Fitch Rates Palmdale Water District Public Fin Auth, California Water Revs 'A+'; Outlook Stable

AUSTIN, Texas--(BUSINESS WIRE)--

Fitch Ratings rates the following Palmdale Water District Public Financing Authority (the authority), California water revenue bonds 'A+':

--Approximately $43.85 million water revenue bonds, series 2013A.

The bonds are scheduled for negotiated sale the week of May 6. Proceeds will be used to refund portions of the outstanding Palmdale Water District (the district) water revenue certificates of participation and to finance various district capital projects.

Additionally, Fitch affirms the district's 'A+' rating on the following bonds:

-- $35.9 million in water revenue certificates of participation (COPs), series 2004 (pre-refunding).

The Rating Outlook is Stable.

SECURITY

The bonds and certificates are secured by net revenues of the district's water system, including connection fees and the district's portion of Los Angeles County's (the county) 1% property tax revenues.

KEY RATING DRIVERS

FINANCIAL PERFORMANCE STABLIZING: Coverage in fiscal 2011 was good at over 2.5x and liquidity improved to 142 days of cash on hand (DCOH). Fitch believes the authority will continue to maintain adequate liquidity and that financial margins will stabilize from prior years of low debt service coverage levels and liquidity relating to litigation, settled in 2012.

MODERATE DEBT BURDEN: The district's debt burden is adequate for the rating level and aligns closely with similarly rated credits. However, the district's overall debt burden is further elevated when taking into consideration off-balance-sheet debt as a result of the district's obligations as a participant in the State Water Project (SWP).

WATER SUPPLY PRESSURE: Water supplies are adequate with the district's demand reduction from conservation and stressed economic conditions in the past few years. The potential for a return to rapid population growth will require acquisition of additional water supplies.

LOCAL ECONOMY PRESSURE: The area economy is characterized by high unemployment levels, with levels 3% higher than the state average and 5% higher than the national average. The district also saw many foreclosures during the housing crisis.

PERMISSIVE LEGAL PROVISIONS: The legal provisions provide for the below-average rate covenant and additional bonds test of 1.1x annual debt service and allows for the use of rate stabilization fund transfers to meet the calculation.

RATING SENSITIVITY

DETERIORATION OF FINANCIAL PERFORMANCE: Favorable financial performance will be critical given the district's recent financial volatility and cost pressure related to water supply acquisition needs.

CREDIT PROFILE

The system provides retail water service within the city of Palmdale and adjacent unincorporated areas of Los Angeles County. The majority of the over 27,000 connections are residential accounts.

WATER SUPPLY LIMITS

Water supply sources include imported water from the SWP at 42%, surface water at 18%, and ground water at 40%. The SWP is owned by the state and operated by the California Department of Water Resources (DWR). The project transports water via a 444-mile aqueduct (the California Aqueduct) to the district's service territory.

The district's total water supply is just over 30,000 acre feet, with the assumption that only 60% of its SWP allocation will actually be delivered. The 60% is a reasonable planning assumption although due to operational constraints and weather conditions, SWP contracts have received anywhere between 35%-100% of their allocations in the past 10 years. The variability of this supply has prompted DWR to explore a potential conveyance pipeline project that would build two underground tunnels to deliver water around the San Joaquin Delta instead of through it. There is considerable uncertainty about the project, including how much it would cost, who would pay for it and if it will be built. If built, it could provide greater reliability to the SWP deliveries across the state.

Water demand in 2012 totaled 19,000 acre feet, which is comfortably under the district's supply. The district is planning for possible resumption of growth in the area for water supply planning purposes, and exploring opportunities to procure additional water supplies. If growth were to resume in the area at levels similar to the 30% population growth that occurred in the past decade, additional water supplies would be needed.

DISTRICT AND CITY RESOLVE RECYCLED WATER DISPUTE

The district also seeks to produce recycled water. In 2009 the city named itself as a purveyor of recycled water within the district's boundaries and the district filed a counterclaim against the city for duplication of service. In 2012 the city and the district reached a settlement in which the city and the district would join together to form a joint power agency (JPA) called the Palmdale Recycled Water Authority. The city will manage office operations and the district will manage field operations.

