OREANDA-NEWS. Fitch Ratings has affirmed the 'AA' rating on the following Padre Dam Municipal Water District, CA (the district):

--\\$51.5 million certificates of participation (COPs) series 2009.

The Rating Outlook is Stable.

SECURITY

The certificates are payable from a first lien on district net revenues, including revenues of the water and sewer systems (the system).

KEY RATING DRIVERS

HEALTHY FINANCIAL METRICS: The district's debt service coverage (DSC) is solid at over 3x for the last two fiscal years and cash levels improved to almost one year's worth of cash on hand, up from 200 days in fiscal 2011.

MANDATORY DROUGHT CONSERVATION: State regulators have ordered the district to reduce water usage by 20% in response to a statewide drought. The mandated reductions will impact financial margins but should be manageable given the system's healthy financial margins and sound cash position.

RELIANCE ON WHOLESALE PROVIDER: The district is dependent on the San Diego County Water Authority (CWA) for 100% of its water supply. This reliance is a vulnerability that can lead to reduced water sales when supplies are curtailed. The availability and pricing of water supply is a key credit driver for the district.

ABOVE AVERAGES RATES: Despite a beneficial rate structure with a substantial fixed base rate, user charges are above Fitch's affordability threshold and generally high for the area. Rates have been driven up by rapidly increasing cost of purchased water, leading to above average retail rates and will likely continue to result in rate pressure.

AVERAGE DEBT PROFILE: The system's debt burden is average for the rating level and anticipated to decline due to lack of planned debt.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: The rating could come under downward pressure if financial margins fall more than expected due to severe, multi-year water rationing related to the current severe California drought.

RATE MANAGEMENT: Direct pass through of increased wholesale water and wastewater costs to retail customers will continue to be necessary to preserve the Padre Dam Municipal Water District's strong financial margins. Although rates are already above average, additional disparity is expected as imported water costs in southern California continue to increase.

CREDIT PROFILE

The district provides retail water and wastewater service to a population of approximately 100,000 residents of the city of Santee and various unincorporated communities in eastern San Diego County. The district also operates a preserve system that consists of a large campground facility, parks and seven recreational lakes. The preserve system is financially self-supporting and uses the output of the district's recycled water facility. District wastewater not treated by the recycled water facility is transported to the city of San Diego's Metropolitan Sewerage System (Metro Sewer) for treatment. Growth in the service territory has been modest, averaging less than 1% in the past five years.

DROUGHT MANDATE IMPACTS MANAGEABLE

On May 5, as a response to the Governor's recent executive order to reduce annual water usage in the state by 25%, the State Water Resource Control Board adopted rules requiring mandatory reductions in water usage for all of California's water providers. The district's required reduction is 20% over 2013 levels, of which the district has achieved 7%. To attain the remaining 13% necessary to meet the mandate, the district has enacted stage 2 water restrictions. The district also plans an aggressive public education campaign and will reach out to high users directly. The district has not adopted drought rates at this time but has not ruled out instituting drought rates if the drought continues.

While the anticipated 20% reduction in water consumption will negatively affect net revenues, such results are expected to be manageable. The district plans to reduce purchases of expensive imported water supplies as consumers reduce usage and also implement other cost cutting measures. Projected all-in DSC, taking into account reduced consumption, dips to 2.1x but remains adequate for the rating level.

RELIANCE ON WHOLESALE PROVIDERS

Water supply is received almost entirely from purchases from the CWA (revenue bonds rated 'AA+', Stable Outlook by Fitch). The district also has a connection with a neighboring water district for back-up or emergency supply. With no local water supply, Padre Dam was subject to significant CWA rate increases in fiscals 2010 and 2011 when rates jumped by 23% and 13%, respectively, followed by increases of 8% to 9% for fiscal years 2012 and 2013. A more modest 4.4% increase was enacted for fiscal 2014 and a 5% increase is anticipated for fiscal 2015.

CWA receives a large share of its water from the Metropolitan Water District of Southern California (Metropolitan; revenue bonds rated 'AA+', Stable Outlook). Metropolitan members are required to meet a legislative requirement to reduce per capita usage by 20% by 2020. That initial requirement was met, but consistent with statewide efforts to reduce water usage and the Governor's executive order to curtail water sales by retail utilities, Metropolitan moved to Stage 3 of its allocation plan in April 2015, requiring its members to reduce their purchases from Metropolitan by 15% in fiscal 2016.

