News Column

Fitch Downgrades Contra Costa Water District, CA Water Revs to 'AA'; Outlook to Stable

May 5, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'AA' rating to the following Contra Costa Water District, CA (the district) obligations:

--$100.1 million water revenue refunding bonds, series T.

The bonds are expected to sell via negotiation the week of May 19. Proceeds will be used to advance refund all or a portion of the district's outstanding water revenue refunding bonds, series N for net interest savings without extension of the maturity of the debt.

In addition, Fitch downgrades the following ratings on outstanding obligations:

Contra Costa Water District

--$376.4 million in outstanding water revenue bonds, series 2003M, 2005N, 2007O, P, Q and R to 'AA' from 'AA+';

--$99 million in outstanding water revenue notes, series 2010A and B to 'AA-' from 'AA';

--Implied long-term subordinate lien rating to 'AA-' from 'AA'.

Contra Costa Water Authority, CA (the authority)

--$22.9 million water treatment revenue refunding bonds, series 2012A at 'AA' from 'AA+'.

Fitch also affirms the following district rating:

--Up to $80 million in authorized extendable municipal commercial paper (CP) notes at 'F1+'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The district bonds are senior lien obligations payable from net revenues of the district's water system (the system). The authority bonds are senior obligations payable from rental payments made by the district to the authority from net system revenues. The water revenue notes, series A and B, are mezzanine obligations payable from net system revenues on a basis subordinate to the senior debt. The CP notes are subordinate lien obligations payable from net system revenues on a basis subordinate to the senior and mezzanine debt.

KEY RATING DRIVERS

DOWNGRADE DUE TO LOWER OPERATIONS: The downgrade and revision in Outlook to Stable from Negative reflects a stabilization of debt service coverage (DSC) at a lower level from prior highs and one that is more consistent with a 'AA' senior lien/'AA-' subordinate lien rating given all other credit factors.

SIGNIFICANT LIQUIDITY: DSC concerns are partially mitigated by the district's consistently high cash levels with reserves equal to over two years operations, or approximately double the average for the rating category.

AMPLE SUPPLY: District supplies are sufficient to meet user demands with only a moderate request for voluntary cutbacks of customers during the current drought cycle. The district's diverse supply portfolio is also capable of satisfying customer demands through build out, which is estimated to occur in 2050.

STABLE CUSTOMER BASE: The district provides water to a full composition of residential, municipal, and industrial customers in a stable growth environment.

ELEVATED DEBT; MANAGEABLE NEEDS: Capital needs are manageable and amortization is fairly rapid, which should allow the district's debt profile to come more in line with median levels by the end of the forecast period.

SHORT-TERM RATING: The 'F1+' rating on the district's extendable CP program reflects anticipated market access of the district and corresponds to the district's 'AA-' implied long-term subordinate lien credit rating.

RATING SENSITIVITIES

IMPROVING OPERATING MARGINS: Actual DSC results or relatively near-term prospects of results that are more consistent with historical DSC would be viewed favorably.

OVER RELIANCE ON CONNECTION FEES: The district's DSC levels net of connection fee revenues over the forecast period range from just above 1.0x to under 1.5x, well below average for the rating level. Failure by the district to generate at least 1.0x DSC from recurring revenues would likely pressure the rating even with the prospects of likely sizeable DSC margins subsequent to the forecast period.

CREDIT PROFILE

The district provides both retail and wholesale water service to about 500,000 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).

ADEQUATE COVERAGE/STRONG LIQUIDITY

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. DSC has declined more recently due to lower sales resulting from several years of drought followed by a cool, wet weather year, conservation efforts, and the economic downturn. For fiscal 2012 total DSC was just 1.4x compared to the prior three-year average of 2.1x.

Fiscal 2013 total DSC remained 1.4x on a 3.5% rate hike and uptick in sales volume that was offset by rising operating expenses. Total DSC is expected to remain at this lower level (in the 1.3x-1.5x range) through most of the fiscal 2014-2018 financial forecast. The lower DSC is driven predominantly by the expectation of a drop in sales to just 87,000 acre-feet (af) in fiscal 2015 related to the current drought and calls for conservation coupled with only moderate annual sales increases through fiscal 2020 when total sales are expected to reach 115,000 af and approximate pre-recession highs.

This lower DSC is more consistent with the 'AA' senior/'AA-' subordinate lien level. Despite the lower DSC, cash flows are expected to be sufficient to allow the district to meet the vast majority of its capital needs through pay-go sources and preserve very strong reserve levels. For fiscal 2013 the district maintained over 730 days cash based on unrestricted resources as well as board-restricted reserves consisting mostly of the district's $57 million rate stabilization fund.

MANAGEABLE CAPITAL NEEDS

Ongoing capital needs are manageable given the recent completion of major water supply projects, including the expansion of the district's Los Vaqueros Reservoir (LVR). LVR was designed to ensure water quality to district customers and provide reliability during drought periods. For the current drought, LVR has limited the drought impact to customers such that the district is seeking only moderate levels of conservation from customers and only in outdoor watering.

Capital costs for the 10-year fiscal 2015-2024 period total $560 million, of which only $299 million are higher priority projects that are identified for funding. Remaining capital costs are lower priority projects that must meet certain parameters before they would become available for funding. Priority capital projects identified in the district's CIP focus on ongoing renewal of system assets and will be funded almost exclusively through pay-go resources and existing cash balances. Only 5% ($16 million) of the district's 10-year CIP is expected to be debt funded.

ELEVATED DEBT PROFILE TO IMPROVE

The planned debt to equity funding of the CIP is favorable, although prior issuances have led to elevated existing debt ratios. Currently, outstanding debt per capita of $1,060 is over 2x the 'AA' category median. However, the district's 10-year principal amortization is rapid and nearly 2x that of comparably-rated credits.

This rapid principal amortization of existing debt and lack of significant borrowing plans in the future will allow debt ratios to fall dramatically in the coming years. Currently elevated debt carrying charges should also level off in fiscal 2020 and then fall significantly beginning in fiscal 2025. As debt service costs drop, even more surplus cash would be available for capital and should preserve and likely enhance district cash reserves and operating margins. Greater certainty of this improving financial profile could lead to positive rating action in the future.

STABLE SUPPLY AND CUSTOMER BASE

The customer base is sufficiently diverse, with treated water customers consistently accounting for about 62% of total operating revenues and untreated (i.e. wholesale deliveries) accounting for about 33%. Untreated water is about evenly split between municipal and industrial 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 20% of total untreated water revenues or 6% of total operating revenues.

The district benefits from its location in the eastern portion of the greater San Francisco Bay area, with access to employment centers of San Francisco, Oakland, and Silicon Valley. County income levels are 50% higher than U.S. averages and 28% above the state average. Unemployment of 6.9% as of Dec. 2013 is on par with the nation and lower than the state's 7.9%.

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria (June 2013);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Outlook: Water and Sewer Sector' (December 2013).

Applicable Criteria and Related Research:

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Additional Disclosure

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE '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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Doug Scott, +1-512-215-3725

Managing Director

Fitch Ratings, Inc.

111 Congress Ave, Ste 2010

Austin, TX 78701

or

Secondary Analyst

Andrew Ward, +1-415-732-5617

Director

or

Committee Chairperson

Jessalynn K. Moro, +1-212-908-0608

Managing Director

or

Media Relations

Elizabeth Fogerty, +1-212-908-0526 (New York)

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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