Fitch Ratings assigns the following ratings to Contra Costa Water District, CA (the district):
--$80 million extendable municipal commercial paper (CP) notes 'F1+';
--Implied long-term subordinate lien rating 'AA'.
The notes are expected to be issued beginning the week of Sept. 17, 2012. Proceeds will be used to refinance maturing mezzanine debt ($30 million water revenue notes maturing Oct. 1, 2012 and potentially another $30 million maturing Oct. 1, 2013) and finance a portion of the costs related to the Los Vaqueros Reservoir Expansion Project, the Shortcut Pipeline Project, and other capital costs.
In addition, Fitch affirms the following ratings:
Contra Costa Water District
--$133.8 million water revenue refunding bonds, series P and Q at 'AA+';
--$249.5 million water revenue bonds series 1992E, 2001K, 2002L, 2003M, 2005N, 2007O at 'AA+';
--$162 million mezzanine water revenue notes, series 2010A and B at 'AA'.
Contra Costa Water Authority (the authority)
--$25.5 million water treatment revenue refunding bonds, series 2002A and 2012A at 'AA+'.
The Rating Outlook is Negative.
The notes are subordinate lien obligations payable from net revenues of the district's water system on a basis subordinate to the senior and mezzanine debt. While revenues exclude taxes and assessments, operations and maintenance (O&M) expenses under the trust agreement are net of costs paid from taxes.
The district bonds are senior lien obligations payable from net revenues of the district's water system. The notes are mezzanine obligations payable from net revenues on a subordinate basis to the bonds. The authority bonds are senior obligations payable from rental payments made by the district to the authority from net revenues, including rate stabilization fund moneys.
KEY RATING DRIVERS
SHORT-TERM RATING: The 'F1+' rating on the district's extendable commercial paper (CP) program reflects anticipated market access of the district and corresponds to the district's 'AA' implied long-term subordinate lien credit rating.
ADEQUATE DEBT SERVICE COVERAGE: The Negative Rating Outlook is due to annual debt service (ADS) coverage that is lower than historical levels and below average for the current rating level due in part to reduced water sales. Coverage is somewhat reliant upon grant revenues and is expected to remain at just adequate levels in the current forecast period.
HEALTHY LIQUIDITY: Although internal liquidity does not drive the short-term rating, the district maintains consistently high cash levels.
AMPLE SUPPLY: The district has a diverse supply portfolio sufficient to meet customer demands through build out estimated to occur in 2050.
STABLE CUSTOMER BASE: The district provides water to a diverse base of residential, municipal and industrial customers in a stable growth environment.
ELEVATED DEBT; MANAGEABLE NEEDS: Capital needs are manageable, which offsets some concerns related to an elevated debt profile.
WHAT COULD TRIGGER A RATING ACTION
PERSISTENTLY LOW OPERATING MARGINS: The district's inability to return debt service coverage to historical levels, to generate cash flow sufficient to maintain liquidity, and to fund projected capital spending may result in negative rating action by Fitch.
CONTINUED RELIANCE ON GRANTS/CONNECTION FEES: The district's dependence on grants and connection fee revenue to fund recurring expenditures, including debt service obligations, could exert downward pressure on the rating.
The district provides both retail and wholesale water service to about 550,000 residents in central and northern Contra Costa County, a largely residential county in the north east San Francisco Bay Area. Water supplies are derived from the Sacramento River-San Joaquin River Delta in which the district has acquired various water rights and also has contracted for water from the U.S. Bureau of Reclamation via the Central Valley Project (CVP).
COMMERCIAL PAPER STRUCTURE
The notes are limited by a rate covenant of 1.15x on all outstanding debt, including the senior district and Contra Costa Water Authority water revenue bonds and state revolving fund loans totaling $422.5 million and mezzanine notes totaling $157.5 million. Once issued, the $80 million CP program will represent about 12% of the district's outstanding debt. Fitch considers this to be a manageable level of short-term, variable rate obligations.
The notes will be extendable municipal CP with original maturities from 1 - 120 days from the original issue date of each note. The district reserves the right to extend the maturity up to 270 days from the original issuance date. If the notes are extended to the extended maturity date, the interest rate would be reset to the greater of: (a) SIFMA plus a fixed number of basis points, or (b) a fixed interest rate, either of which is determined based on the CP's prevailing credit rating. The rate shall not exceed a maximum interest rate of 12% per annum. Approximately $160.9 million (as of 6/30/12) in unrestricted and board-designated funds, including the rate stabilization fund, could be used to support the CP program, if needed.