The district is a party to two agreements with Metro Sewer, one to treat additional flows and one to handle sludge from the district's recycling plant; the agreements expire in 2050. All payments to Metro Sewer are treated as operating expenses by the district. The Metro Sewer plant is currently operating under a 301(h) waiver of the federal Clean Water Act, which expires in July 2015. The plant could require significant regulatory-related capital investments in the coming years, which could result in higher sewer system charges to members, including the district.

RATE FLEXIBLITY STRAINED BUT STRUCTURE STRONG

The cost pressures on imported water in southern California are expected to continue, which will directly impact the district's retail rates and those of other area utilities. The district's rates are relatively high, a function of both water supply costs and ongoing capital investment to maintain infrastructure. In 2007 the district's board adopted a multi-year rate increase package that averaged 9.4% annually for water customers and 10.4% annually for wastewater customers, including the direct pass-through of rate increases by the wholesale water and wastewater providers to the district.

The five-year internal rate package adopted in 2012 includes more moderate increases of 4.75% annually for water rates and 1.5% annually for sewer rates. In 2011, the board also approved a significant increase in the fixed rate charged as well as a rate pass-through ordinance in which rate increases imposed by wholesalers are directly passed through to rate payers. Rate flexibility is limited, as current average bills register at 2.5% of median household income - already above Fitch's affordability threshold of 2.0%.

The increases and rate structure adjustments, along with downsizing and reduced capital spending successfully eliminated budget deficits. Further, rate adjustments position the utility to support debt service on the anticipated 2009 COPs. The budget deficit also was addressed through downsizing and reduced capital spending. Fitch sees these adjustments as positive credit factors that should maintain stable financial metrics going forward.

STRONG FINANCIAL METRICS PREVAIL

The district's DSC historically has been healthy. Coverage was projected to remain above 2.0x even after the issuance of the 2009 COPs (excluding connection fees). Audited results for fiscal years 2012-2014 confirmed this projection, with coverage levels exceeding 2.0x on all system debt. Liquidity continues to improve growing to 359 days of cash on hand in fiscal 2014, up from 199 days in fiscal 2011. Forecasts provided by management, which appear reasonable and take into account drought related adjustments, indicate continued strong annual DSC levels dropping to no lower than 2.1x in 2017 with cash balances remaining over 200 days.

The economic recession in California has not had a major impact on the district's development; dependence on connection fees is minimal. However, the district does receive a portion of the county's property tax revenues (as do many special districts in the state), and 8% of those monies will be borrowed by the state to be repaid at a later date. The financial impact to debt service coverage is expected to be marginal.

DISTRICT EXPANDS RECYCLED WATER USE

The district's most recent five-year capital (2013 - 2017) plan is a manageable \\$69 million, or \\$1,818 per customer, and is primarily focused on water system needs. The capital plan will be funded primarily with surplus revenues and remaining series 2009 COPs proceeds, as there is no planned borrowing. Out-year capital plans include expansion of the district's advance purification facilities. Expansion of recycled water facilities could reduce some of the district's reliance on costly imported water, while also reducing costs associated with wastewater treatment, by utilizing the system's own effluent for advanced treatment.

Phase one of the advanced purification plan would include injecting highly treated wastewater into aquifers to be withdrawn and treated again at a later time before being added to the drinking water system. The costs associated with Phase one are estimated at roughly \\$130 million to \\$150 million. The district anticipates applying for state water board grants and loans to fund the phase one of the project with timing and amounts still to be determined. The second phase of the district's advance purification system expansion would be longer range and possibly include other regional participants.

OFF BALANCE SHEET OBLIGATIONS INCREASE AVERAGE DEBT PROFILE

Debt levels, currently at \\$1,822 per customer, align well with the 'AA' median of \\$1,934 and debt amortization is average with 73% being paid off in 20 years. However, taking into account the district's off-balance sheet obligations through both CWA and Metro Sewer, system debt levels are further elevated.

STABLE SERVICE AREA

The district service area benefits from a fundamentally sound regional economy. Wealth levels are 116% and 134% of the state and national average, respectively. Regional unemployment is below average with Santee registering 5% and San Diego County coming in at 5.1% for March 2015, both under the state (6.5%) and national (5.6%) averages.