OREANDA-NEWS. Fitch Ratings has affirmed the following Olivenhain Municipal Water District, CA (the district or OMWD) obligations at 'AA+':

--$26 million OMWD water revenue refunding bonds series 2006A;
--$17 million OMWD Financing Authority water revenue bonds series 2009.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

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.

EXCELLENT FINANCIAL PERFORMANCE: The district's debt service coverage (DSC) is strong and projections indicate DSC will remain favorable despite drought driven water conservation mandates. The district also has consistently maintained very strong liquidity due to large capital, operating and rate stabilization fund balances.

DISCIPLINED RATE-SETTING: Policymakers have consistently raised rates to maintain financial health, and rates remain affordable relative to incomes despite prior increases.

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.

ELEVATED DEBT BUT MANAGEABLE BORROWING PLANS: The district's fiscal 2016 - 2020 capital plan may require $18 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

DROUGHT PRESSURES: The district 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.

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. The Stable Outlook means that Fitch believes such shifts are unlikely over the next two years.

CREDIT PROFILE

The district provides water and sewer services to an affluent service area of about 83,000 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), total DSC averaged 2.9x over the three years ended fiscal 2014. 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 2014 liquidity remained extremely strong with unrestricted cash and equivalents equal to 449 days of operating expenses. Cash flows were also favorable, with surplus revenues equaling 106% of depreciation expense for the year.

Preliminary unaudited results for fiscal 2015 for pledged revenues alone show a decline in DSC to a still solid 2.1x on an all-in basis and 2.6x on the senior lien due primarily to drought related water conservation efforts. Commensurate with the state's mandate to further reduce water use, the district forecast shows all-in DSC at 1.9x and senior lien at 2.3x in fiscal 2016. Subsequently, coverage is projected to average more than 2.0x over the next three years in a relatively conservative district forecast that includes no gains in tax revenues, no significant pickup in connection fees, reasonable cost increases, but a moderate recovery in water usage.
WATER CONSERVATION

In response to the Governor's recent executive order to reduce statewide annual water usage by 25% over 2013 levels, the State Water Resource Control Board (SWRCB) issued a revised plan for mandatory water cuts for all of California's public water providers. The district's required reduction is 32% over 2013 levels. However, the district's recycled water use, which currently comprises roughly 11% of total water demand, comes off the top of the required reductions. Additionally, certain agricultural water use is exempt from the required reduction.
Although the district is largely in compliance with its required gallons per capita per day reduction, the district's board enforced a comprehensive water use efficiency program that included increased public outreach, education, and turf removal programs. The district also implemented higher level 2 shortage rates effective July 1, 2015 that are designed to induce an additional 20% reduction in water use, while remaining revenue neutral. Additional conversions to recycled water are in progress.

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 8.9% annually in the five years ended 2014. On April 1, 2015, the board increased its commodity rates and fixed charges by 5% and added a fourth tier to supplement its conservation efforts. Additionally, the new rate ordinance authorizes 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.

Despite the rate increases, rates remain affordable at 0.8% of median household income (MHI) using Fitch's standard 10 hundred cubic foot 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 (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 $59 million fiscal 2016 - 2020 capital improvement plan includes about $18 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.

The district's current debt burden is above-average but affordable at $2,270 per customer. Debt ratios that relate leverage to the district's significant resource base are more favorable. For example, its fiscal 2014 debt-to-equity ratio of 1.5x is less than one-half the median of 3.6x for 'AA'-category utilities, while debt-to-net plant assets is low at 20% compared with 50% median for 'AA'-category utilities. Amortization is rapid with 57% of principal repaid over 10 years and 94% 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 March 2015 was below state (6.5%) and national (5.6%) levels. Wealth levels as measured by MHI are high at approximately 1.5x that of the state's MHI.