LONG-TERM CREDIT QUALITY DRIVES SHORT-TERM RATING
The 'F1+' rating on the district's CP program reflects anticipated market access of the district and corresponds to the district's 'AA' implied long-term subordinate lien credit rating. The district's long-term ratings reflect the district's healthy liquidity, extensive planning efforts and policies, and stable supply and customer base. Other credit drivers include the district's high existing debt levels which are expected to decline over time given the recent completion of reservoir capacity expansion.
WEAKENED FINANCIAL PERFORMANCE
Financial performance has historically been strong as a result of significant planning efforts, comprehensive policies regarding reserve levels, and consistent annual adjustments to rates necessary to support operations. However, coverage has declined due to lower sales resulting from several years of drought followed by a cool, wet weather year. Also precipitating a decline in coverage are conservation efforts and the continued economic downturn.
Water sales revenues declined by a cumulative 10.5% from 2008 to 2011 despite annual rate increases ranging from 2.75% to 4.3%. Combined senior and mezzanine coverage equaled 1.8x in fiscal 2011 (just 1.0x less capital contributions). Excluding a one-time $28.9 million state grant received in fiscal 2011, all-in ADS coverage dropped to a low point of 1.2x. Fitch notes that the grant was related to a canal project and was prudently used to pay maturing notes in fiscal 2012.
Water sales revenues were $3.2 million under budget in fiscal 2012 due primarily to cool, wet spring weather. However, the district posted a $3.1 million surplus due to unanticipated settlement payments and cost containment. Including the issuance of $80 million in CP in 2013 and 2014 and refinancing of the mezzanine debt, coverage is projected to range between 1.31x to 1.75x through fiscal 2018. This is based on the district's assumption that water sales rise 4% annually, which Fitch considers aggressive. Water sales increased slightly to 94,000 acre-feet (af) in fiscal 2011 from 93,000 the prior year. It further increased to 98,500 af in fiscal 2012. However, consumption remains far from its peak of 122,000 in 2007. Management projects a return to normal levels by 2017.
Fitch's concern regarding ADS coverage is somewhat mitigated by the district's strong liquidity. The district maintains a significant rate stabilization fund with a balance of $56.88 million. In addition, the district also maintains healthy system reserves, with 590 days cash on hand.
MANAGEABLE CAPITAL NEEDS
Capital needs are manageable as the district nears completion of a major water supply project, the expansion of its Los Vaqueros Project (LVP). The LVP includes a reservoir, pumping stations, two Delta intakes, and other facilities. The new facility is designed to provide reliability during drought periods and will allow the district to market its storage capacity to others. Annual capital costs are expected to fall significantly and focus more on renewal of system assets.
Capital costs for the 10-year fiscal 2013 - 2022 period total $477.6 million, which is over $100 million lower than just two years prior. Borrowed sources account for about 13.4% of the costs of the higher priority projects. Supplies are expected to be sufficient to meet customer demands through ultimate build-out of the service area. This will be primarily due to existing resources and source water development projects contained in the district's CIP.
ELEVATED DEBT PROFILE
While planned debt to equity funding of the CIP is favorable, prior issuances by the district have led to elevated debt ratios. However, amortization is relatively rapid, with more than 60% of principal repaid within 10 years although the district expects amortization to slow with smoothing of principal through refinancing. This should allow the debt profile to improve over the medium term. The district expects to continuously rollover maturing series B mezzanine notes, which mature Oct. 1, 2016, until fiscal year 2021. At that time, Fitch expects the district will refinance the maturing notes with senior lien long-term debt. Management expects to initiate an $80 million extended
STABLE SUPPLY AND CUSTOMER BASE
The customer base is sufficiently diverse, with treated water customers accounting for about 62% of total water sales and untreated accounting for about 35%. Residential customers account for about 78% of treated water revenues. Untreated water is about evenly split between municipal customers. This includes the cities of Antioch, Martinez, Pittsburg, and Brentwood, and industrial customers, including Tesoro, and General Chemical. The largest wholesale customer, Shell Oil Company, accounts for 22% of total untreated water revenues.
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.
In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012);
--'Rating U.S. Municipal Short-Term Debt' (Dec. 8, 2011);
--'2012 Water and Sewer Medians' (Dec. 8, 2011);
--'2012 Sector Outlook: Water and Sewer' (Dec. 8, 2011).
--'Fitch Rates Contra Costa Water District (CA) & Water Authority Revs 'AA+' (June 19, 2012).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Water and Sewer Revenue Bond Rating Criteria
Rating U.S. Municipal Short-Term Debt
2012 Water and Sewer Medians
2012 Outlook: Water and Sewer Sector
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