant requirements. The 2009 settlement agreement revenues and a decrease in debt service resulting from the prudent cash defeasance of debt, improved cash flow in fiscal 2010. Future financial performance will depend, in large part, on the structure and timing of new debt.
GOVERNANCE CONCERNS: Frequent senior management turnover at the district has been a credit concern given the long-term capital needs that are required to comply with the QSA.
WHAT COULD TRIGGER A RATING ACTION
CAPITAL INVESTMENT NOT DISCRETIONARY: The district's completion of the conservation projects over the next five years is important in that if conservation water is not available to meet required transfers, IID would have to reduce water sales to its irrigations customers, which would be highly unpopular and potentially damaging to the regional economy.
ADDITIONAL DEBT ISSUANCE: Costly required conservation projects are expected to result in additional borrowing, the structure and timing of which is presently unclear. While the growing revenues from water transfers appear overall to be sufficient to support the increasing debt burden, decisions regarding the structure of the new debt may impact financial margins for existing bondholders and, perhaps, credit quality.
STRONG WATER RIGHTS
Imperial Irrigation District is located in southeastern California, near the borders of Mexico and Arizona. The district enjoys a 3.1 million acre-feet entitlement to flows from the Colorado River and delivers approximately 2.4 million acre-feet of raw water to irrigation customers in the Imperial Valley, where a tremendous amount of California's agricultural activity takes place.
The Imperial Valley economy is linked to that of Mexicali, MX, located just south of the service area. The economy has been seriously affected by the economic downturn. The district's water rights to a share of California's apportionment of the Colorado River are plentiful and superior to many in the state, including the water rights of Metropolitan Water District of Southern California, used to serve the urban Los Angeles and San Diego areas.
WATER TRANSFER SALE OBLIGATIONS
In a broad regional agreement signed in 2003, the QSA, the district agreed to execute substantial conservation projects that would generate water to be sold to other regional entities to meet population growth. IID is poised to embark on a sizable capital program to implement the long-term conservation projects needed to meet the required deliveries to SDCWA and CVWD that grow to 278,000 acre-feet by 2021.
In the interim period, the district is meeting initial water transfer sale requirements through land fallowing programs with Imperial Valley farmers. Financial pressure could result in the interim period since IID must spend capital dollars to construct conservation projects, but the bulk of revenues from these projects will be generated a number of years after construction is complete. IID is expected to debt finance the majority of project costs in addition to $50 million in up-front capital funds provided by a 2009 settlement agreement with SDCWA.
IID is required as part of the QSA to transfer increasing amount of water to SDCWA and CVWD. The transfers began in 2004 and ramp up to a flat annual level of 200,000 af in 2021. Deliveries to CVWD increase to a maximum of 103,000 in 2026 and deliveries to both entities continue through 2047. Prices for the water transfers to SDCWA and CVWD are fixed under certain agreements with the entities.
In addition, IID is required to transfer 'mitigation' water to the Salton Sea through 2017. However, IID has petitioned the state for the ability to sell the mitigation water to other regional entities and use the resulting funds for alternative mitigation efforts related to the Salton Sea. This type of change, should it occur, is considered neutral from a revenue and credit perspective.
CAPITAL NEEDS WILL INCREASE DEBT
IID expects to complete approximately $293 million in capital projects overall in the next five years, with $216 million related to conservation requirements. Funding will include $50 million provided by SDCWA and bond proceeds. Management is considering the use of parity or subordinate bonds but to date, a structure has not been determined.
The approximately $223 in additional debt estimated over the next five years will represent a substantial increase to the district's existing $124 million in outstanding debt, as of Dec. 31, 2010, including pension obligation bonds and commercial paper. Existing debt was reduced by around $50 million in 2010 when land sale proceeds were used to cash defease early maturities of the outstanding 2004 COPs, the original proceeds of which were used to purchase the land. The defeasance provides some capacity for the additional debt anticipated.
FINANCIAL PERFORMANCE IMPROVED IN 2010
IID's financial performance in fiscal years 2007 through 2009 was slim and debt service coverage was aided by revenues provided by one-time land sales and settlement payments, which were included in 'revenues' for purposes of the rate covenant calculation.
Fiscal 2010 performance was helped by the implementation of two of three rate increases approved in 2009, a substantial reduction in debt service as a result of debt refundings and the cash defeasance in that year. Water transfer sales also increased considerably in fiscal 2009, aiding financial performance. Debt service coverage in fiscal 2010 was 3.5 times (x) and unrestricted cash balances remained healthy, even after the defeasance, with $100 million in cash, or 380 days operations.
Future financial performance is expected to remain in line with 2010 performance although with lower debt service coverage as additional debt is issued. Management's informal policy is to maintain debt service coverage of at least 2.0x. Revenues are expected to increase in future years as a result of increased water transfer sales to SDCWA and CVWD. Salton Sea mitigation revenues provided by a regional JPA will also increase, although these revenues are a direct reimbursement for incurred expenditures. Expenditures will also increase significantly as operational costs increase related to the new capital investments anticipated and related to the previously mentioned Salton Sea mitigation costs.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 10, 2011.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
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