OREANDA-NEWS. October 07, 2015. Fitch Ratings has assigned an 'AA+' rating to the following Sonoma County Water Agency (the agency's) water revenue bonds:

--\\$21.95 million water revenue bonds 2015 series A and 2015 series A-T (Federally Taxable).

The bonds will sell competitively the week of October 12th. Proceeds will be used to fund approximately \\$13.6 million of various capital projects and to refund approximately \\$9.42 million of outstanding water revenue bonds 2006 series A for level savings.

In addition, Fitch has affirmed the 'AA+' rating on the following bonds:

--\\$21 million outstanding water revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by net revenues of the agency's water transmission system. Net revenues exclude property taxes, various capital cost payments from wholesale customers, Russian River Project funds and Marin Municipal Water District payments for firm water supply.

KEY RATING DRIVERS

CONTRACTUAL WHOLESALE WATER SUPPLIER: The agency makes wholesale water sales in accordance with a long-term agreement for water delivery (through 2040 or until all bonds are repaid). The eight prime contractors that are party to the agreement account for around 79% of water sales across a large, diverse, and economically healthy service area with limited alternative supply options.

STRONG FINANCIAL PERFORMANCE: Debt service coverage (DSC) averaged a very strong 4.8x over the three fiscal years ended June 30, 2014. Liquidity is strong with a three year average of over 500 days cash on hand. Annual rate adjustments help mitigate water sales volatility.

LOW DEBT BURDEN: The agency's debt burden is very low and expected to remain low.
ADEQUATE WATER SUPPLIES: The agency has significant supply redundancy and stored water reserves. However, the severity of the current drought in California has resulted in reduced water sales as a result of state mandated conservation.

STRONG BUDGETING AND MANAGEMENT PRACTICES: The agency's revenue based budgeting process provides a high degree of revenue consistency and bondholder protection. Strong management practices include long-range financial, water supply and capital planning with conservative assumptions.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: The current drought could put downward pressure on Sonoma County Water Agency's rating if financial margins or liquidity levels fall significantly below expectations due to severe, multi-year water rationing. However, the stable Outlook reflects Fitch's belief that the agency's revenue based budgeting is expected to insulate revenues from expected lower water sales.

CREDIT PROFILE

The Sonoma County Water Agency serves portions of Sonoma County (implied general obligation (GO) rating of 'AA+' with a Stable Outlook) and Marin County (implied GO rating of 'AAA', Stable Outlook). The agency is a component unit of Sonoma County and the local sponsor of the U.S. Army Corps of Engineers' Russian River Project. The agency sells project water primarily to eight contractors - the cities of Santa Rosa, Petaluma, Sonoma, Rohnert Park, Cotati, the Town of Windsor, the Valley of the Moon Water District, and the North Marin Water District - as well as the Marin Municipal Water District (MMWD: water revenue bonds rated 'AA+'; Stable Outlook).

HEALTHY WATER SUPPLY AND STORAGE POSITION; SALES IMPACTED BY DROUGHT

The agency's supply position is solid with adequate storage capacity in Lake Sonoma and Mendocino (the two main Russian River Project reservoirs). The agency's combined water rights total 75,000 acre-feet (AF) per year, compared to six-year average demand of 49,420 AF. It uses its 367,500 AF of storage rights in the two federal reservoirs to offset the supply fluctuations inherent in its surface water dependence in a region with extremely variable rainfall. The agency believes capacity is sufficient through at least 2027.
The agency currently has about 180,000 AF (73.6% of capacity or more than three times average annual water use) stored in Lake Sonoma, its main reservoir. Mandatory 30% supply cutbacks would go into effect if the level of storage fell below 100,000 AF before July of a given year, which is not expected by the Agency in the near term.

As a wholesaler, the Agency is not subject to the mandatory conservation requirements established in May 2015 by the State Resources Water Control Board. However, it is still exposed to the requested 25% state-wide cutbacks through the individual conservation mandates required of its customers. Most of its customers are reportedly meeting or close to their mandates, and water deliveries dropped 16.5% in fiscal 2015. Because the conservation standard is measured against 2013, the agency has likely already absorbed the bulk of the hit to water sales in fiscal 2015.

