OREANDA-NEWS. Fitch Ratings affirms the following Redwood City Public Financing Authority, CA (the authority) bonds issued on behalf of Redwood City, California (the city):

--$12.5 million water revenue bonds series 2007A at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by net revenues of the city's water enterprise after payment of operations and maintenance expenses.

KEY RATING DRIVERS

VERY STRONG SERVICE AREA: The utility is the monopoly provider of essential water services to a high-income service area about halfway between San Francisco and San Jose. The city is home to major technology companies such as Oracle Corp. and Electronic Arts Inc., yet the utility's payer mix is primarily residential with no significant concentration.

ADEQUATE FINANCIAL PERFORMANCE: All-in debt service coverage averaged a solid 2.1x over the past three fiscal years ended June 30, 2015. Liquidity remained healthy across the period and finished unaudited fiscal 2015 at a strong 406 days.

DISCIPLINED RATE SETTING: The City Council has adopted rate increases as necessary to maintain adequate financial performance, and rates remain affordable at 0.9% of median household income.

HIGH DEBT BURDEN: Debt per capita is high at $2,707 per customer and $762 per capita due to aggressive investments in water recycling and system maintenance. Debt is forecast to decline gradually with no further borrowing planned over the next five years.

JUST ADEQUATE WATER SUPPLIES: The city has access to an adequate, but limited, supply of water via long-term supply contracts with the San Francisco Public Utility Commission (SFPUC). Imported water costs are rising rapidly due to major improvements in the SFPUC water system and declining sales at the wholesale agency.
RATING SENSITIVITIES

IMPROVED FINANCIAL PERFORMANCE: The rating could move higher if recent improvements in financial performance are sustained.

PRESSURE FROM STATEWIDE DROUGHT: The rating could come under downward pressure if California's ongoing drought forces severe multiyear water rationing that leads to a decline in financial performance that is not offset by near-term rate action.

CREDIT PROFILE

The rating reflects significant credit strengths, including a very strong service area, a well maintained system, forward-looking financial and capital planning, a willingness to raise rates when necessary and investments to improve the utility's water supply position through water recycling. These strengths are offset somewhat by a high debt burden, dependence on expensive imported water supplies and financial performance that has been adequate but not consistently strong.

ADEQUATE FINANCIAL PERFORMANCE

Financial performance is the main factor holding the rating back, but has improved in recent years. All-in debt service coverage averaged 1.8x over the three fiscal years ended June 30, 2014. Unaudited actual results for fiscal 2015 show coverage at a strong 2.1x, despite pressure from the ongoing California drought. Coverage is somewhat volatile due to swings in water usage, variable connection fee revenues and price increases from the SFPUC, but it has generally been improving with recent rate increases. The utility's expenses are largely driven by wholesale water purchases and generally match up fairly well with its variable revenues. The utility had $28.3 million of unrestricted cash and investments, or a strong 406 days cash on hand at the end of fiscal 2015, positioning it well to withstand short-term revenue volatility.

Fitch expects financial performance to dip to more moderate for a period due to pressure from the ongoing California drought and a strong conservation response from Redwood City water users. Over the longer term, the utility expects financial performance to improve as it implements rate increases to support increased pay-as-you-go funding of its capital program. The utility's forecast shows senior debt service (on the rated bonds) rising to over 2x on a sustained basis in the out year of its multi-year financial forecast. Such performance could lead to upward movement in the rating if it materializes. The forecast appears quite conservative in its assumptions about connection fee revenues and water sales. The utility's customers have cut usage by over 20% during the drought, and its financial forecast assumes no recovery in usage in the next five years.

SOLID RATE DISCIPLINE

Rate increases have averaged 9.6% annually over the past five years as the utility moved rates higher to accommodate increasing debt service and rising imported water costs. Rates are nearing a level that Fitch considers high (above 1% of median household income for 7,500 gallons of water), but the utility's affluent rate payers have not yet objected to the level of rates. Rates remain competitive with other nearby agencies, most of which face the same cost pressures related to large SFPUC wholesale water rate increases. SFPUC rates are largely volumetric and can rise sharply in periods of falling water sales.

ELEVATED DEBT BURDEN

Debt is high, but expected to decline to typical levels over the next five years. Redwood City's debt burden is about 150% of the median for water and sewer 'A' to 'AAA' rated utilities at $2,707 per customer. The above average reliance on debt weighs somewhat on the rating, but the utility's investments in water recycling and system renewal are a credit positive.
The current five year capital spending plan is modest at $18.3 million, or $155 per customer annually. It will require no further borrowing, allowing debt to decline to a very typical $2,097 per customer in five years. Amortization is solid with 44% of principal repaid in 10 years and 100% in 20 years.

VERY STRONG SERVICE AREA

The utility's greatest strength is its service area. Redwood City is both home to major technology companies and a relatively affluent, highly educated populace. Median household income is very solid at 163% of the national level. The city's unemployment rate trended much lower than the state and national averages over the past decade. Redwood City's 2.7% unemployment rate in September 2015 was below the nation's 4.8% rate and California's 5.5%.

The robust underlying economic fundamentals of the service area give the utility greater latitude to raise rates and the ability to make investments in the water system. Fitch believes the service area could support a higher rating if the utility's financial performance improves as forecast.