VOLATILE FINANCES APPEAR TO HAVE STABILIZED

Senior lien debt service coverage (DSC) has been volatile for the last several years, rising to over 2.5x in fiscal 2011 from a low of 1.4x in 2008. DSC in fiscal 2012 was 1.9x based on unaudited financials, or 1.0x all-in coverage, including a portion of costs paid to the SWP for capitalized expenses. These levels have stabilized from previous years when rate hikes in 2009 boosted revenues but legal battles caused expenses to spike in 2010. The district's liquidity declined to just 95 days cash on hand (DCOH) in 2008 after reaching over 800 DCOH in 2006. Unrestricted cash balances have appeared to stabilize, growing to $9.25 million in fiscal 2012 (unaudited) or the equivalent of 149 DCOH.

Management's current forecasts through fiscal 2017 indicate DSC levels averaging 1.4x. The forecasts incorporate conservative assumptions: flat connection fee revenue and customer growth; 2.5% revenue growth; and a 3% increase in expenses. Management assumptions also use property assessments to offset capitalized costs of the SWP. Fitch anticipates actual results will out-perform projections, resulting in slightly higher DSC.

INCREASING DEBT BURDEN

The district's capital improvement plan (CIP) for fiscal years 2013-2017 projects about $19.5 million in projects, with the current offering providing $8.5 million. The 2013 issuance will increase the district's debt load by 17% which will result in debt per capita of $499. This compares favorably to the 'A' rating category median of $521. Also adding to the district's overall debt burden is its participation in the SWP. Under the SWP contract, the district is obligated to pay allocable portions of cost of construction of the system and ongoing operations and maintenance through at least 2035, regardless of the quantities of water available. According to the state's latest estimates, the district's long-term obligation under the contract totals $95.38 million, with $5.18 million (exclusive of variable power costs) estimated for 2012.

RESOLUTION TO RATE LITIGATION

In 2009 the district undertook a series of rate increases, to be implemented over the ensuing five years, in an effort to stabilize and bolster its deteriorating financial position as well as provide funding for support of additional bonds. The board adopted rate increases ranging from 14% to 8% in May 2009 following public notification to customers.

The new rate structure represented the first rate adjustment since the 2005 five-year was frozen due to the application of proposition 218. The city filed suit against the district contesting the rate increases, citing violations of the proposition 218 notification process and challenging the reasonableness of the charges.

In 2012 the district and the city agreed to a settlement of the rate litigation which resulted in allowing a 5% increase in 2011 and an 8% rate increase in 2013. Also part of the settlement agreement was a 10% larger base water allowance which in effect reduced the number of accounts entering the higher tiers of usage.

By the end of 2014 the district will also perform a rate study including a cost of service evaluation. The district has the option to implement an 8% rate increase in 2014 or later, with no further notice or proposition 218 hearing. Currently, user rates are relative high at 1.2% median household income (MHI), registering above Fitch's affordability threshold of 1% MHI.

WEAKENED ECONOMY; PERMISSIVE LEGALS

The area economy has been hard hit by the economic downturn and unemployment remains elevated at 13.5% as of January 2013; substantially higher than the state and national averages of 10.4% and 8.5%, respectively. The city's population grew a substantial 30% since 2000 and while growth has certainly slowed, Fitch remains concerned that future growth will further pressure an already tight water supply profile. The district's current supply levels are adequate, but if growth ramps up again, Fitch believes the authority will be challenged to manage additional supply.

Legal provisions are permissive, allowing for the use of rate stabilization fund transfers to meet a 1.1x rate covenant and 1.1x maximum annual debt service additional bonds test.

Additional information is available at 'www.fitchratings.com'

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);

--'2013 Water and Sewer Medians' (Dec. 5, 2012);

--'2013 Sector Outlook: Water and Sewer' (Dec. 5, 2012).

Applicable Criteria and Related Research

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684901

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

2013 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695756

2013 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695755

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=789929

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