OREANDA-NEWS. Fitch Ratings has assigned a 'AAA' rating to the following Olivenhain Municipal Water District, CA (the district or OMWD) revenue bonds:

--Approximately $17 million OMWD water system refunding revenue bonds, series 2016A.

The bonds will be sold via competitive bid on September 27. Proceeds will be used to refund outstanding series 2009 water revenue bonds for debt service savings.

In addition, Fitch has upgraded the following ratings (pre-refunding):

--$16.6 million OMWD Financing Authority water revenue bonds, series 2009 to 'AAA' from 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a first lien on net district water revenues after payment of operations and maintenance (O&M) expenses.

KEY RATING DRIVERS

UPGRADE ON EXCELLENT FINANCIAL PERFORMANCE: The rating upgrade reflects the district's historically strong financial margins which withstood the stress of the drought of record while maintaining solid debt service coverage (DSC). Projections indicate DSC will remain favorable over the forecast period even with lower forecast water sales. The district also has consistently maintained very strong liquidity due to large capital, operating and rate stabilization fund balances.

AFFLUENT SERVICE AREA: The district's role as the water supplier to an affluent, economically vibrant suburban service area in northern San Diego County provides strong fundamental support for bond repayment.

DISCIPLINED RATE-SETTING: Policymakers have consistently raised rates to maintain financial health, and rates remain affordable relative to incomes despite prior increases. OMWD's rate ordinance authorized the district board to pass through increases on purchased water wholesale costs, O&M, capital facilities costs, and any reduction in property tax revenues by the state not to exceed 15% annually through Dec. 31, 2019.

IMPORT RELIANCE: The district's main credit weakness is dependence on imported water supplies, which exposes it to supply cuts and rate hikes that can threaten margins and pressure rates. However, OMWD's historical rate discipline and new rate ordinance largely mitigates this risk.

ELEVATED DEBT BUT MANAGEABLE BORROWING PLANS: The district's fiscal 2017 - 2021 capital plan includes about $17 million of additional debt, keeping the district's elevated debt ratios roughly stable amid rapid amortization of outstanding bonds and a practice of paying for most capital spending from ongoing revenues.

RATING SENSITIVITIES

SHIFT IN FUNDAMENTALS: The rating is sensitive to fundamental shifts in the district's credit profile, particularly changes in the debt burden, availability of imported water supplies and rate-setting behavior.

CREDIT PROFILE

The district provides water and sewer services to an affluent service area of about 84,000 people in the suburbs 30 miles north of downtown San Diego. The district service area includes portions of the cities of Encinitas, San Marcos, Solana Beach, Carlsbad and adjacent areas.

STRONG FINANCIAL PROFILE

The district's financial performance remains strong. Based on audited financials (which include a modest amount of non-pledged sewer revenues and special assessments), total DSC including obligations secured by special assessment revenues averaged 3x over the five years ended fiscal 2015. Annual DSC results vary somewhat due to large swings in connection fee revenues and water sales volumes. However, coverage has remained at levels consistent with the current high rating even in the most difficult operating environments, including drought, sharp increases in wholesale water costs, and a deep recession.

Similar to the district's solid DSC, liquidity has been very high historically. At the end of fiscal 2015 liquidity remained extremely strong with unrestricted cash and equivalents equal to 525 days of operating expenses. Despite drought related contraction of sales, cash flows remained satisfactory with surplus revenues equaling 76% of depreciation expense for the year.

Preliminary unaudited results for fiscal 2016 for pledged revenues alone show a slight decline in DSC to a still solid 2.7x on the senior lien water revenue debt due primarily to drought related water conservation efforts which curtailed potable water sales by 21% for the year. The district projects senior lien DSC will range from a low 2.6x to a high of 3.5x from fiscal years 2017 to 2021, in a relatively conservative district forecast that includes no gains in tax revenues, no significant pickup in connection fees, reasonable cost increases, and modest recovery in water usage. Fitch-calculated total DSC is also expected to remain solid, averaging 2.7x during the forecast period.

WATER CONSERVATION

The California State Water Board ordered all public water providers to reduce water usage in recent years due to extreme state-wide drought conditions. The district fully complied with its reduction requirements and its financial performance held up very well during the period of mandatory conservation because its tiered rate structure increased the average cost of water while promoting conservation. When the district needs to conserve water, policymakers declare a higher drought stage ranging from watch to emergency levels. The rate structure stabilizes revenues while promoting conservation by pushing usage into more expensive tiers, increasing the average price of water sold. While drought conditions continue, recent regulatory changes have eased conservation requirements.

GOOD RATE DISCIPLINE

OMWD's board has consistently approved necessary rate increases to maintain its strong financial position and to provide significant pay-go funding for the district's capital program. The board increased water rates by an average of 5.9% annually in the five years ended fiscal 2015 based on Fitch's standard 10 hundred cubic foot (hcf) assumption. Moreover, a healthy 52% of rates are recovered in the base charges under the same assumption.

On April 1, 2015, the board adopted a new rate ordinance increasing its commodity rates and fixed charges by 5% and added a fourth tier to supplement its conservation efforts. Additionally, the new rate ordinance authorized the board to pass through wholesale water cost increases and any reduction in property tax revenues by the state in an amount not to exceed 15% per year through Dec. 31, 2019. OMWD implemented a 6% rate increase effective on March 31, 2016 under this rate authorization.

Despite the rate increases, rates remain affordable at 0.8% of median household income (MHI) based on 10 hcf water usage assumption. Actual usage is significantly higher in this semi-arid region, suggesting that average bills are above Fitch's 1% of MHI affordability threshold. However, rates are typical for San Diego County and have not elicited significant formal rate protests from customers. Fitch considers rate flexibility to be adequate.

IMPORT DEPENDENCE

The district is a member agency of the San Diego County Water Authority, CA (SDCWA, revenue bonds rated 'AA+' by Fitch) and receives 100% of its potable water supply from SDCWA. SDCWA in turn, imports water which it buys primarily from the Metropolitan Water District of Southern California (MWD, revenue bonds rated 'AA+' by Fitch). Both SDCWA and MWD imposed large rate increases on member agencies in recent years, pressuring rates for retailers across the region.

OMWD is working to diversify its water supply via water recycling and possible future investments in a brackish water treatment facility. Investments that diversify the district's water supply are positive for credit quality in the long-term because they provide more reliable supplies at more predictable prices, but the projects are likely to pressure rates somewhat.

REASONABLE DEBT BURDEN

The current $55 million fiscal 2017 - 2021 capital improvement plan includes about $17 million in debt issuance for a potential brackish water treatment facility. The plan is manageable and would not meaningfully change the district's debt burden given the rapid amortization rate of existing debt.

The district's current debt burden is above-average but affordable at $2,117 per customer. Debt ratios that relate leverage to the district's significant resource base are more favorable. For example, its fiscal 2015 debt-to-equity ratio of 1.5x is in line with the median of 1.4x for 'AAA' utilities. Debt-to-net plant assets also compares favorably at 19% compared with the 27% 'AAA' median. Amortization is rapid with 60% of principal repaid over 10 years and 95% over 20 years.

MATURE RESIDENTIAL AREA

San Diego County (implied general obligation rating of 'AAA' by Fitch Ratings) has a diverse economy centered on manufacturing, military and related defense industries, and tourism. The service area is primarily residential and about 90% built out. County unemployment at 5.1% as of June 2016 was on par with the national level but below the state (5.7%). Wealth levels as measured by MHI are high at approximately 1.5x that of the state's MHI.