OREANDA-NEWS. Fitch Ratings upgrades the ratings on the following City of Santa Maria, CA (the city) bonds to 'AA' from 'AA-':

--$50.2 million water and wastewater subordinate lien revenue refunding bonds series 2012A and 2012B (taxable).

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a subordinate lien on net revenues from the city's water and wastewater system (the system). The city has $3.3 million of senior lien 1997 COPs outstanding (not rated by Fitch) with a final maturity in 2023. The senior lien is closed.

KEY RATING DRIVERS

UPGRADE REFLECTS STRONG FINANCIAL PROFILE: The upgrade reflects Santa Maria's strong financial performance even with the moderate decrease in revenues resulting from required statewide conservation. All-in debt service coverage is projected to remain around 2.0x and liquidity is strong.

CITY CHARTER RATE INCREASES: The city has enacted 5% annual rate increases on both the water and wastewater systems for the past 36 and 25 years, respectively, as outlined by the city charter. This practice is expected to continue, subject to California's Prop 218 notification requirements.

AVERAGE DEBT; MODEST CAPITAL NEEDS: Debt levels are moderate and should improve with the city's limited capital needs. Capital is expected to be financed entirely from rates in the five-year forecast period.

ROBUST WATER SUPPLY: Despite the California drought and ongoing low allocations from the State Water Project (SWP), Santa Maria has sufficient water supply through its groundwater rights to meet total water demand, if necessary. The city has met its state mandated 16% conservation target.

LIMITED OPERATIONAL RISK: The water system is entirely gravity-fed, reducing pumping needs and power costs. Water treatment of SWP water is provided by the Central Coast Water Authority (CCWA). The city's wastewater system collects wastewater and provides treatment at one central plant owned by the city.

STABLE CUSTOMER BASE: The customer base is a stable credit factor even though the local economy exhibits vulnerability associated with a concentration in agriculture. The city's customer base does not include agricultural production; agricultural entities have their own groundwater sources.

RATING SENSITIVITIES

DECLINE IN FINANCIAL METRICS: The stable outlook reflects the expectation that financial metrics will remain in the strong range. However, lower financial metrics that result from unexpected additional capital needs or a reversal to the city's long-standing annual rate increases could pressure the rating.

CREDIT PROFILE

MODERATE SERVICE AREA CHARACTERISTICS; STABLE CUSTOMER BASE

The City of Santa Maria (is located on the California central coast in northern Santa Barbara County with a population of 101,500. The economy's historic concentration in agriculture has diversified somewhat in recent years. The customer base for the water and wastewater systems includes around 22,000 customers and has been stable, with average annual growth of 0.9% over the past five years. The customer base exhibits limited concentration, with the top ten water customers accounting for 12.5% of combined revenues. Further, customer levels do not include agricultural load. Residential customers provide 68% of combined revenues.

STRONG FINANCIAL MARGINS

The system's revenues exhibit annual growth from annual 5% water and wastewater increases. The city charter allows for this level of annual rate increases for both systems and the city has a long practice of implementing the increases. Management is engaged in a cost of service study to determine whether higher increases or rate restructuring may be appropriate given the high levels of conservation occurring in California. The existing rate structure provides a high degree of stability, recovering 40% of revenues through the fixed charges.

The ongoing rate increases and a debt restructuring done in 2012 have positioned the utility for improved financial performance. Debt service coverage of the remaining senior lien bonds (lien closed) was 3.6x in fiscal 2015 and all-in debt service coverage was 2.4x. Preliminary indications for fiscal 2016 all-in debt service coverage is still over 2.0x, even with the lower revenues management anticipates from the mandated state conservation and lower resulting water sales.

Liquidity levels are strong with $31.6 million in unrestricted cash at the end of fiscal 2015 (434 days operating cash). Balances are projected to remain robust.

AVERAGE DEBT; MODEST CAPITAL

Much of the city's outstanding debt relates to infrastructure put in place in 1997 to take delivery and blend SWP treated water with its groundwater supply. Debt levels are around average with debt/funds available for debt service (Debt/FADS) of 5.5x in fiscal 2015 as compared to Fitch's median for 'AA' category water utilities of 6.2x. Debt to net assets is high at 72% as compared to Fitch's median of 47%.

The city's capital needs are limited, estimated around $20 million for both systems over the next five years. The city expects to fund capital spending from ongoing revenues and no additional debt is expected.

AMPLE WATER SUPPLY; MEETING CONSERVATION TARGET

Drought conditions in California are not a credit concern for the utility given the redundancy in its water supplies that protect against shortages in the SWP supply. The city has ample groundwater rights of 33,000 acre-feet (af) per year, in relation to the city's total water sales of between 13,000 af and 14,400 af annually. The groundwater basin is adjudicated, which provides a high degree of certainty to water availability and protection from over-drafting of the basin.

The city began purchasing SWP water in 1997 to alleviate pressure on the groundwater basin and now uses as much SWP water as is made available by the California Department of Water Resources and supplements this imported supply with its groundwater. The city targets to use SWP water for at least 50% of its water supply but actual use has ranged between 17% and 91% between 2011 - 2015. The lower availability of SWP in recent years has required the city to rely more heavily on groundwater. Santa Maria's mandated conservation tier is 16%, which the city has achieved on a cumulative basis over its 2013 potable water usage.