STRONG FINANCIAL PERFORMANCE DESPITE SALE VOLATILITY

Financial performance has been consistently sound and jumped to very strong levels over the past few years. Fitch-calculated DSC was 5.0x and 5.6x in fiscals 2014 and 2013, respectively, from 3.9x in fiscal 2012 and about 2.2x the prior two years. Given the agency's low leverage position and modest debt service payments, debt service coverage ratios increased substantially as the improving economy and dry weather boosted water sales. The utility budgets to achieve debt service coverage of at least 1.5x. Free cash-to-depreciation has averaged a good 183% over the past three years.

Liquidity has been consistently strong with unrestricted cash and investments averaging 459 days of operating cash over the past five years. Cash rose to a particularly strong \\$42.4 million in 2014, equaling 564 days cash. The agency's reserve policies require it to maintain at least 3 months of operating cash in the water transmission fund. The utility has regularly exceeded that low minimum target and Fitch expects it to continue to do so.

Pledged revenues exclude various sub-charges to wholesale customers for capital and other costs. The agency therefore excludes associated expenditures, historically greater than sub-charges, from coverage calculations. Fitch considers coverage on an all-in basis as the true cost of operations. The agency does have substantial flexibility to delay or defer the spending on the projects funded by the sub-charges in any given year. Indenture DSC projections through fiscal 2020 show DSC of no less than 3.3x.

GOOD RATE DISCIPLINE; REVENUE REQUIREMENT BUDGETING

The agency has raised rates as needed to maintain solid financial performance. Conservative budgets are built around reasonable demand assumptions that generally assure results that beat the agency financial targets. The agency raised rates for water delivered through its Santa Rosa Aqueduct by an average of 4.7% annually over the five years ending fiscal 2016. Rates are built around a revenue requirement specified in the agency's Restructured Water Supply Agreement with contractors, which expires in 2040.

The contract unconditionally obligates contractors to pay agency costs regardless of water deliveries. In addition, it provides that a failure to pay by one or more customers would have to be covered by the others through the next year's rate-setting process. In practice, the agency sets its budget annually with water rates based on the revenue requirement and expected demand (dividing the revenue requirement by the lower of the average demand over the prior three years, the prior year's deliveries or requested deliveries).

The formula is a credit strength because it has generally led to customer and elected policymaker consensus around rates. It also provides revenues comfortably above the revenue requirement during typical periods of gradually rising water demand. The formula yields manageable, transitory revenue misses in periods of declining demand. The supply agreement allows the agency to quickly recoup lost revenues, while forcing demand assumptions lower and rates higher in subsequent years. Further enhancing stability, most of the wholesalers, excepting North Marin Water District and MMWD, do not have alternate sources of supply.

LOW DEBT LEVELS, MANAGEABLE CAPITAL PLANS

The agency's debt burden is expected to remain low over the next five years. After this issuance, it will have \\$41.9 million of debt outstanding, including the rated bonds and parity state revolving fund loans. Per capita debt is just \\$68, about a quarter of the median for 'AAA' rated water and sewer systems. Debt is also very low at 25% of net plant assets and just 0.8x equity (unrestricted net assets). The debt portfolio is stable, comprised of only fixed-rate, fully amortizing obligations. Amortization is rapid with 47% of debt repaid in 10 years and 83% repaid in 20. Debt will remain very low with no near term borrowing expected.

The agency's manageable current capital needs focus on environmental regulatory compliance, earthquake hazard mitigation and improvements to its south transmission pipeline. The biggest capital needs relate to compliance with a biological opinion issued by the National Marine Fisheries Service in 2008 governing operations on the Russian River related to fish protection measures. The agency could face significant additional capital demands if current work to fish that spawn in the watershed fails to meet regulatory goals. The current rating could come under downward pressure if the agency were forced to make capital improvements that pushed the agency's debt burden significantly above average.

STRONG SERVICE AREA

The service area is very strong economically with high incomes and very low unemployment rates. The agency and its contractors provide water to the most heavily populated areas of central and southern Sonoma County and Marin County. Median household income is solid at about 126% of the national level in Sonoma County (the core of the service area) and very strong at 170% of the national average in Marin County. Unemployment rates are well below the national average at 4.3% and 3.5% in Sonoma and Marin Counties, respectively, as of August 2015.