OREANDA-NEWS. Fitch Ratings has affirmed its 'AA+' rating on the following Hillsborough Public Improvement Authority, California's (the authority) certificates of participation (COPs) issued on behalf of the Town of Hillsborough, California (the town):

--$31.565 million outstanding COPs, series 2000A, 2000B, 2003A, and 2006A.

The Rating Outlook is Stable.

SECURITY
The COPs are payable from installment payments from the town to the trustee as assignee of the authority. The town's obligation to make installment payments is secured by a first lien on the net revenues of the town's water and sewer system (the system).

KEY RATING DRIVERS
SOUND FINANCIAL PROFILE: The system's financial metrics are sound, with debt service coverage (DSC) continuing to outpace prior forecasts. The system's liquidity has also remained consistently strong.

STRONG RATE-ADJUSTMENT HISTORY: The town continues to demonstrate a willingness to raise water and sewer rates to fund rising wholesale water costs and capital improvements. Rate increases have also been approved as part of a five-year rate package through fiscal 2015 for water and fiscal 2016 for sewer.

HIGH DEBT LEVELS: Debt ratios are much higher than similarly rated systems. However, debt is manageable with limited planned leveraging to address an outstanding cease and desist order (CDO). Hillsborough's wealthy customer base partially offsets pressure from the high debt load.

LARGE BUT WELL-MANAGED VRDO PORTFOLIO: The town's large variable rate debt obligation (VRDO) portfolio, while managed well, could present a burden to system finances. Variable rate concerns are somewhat mitigated by strong liquidity levels and a demonstrated willingness to raise rates.

STABLE AND AFFLUENT CUSTOMER BASE: While the service area is small, it is located in the broad and diverse San Francisco MSA with a stable customer base characterized by above-average income levels and low unemployment.

RATING SENSITIVITIES
MAINTENANCE OF STRONG FINANCIAL METRICS: The town's ability to maintain debt service coverage and liquidity levels in light of the rapidly increasing cost of San Francisco Public Utilities Commission (SFPUC) water, the system's wholesale provider, along with declines in usage due to conservation, are important to maintaining the 'AA+' rating.

DROUGHT PRESSURES: The town appears poised to withstand the effects of a decrease in water sales over the short term, but further cuts beyond those currently expected could pressure operational revenues. Reduction in expenditures and/or additional rate increases may be necessary to maintain current DSC margins and thereby maintain rating stability.

CREDIT PROFILE
The system provides water and sewer distribution and collection for roughly 4,200 primarily residential customers. The town is located on the San Francisco Peninsula approximately 17 miles south of downtown San Francisco. The service area is wealthy and includes the town as well as portions of neighboring cities of San Mateo and Burlingame and unincorporated county areas.

The town does not own its water supply or operate any treatment facilities. Instead it purchases Hetch Hetchy system water through a long-term wholesale contract with the SFPUC along with 26 other retailers. Wastewater treatment services are provided by San Mateo and Burlingame through separate, long-term wholesale agreements.

SOUND FINANCIAL PERFORMANCE
Financial margins have increased in recent years above expectations due in part to a five-year rate package. Fitch calculated DSC increased to 2.5x and 3.1x in fiscals 2013 and 2014, respectively, after remaining at 1.5x-1.6x the prior three years. Liquidity has been consistently strong with fiscal 2014 year-end cash of $22.6 million, equal to the five year average of 609 days cash on hand.

Despite achievement of 25% water conservation in fiscal 2015, Fitch calculated DSC based on financials provided by the town equal 2.6x due to implementation of a 13% water rate increase and decline in water purchases. It expects DSC of 2.1x in fiscal 2016 with an additional 11% conservation. These estimates include a 20% increase in purchased water rate in fiscal 2015 and 28% in fiscal 2016.

System DSC projections through fiscal 2018, which do not include any connection fees, equal no less than 2.1x assuming flat purchased water rate increases as estimated by SFPUC as well as additional SRF loan debt service payments beginning in fiscal 2017. Projections also include continued annual sewer rate increases of 7% and no additional water rate increases. Additionally, the projections contain continued 36% conservation through fiscal 2017 followed by a return to normal water usage in fiscal 2018. While DSC expectations are favorable, rising wholesale water costs and continued lower water demand levels could pressure DSC without offsetting rate increases and/or spending adjustments.

USAGE REDUCTION IN REPONSE TO DROUGHT
In May 2015, as part of the State Water Resources Control Board mandated state-wide water reductions, the state placed the town in the highest tier of required conservation, equal to 36% of usage. The town has already achieved 25% from June 2014 to February 2015, which management attributes to the town's call for voluntary 10% conservation. The town adopted an urgency ordinance on June 8, 2015 updating its existing code, which sets monthly water usage allotment targets and imposes penalties of $30 per unit of water above the target. The town is limiting irrigation and vehicle washing and conducting site inspections for repairs and replacement of plantings, among other actions. Management reports that the voluntary consumption and the ordinance have reduced town water use by 40-50% as of May 2015. The town is also checking the entire system for leaks and conducting outreach and education. The town plans to install automated meter readers in fiscal 2016.

RATE-RAISING WILLINGNESS A CREDIT STRENGTH
Hillsborough has raised both water and sewer rates consistently in order to ensure necessary resources for rising wholesale water costs and capital spending. The city council approved annual customer rate increases of approximately 13% in each of fiscals 2014 and 2015 for water and 7% in each of fiscals 2015 and 2016 for sewer. Despite the level of adopted rate hikes, rates are only equal to about 1.6% of median household income. As such, the system maintains sufficient rate raising flexibility due to the very high wealth levels of the customer base. A new rate study is underway for both water and sewer, with implementation expected in fiscal year 2016.

DEBT LOAD IS HIGH, YET MANAGABLE
Debt ratios are high, with debt per customer at $4,112 at fiscal year-end 2014. Debt per customer increases further to $5,580 in 2015 with the addition of a $12 million state loan - nearly three times that of Fitch's median for 'AA' category credits. In addition, debt to net plant of 74% is higher than the 'AA' category median of 50%. The high debt ratios are driven by a small customer base and capital projects required to comply with the CDO for sewer overflows. The town's affluent customer base and general support from the community, somewhat mitigate concerns of a high debt load.

WELL-MANAGED VARIABLE-RATE DEBT PORTFOLIO
All of the town's parity utility system bonds have been issued as VRDOs, with a liquidity facility provided by JP Morgan Chase Bank, N.A. (rated 'A+/F1' by Fitch, with a Stable Outlook). Three of the system's four outstanding bonds have synthetic fixed-rate payor swaps. Only one outstanding COP issue--the 2000 series A, which currently totals $3.7 million--is unhedged.

While the town continues to successfully manage its debt portfolio with good fiscal oversight and planning, including its use of swaps to hedge against interest rate risk, the town's ability to effectively manage risk related to the swaps is essential to the rating. These risks are somewhat mitigated by the fact that management monitors its swaps regularly and budgets for debt service using the fixed rate under the swaps. Management also assumes a 12-month historical average on the non-hedged variable-rate bonds. In addition, the town continues to maintain very high liquidity levels.

SMALL WEALTHY CUSTOMER BASE
Hillsborough serves a small but stable and affluent customer base with approximately 11,400 residents. The town's median household income of $236,528 is 387% and 446% of the state and national averages, respectively. County unemployment rates are low at 3.4% as of March 2015 compared to rates of 6.5% for the state and 5.6% for the nation. The town benefits from its close proximity to the San Francisco Bay Area and Silicon Valley.