OREANDA-NEWS. Fitch Ratings affirms the following ratings for Alisal Water Corporation (Alco):

--\$6.5 million of outstanding 2007A senior secured taxable bonds at 'BB+';
--Issuer Default Rating at 'BB-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a security interest in pledged collateral, which consists of all tangible and intangible assets owned by Alco.

KEY RATING DRIVERS

FINANCIALS NARROW BUT ADEQUATE: Alco's ratings reflect the utility's adequate but relatively weak financial metrics, including very low liquidity levels and modest cash flows. A rate base increase in 2011 improved Alco's financial profile from prior levels, but margins have weakened in recent years and are expected to remain limited in light of mandated statewide conservation requirements into at least the first part of 2016.

FAVORABLE REGULATORY ENVIRONMENT: The California regulatory environment is relatively predictable and the utility has achieved rate relief as needed, although customer charges are somewhat high.

LIMITED SERVICE AREA AND MANAGEMENT: The customer base is limited and includes a narrow economic profile and very high unemployment. Reflective of the size of operations, the number of employees is relatively small, although the executive team is well qualified.

CAPITAL STRUCTURE TO CONTINUE: Capital needs are manageable, which should help to improve Alco's elevated debt-to-equity mix over time.

LONG-TERM SUPPLY ADEQUACY: The utility provides an essential service and water supplies are sufficient to meet long-term demands. Drought conditions affecting the state have limited impact on Alco's own supplies despite mandated conservation requirements.

RATING SENSITIVITIES

USAGE DECLINES: Continued declines in sales volume could pressure operations and limit capital investment even with rate base offsets given the mismatch of revenue recovery.

CAPITAL STRUCTURE: Improvement in Alco's capital structure would alleviate leverage concerns.

REGULATORY FRAMEWORK: Unfavorable changes in California's regulatory environment that make it more difficult to achieve sufficient rate base adjustments to provide adequate financial margins would be viewed negatively.

CREDIT PROFILE

ADEQUATE BUT WEAK FINANCIAL PERFORMANCE; NEAR-TERM CHALLENGES

Operating revenues were off nearly 3% for calendar 2014 as a result of a weak sales environment (water production was down 14%), spurred by calls for conservation by the Governor in light of the drought gripping the state. Alco cut routine operating expenses for the year to match the lost revenues but costs ended the year up about 4% in light of around \$300,000 in contract work for pipe maintenance. Absent this charge, operating expenses would have been flat.

Overall, 2014 EBITDA covered interest by 1.9x (down from 2.3x in 2013) and net revenues covered total debt service by 1.3x (down from 1.5x). Along with the slight weakening in operating results, cash flows from operations were down \$200,000 from the prior year. As a result, Alco's return on equity (ROE) - per Fitch's calculation which includes interest costs - fell to under 3% from around 6% in 2013. Despite the weak cash flows the net positive operating results for the year allowed Alco to increase its liquidity slightly, with days cash rising to 15 in 2014 from 11 in 2013.

Alco has prepared an updated forecast through 2019, which includes the impact of a state-mandated 24% cut in sales from the summer of 2015 through Feb. 2016. Much of Alco's lost sales revenues are expected to be recovered through various surcharges, although there is something of a timing delay in the revenue recovery which could lead to pressured operations if required reductions continue beyond Feb. 2016. On the expense side, Alco is forecasting essentially inflationary adjustments to operating expenses and no additional borrowings. Based on these assumptions, financial margins will remain tight but adequate at the current rating level, with EBITDA coverage of interest expected to be above 2.1x and total debt service coverage anticipated to approach or exceed 1.4x.

DEBT PROFILE REMAINS ELEVATED BUT IMMEDIATE CAPITAL NEEDS MODEST

For 2014, Alco's debt relative to equity improved marginally to 72% from 74% the year prior as a result of amortization of existing debt and lack of new borrowings. Debt-to-EBITDA weakened for the year, though, on the softer financial results, rising to 6.6x from 5.3x in 2013.

The system's elevated debt profile continues to be a major credit factor. However, incremental improvement in the system's debt profile is expected over the near term given no additional borrowings are planned through the forecast period and amortization of existing debt will continue to occur. Overall, Alco's capital needs are expected to be limited through the fiscal 2019 forecast and consist essentially of ongoing renewal and repair of assets as they become necessary, with such costs paid from surplus net revenues.

FAVORABLE, STABLE REGULATORY ENVIRONMENT; ELEVATED RATES

Alco is regulated by the California Public Utilities Commission (CPUC) but regulations are fairly well-defined and Alco historically has received timely rate relief. Fitch expects the CPUC will continue to allow future adjustments to cover necessary operating and capital expenditures and to generate an ROE commensurate with other similarly-sized private water utilities in the state (currently in the 10% range). Having said this, user rates are elevated and will remain somewhat high based on Alco's 2011 rate case. Currently, residential charges equal 1.1% of median household income based on 1,000 cubic feet of water usage per month.

LIMITED SERVICE TERRITORY AND MANAGEMENT

Alco is a private retail water company in Monterey County California, serving a portion of the city of Salinas and a population of around 29,000. Part of Alco's certificated service area includes undeveloped land within the city's extra-territorial jurisdiction. Water supplies are derived exclusively from groundwater sources. Supplies are estimated to be sufficient to meet customer demands for the foreseeable future and are essentially unaffected by the severe drought conditions currently plaguing the state.

Given the scope of operations, the number of company personnel is limited, including the executive team. Largely offsetting the concern related to limited personnel are the sound experience and qualifications associated with Alco's executive management team.