OREANDA-NEWS. Fitch Ratings has affirmed the following Santa Margarita/Dana Point Authority, CA (the authority) bond ratings:

--$57.2 million refunding revenue bonds, series 2014A (Santa Margarita Water District Improvement Districts Nos. 2, 2A, 3, 3A, 4, 4A and 4B general obligation [GO] refunding bonds) at 'AA+';
--$14.7 million revenue bonds, series 2009B (Improvement District Nos. 2, 2A, 3 and 4 GO refunding bonds) at 'AA+';
--$34.2 million revenue bonds, series 2009A (Improvement District Nos. 2, 3 and 4 GO bonds) at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are special revenue obligations of the authority, payable from unlimited ad valorem taxes on taxable land within improvement districts (IDs) located in the Santa Margarita Water District (the district). Each ID's obligation is several and not joint, and the property tax levy for debt service is allocated among the district's IDs based on the benefit each receives from the bond-financed facilities. Also pledged as security are each ID's share of the countywide 1% property tax levy, proceeds from property foreclosures, and investment earnings.

KEY RATING DRIVERS

ANALYSIS OF INDIVIDUAL IDS: The rating reflects the weakest link among the individual IDs as their obligations are several and not joint. Fitch views ID Nos. 4 and 4B as the least strong due to high overall debt levels and lower value-to-lien ratios. However, they also have the greatest upside potential given ongoing housing construction.

STRONG SERVICE AREA; MODERN INFRASTRUCTURE: The district services a largely built-out, affluent residential community demonstrating ongoing property development. No additional debt is planned, and amortization is typically rapid.

HEALTHY OPERATIONS: The district's water and sewer operations are financially healthy, with midrange liquidity and a new rate structure designed to better balance revenues generated to cover fixed costs with those generated by water usage.

STRONG TAX BASE GROWTH: The bonds are secured by an ad valorem tax pledge from taxable land only (excluding improvements). All IDs' land values increased significantly in fiscal 2016 and are projected to increase further in fiscal 2017.

RATING SENSITIVITIES

The rating is sensitive to tax base weakening, and shifts in the district's strong financial profile and customer base. The Stable Outlook reflects Fitch's expectation that such shifts are highly unlikely, particularly given high post-recession AV growth.

CREDIT PROFILE

The district is located in the southeastern portion of Orange County (implied GO bond rating of 'AA+' with a Stable Outlook by Fitch) and is the county's second largest water district, serving about 156,000 customers in a 97-square mile service area. The district comprises 14 IDs (including six sub-IDs) and one community facilities district. These fund water and sewer capital improvements via separate funding obligations. The service area is substantially built out and predominantly residential.

STRONG FINANCIAL PROFILE

The district's water and sewer operating profile is strong, reflecting low customer concentration, limited capital needs, and solid financial performance. The district's liquidity remains good, but has been declining. The district currently has 259 days cash on hand, which Fitch evaluates as midrange. This is the result of two factors: drawdowns for capital construction projects and artificial cash balance suppression while the district changes its banking service.

Operations are financed by a combination of user fees and property taxes. Operations remained positive after debt service payments during the recession, supported by draws on the rate stabilization fund. Subsequently, operations remained positive through fiscal 2014 but ended with a relatively small net deficit in fiscal 2015, due to a variety of one-time expenditures. The district expects to return to breakeven operations in fiscal 2016.

Contrary to Fitch's previous understanding, the district no longer intends to rebuild its rate stabilization fund. Instead, it expects to deplete that reserve by fiscal 2018, using the remaining funds to smooth the current transition to its new rate structure. By fiscal 2018, the district anticipates the new rate structure will be fully implemented, obviating the need for a rate stabilization fund buffer against variable third-party water costs and economic cycles. The new rate structure is designed to provide more consistent funding for the district's fixed costs from fixed charges, to both fund water reliability initiatives and ensure revenue coverage in the event of lower water usage projected in the future.

WEAK LINK ANALYSIS

Direct debt levels are low for the IDs, while overall debt is high for ID Nos. 4 and 4B. The district has no plans to issue further debt for its IDs despite $657 million in remaining debt authorization, as most of them are substantially developed and their infrastructure is relatively new. Land AV declined for all IDs during the recession; however, all have rebounded strongly, with further increases projected in fiscal 2017. Taxpayer concentration is low in all IDs, and the current total tax collection rate as a percentage of secured taxes levied in each ID is typically over 100%.

Fitch analyzed each of the seven IDs and concluded that ID Nos. 4 and 4B demonstrate relatively lower credit quality for two reasons: high debt and historical tax base pressure. ID Nos. 4 and 4B have the highest overall debt levels at $9,804 and $14,833 per capita respectively, and 11% and 14.5% of land AV respectively. Between 2009 and 2013, ID No. 4 experienced a significant land AV loss (approximately 27%). ID No. 4B sustained an even greater loss (approximately 35%) and had one year of particularly low total tax collections (88% in 2011). Positively, both IDs have rebounded very strongly, with land AV growth outpacing the other IDs. Given ongoing property development, ID No. 4 rebounded by approximately 47% in fiscal years 2014-2016, while ID No. 4B rebounded by approximately 52%. Debt amortization is rapid at 75% within 10 years for ID No. 4 and moderate at 49% for ID No. 4B, further mitigating concerns.

STRONG SERVICE AREA

Compared to state and national levels, county incomes are very high and unemployment is below average at 4% as of January 2016. The district serves the communities of Coto de Caza, Rancho Santa Margarita, and San Clemente, which all have extremely high wealth levels and high property values. Demand for new housing continues to be strong, with rapid absorption of new product and a large number of residential properties planned for construction during 2016-2020, primarily within ID No. 4.