OREANDA-NEWS. April 13, 2015. Fitch Ratings affirms the 'A+' rating on the following Palmdale Water District Public Financing Authority (the authority), California water revenue bonds:

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

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

ADEQUATE FINANCIAL PERFORMANCE: Senior lien debt service coverage (DSC) in fiscal 2014 was solid at 2x and cash balances have improved to over 200 days cash on hand. All-in DSC is weaker at 1.3x when taking into account the district's capitalized obligation in the State Water Project (SWP). Financial metrics are adequate for the rating category.

DROUGHT CONCERNS: California' ongoing drought, coupled with an anticipated groundwater allocation reduction, is pressuring the district's water supplies. Water sales have declined in recent years as a result of conservation efforts but potential mandatory rationing by the state could require significant further declines in water sales.

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 SWP.

LOCAL ECONOMY PRESSURE: The area economy is characterized by high unemployment levels, with levels almost 3% higher than the state average and about 4% higher than the national average.


RATING SENSITIVITIES

DETERIORATION OF FINANCIAL PERFORMANCE: Preservation of healthy financial margins is needed to support the district's planned water supply acquisition spending.

PRESSURE FROM STATEWIDE DROUGHT: Declines in financial margins could occur if California's statewide drought continues to erode water sales.

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 REDUCTIONS

The district's total water supply is just over 30,000 acre feet (af), which includes the district's SWP allocation (21,300 af), a lease agreement with Butte County for additional SWP water (11,300 af), surface water from the Littlerock Reservoir (5,500 af) and groundwater rights (up to 12,000 af). The district typically takes the allocation received from the SWP, the about half the amount of water available from the Littlerock Reservoir and balances the rest of its customer demand from groundwater.

The district assumes for planning purposes, that only 60% of its SWP allocation (12,780 af) will actually be delivered in any given year as a result of the operational and environmental challenges associated with the SWP. However, the current drought has resulted in much lower annual allocations with the district only receiving 5% in 2014 and 20% in 2015. The district supplemented these lower allocations with voluntary and now mandated conservation measures from its customers, additional groundwater pumping and the multi-year lease with Butte County.

The district's groundwater allocation is expected to decline as a result of a settlement regarding the Antelope Valley Basin Adjudication that will conclude 15 years of litigation. The district expects a settlement to be reached in 2015 but the full effects of reduced pumping requirement will not be realized for seven years. The settlement is expected to provide longer-term sustainability to the basin, which will place the district in line with goals established in the state's recently passed groundwater sustainability legislation.

Due to the drought and upcoming basin settlement reductions, the district is investing in alternative water supply sources. The district is participating in the development of multiple reclaimed water projects and water recharge facilities that are expected to supplement supplies and improve storage capacity. Funding is anticipated to coming from a variety of sources including grants, low interest state revolving loans, impact fees and partnership contributions.

DEMAND REDUCTIONS

Water sales have declined from a high point of 22.7 million gallons per day (mgd) in 2008 - consistent with other regional utilities - as a result of the economic recession, conservation efforts, and variable weather conditions. Sales rebounded slightly in 2012 and 2013, reflecting the beginning of the current drought and higher demands for water. With more recent statewide conservation messaging and district programs, demand fell to 16.2 mgd in fiscal 2014 from 17 mgd in fiscal 2013. The ongoing drought has prompted an executive order from the Governor for the state to achieve a 25% reduction in water usage by February 2016.

MODERATE DEBT BURDEN

The district's capital improvement plan (CIP) for fiscal years 2015-2019 projects totals a high level of spending at \\$110 million and is largely focused on the \\$85 million groundwater recovery project. The CIP will be funded from remaining series 2013 bonds proceeds, grants, district revenues, and some additional debt is planned. Debt per customer of \\$1,965 is slightly under the 'A' median of \\$2,218. Debt amortization is slow with only 77% of debt maturing in 20 years. Adding to the district's overall debt burden is its obligations for 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 \\$112 million for fiscal 2014.

FINANCES APPEAR TO HAVE STABILIZED

Senior lien DSC has exhibited greater stability in the past four years at over 2x, following more volatile performance in prior years. All-in coverage, including the capitalized portion of the SWP expenses, has been stable in recent years also but is more modest at 1.3x. The limited margins following payment of all obligations results in low free cash flow to depreciation, for example only 25% in fiscal 2014. Cash reserves have improved in fiscal years 2013 and 2014 to just over 200 days, up from a low of 98 days in fiscal 2010. Based on management financial projections which assumed annual 5.5% rate increases, forecast all-in DSC points to at or better than 2014 levels. However, lower water sales, as may be mandated by the state, could reduce current estimates of financial performance.

ELEVATED RATES - STRONG RATE STRUCTURE

Following a legal settlement with the city of Palmdale over 2009 rate increases, the district recently completed a new rate study and the board has approved rate increases of no more than 5.5% for the next five years, with the board approving a slightly smaller 2.5% for fiscal 2015. The rate structure includes a fixed charge of about 50% of the total bill and a commodity charge which is based on water volume. This strong 50% fixed charge provides revenue stability and is seen as a credit positive. The current average residential rate is \\$53 and is noted as somewhat high for the region, registering as the fifth highest compared to surrounding communities. The district's plan is to increase rates by no more than 5.5% annually, which shouldn't be overly burdensome to rate payers, but provide for continued stable financial performance.

WEAKENED ECONOMY

The area economy was hard hit by the economic downturn and unemployment remains elevated at 9.3% as of December 2014; substantially higher than the state and national averages of 6.7% and 5.4%, 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.