TEXT - Fitch rates Metro Water District of Southern California
Feb 8 - Fitch Ratings assigns the following ratings to the Metropolitan Water District of Southern California's (Metropolitan) water revenue refunding bonds: --Approximately $90.3 million water revenue refunding bonds, series 2013A at 'AA+'; --Approximately $18.9 million water revenue refunding bonds, series 2013B (taxable) at 'AA+'; --Approximately $13.5 million water revenue refunding bonds (term mode), series 2013C-1 at 'AA+' --Approximately $14 million water revenue refunding bonds (term mode), series 2013C-2 at 'AA+' --Approximately $8.8 million water revenue refunding bonds (term mode), series 2013C-3 at 'AA+'. In continuation of Metropolitan's strategy to reduce its outstanding variable rate and swap portfolio, bond proceeds will refund outstanding variable rate obligations of Metropolitan (series 2013A and 2013C) and pay swap termination costs (series 2013B). Bonds are expected to price via negotiated sale on Feb. 27, 2013. The bonds do not have a debt service reserve fund. The series 2013 C-1, C-2, and C-3 bonds will be issued in the term mode with a fixed interest rate until the mandatory tender dates of July 1, 2019, 2020, and 2021, respectively or until such time as Metropolitan exercises its option to require an unscheduled mandatory tender after the call protection dates, three months prior to the mandatory tender dates. Fitch also affirms the following ratings: --$3.88 billion in outstanding water revenue and index mode bonds at 'AA+'; --$504.6 million index mode bonds at 'AA+'/'F1+'; --$99.9 million special variable rate water revenue refunding bonds, series 2010A (self-liquidity) at 'AA+'/'F1+'; --$196.5 million waterworks general obligation (GO) bonds at 'AAA'. The Rating Outlook on all bonds is Stable. SECURITY GO BONDS: The GO bonds are secured by an unlimited ad valorem tax on all property within the district. WATER REVENUE BONDS: Revenue bonds are secured by net water revenues of the district. The series 2010A bonds (self-liquidity) do not have a liquidity facility to support the weekly tender but instead rely on Metropolitan's own liquidity. Payment of a tender for these bonds, the SIFMA index notes, or the term bonds is secured by a subordinate pledge of net revenues. Payment of principal at the final maturity is secured by net revenues. NO CROSS DEFAULT: A failure by Metropolitan to provide sufficient proceeds to pay the purchase price of the SIFMA or term mode bonds or the self-liquidity 2010A bonds at the tender date would not constitute an event of default on Metropolitan's revenue or GO bonds. KEY RATING DRIVERS WHOLESALE SUPPLIER: Metropolitan is the supplemental wholesale water supplier to 18 million people in southern California. Water is provided from two major supply sources that have experienced supply fluctuations and variability. Revenues are provided from 26 member agencies that exhibit strong credit quality. ADEQUATE FINANCIAL PROFILE: Financial metrics are low for the rating but typical for a wholesale agency with additional financial strength provided by the members and timely rate recovery. Financial performance in fiscal 2012 improved and reflects board adopted financial policies. DEMAND VARIABILITY: Water sales declined 29% over fiscal years 2009 - 2011, causing a direct impact on district revenues. While water sales have increased from 2011, the variability of water sales is a credit risk given the rate structure that is primarily volumetric. RATE FLEXIBILITY: Metropolitan's revenue flexibility is evident in the 75% cumulative rate increases over the recent six-year period, although rate sensitivity is likely heightened given the magnitude of recent rate actions. LIMITED EXPENDITURE FLEXIBILITY: Expenditure flexibility is limited given Metropolitan's relatively high fixed costs associated with its water supply and debt costs. Pay-as-you-go capital appropriations and cash reserves provide some flexibility to absorb weather related demand fluctuations. COMPLEX DEBT PORTFOLIO: Metropolitan's debt portfolio continues to require management attention, given its complexity and the use of short-term debt with and without liquidity support and a large swap portfolio, although these amounts have been reduced substantially in recent years. INDEX MODE BONDS: The 'AA+'/'F1+' rating on the SIFMA index mode bonds reflects the market access implied by the Metropolitan's long-term credit quality. SELF LIQUIDITY VARIABLE RATE DEBT: The 'AA+'/'F1+' rating on the series 2010A self-liquidity bonds, outstanding in the weekly mode, reflects the liquidity provided by Metropolitan's $649 million in unrestricted cash and restricted O&M fund as of Dec. 31, 2012. GO BONDS: Metropolitan's GO rating of 'AAA' is based on its ability to levy unlimited ad valorem taxes on its sizable $2 trillion tax base, with the property tax revenues restricted to be used only for debt service on the GO bonds and capital costs related to the State Water Project (SWP). CREDIT PROFILE Metropolitan is a wholesale water supplier in a large and diverse six-county area in southern California to 26 member agencies, many of whom have some limited form of local water supply and, given the significant cost increases in Metropolitan's supply, are investing in alternative supplies to reduce water purchases from Metropolitan, when economical. FINANCIAL PERFORMANCE STABILIZED IN FISCAL 2012 Metropolitan's financial position remains healthy, despite declining financial margins between 2006 and 2011. Financial performance reached an exceptionally low level in fiscal 2011, primarily resulting from only 1.63 million acre feet (maf) of water sales as compared to the budgeted amount of 1.93 maf. Debt service coverage, excluding one-time revenues, was 1.35x on revenue bonds and 0.94x coverage on all payment obligations. Metropolitan used $49 million from its rate stabilization fund in fiscal 2011, which improved coverage levels to 1.57x and 1.09x, respectively. Debt service coverage of revenue bonds improved in fiscal 2012 to 1.81x with fixed charge coverage of 1.31x. The improvement reflected water sales of 1.68 maf. While sales came in below budgeted sales of 1.85 maf, financial performance improved with a 7.5% rate increase effective mid-year 2012 and expenditure reductions in areas such as conservation spending, water delivery costs, and power expenses. Operating and maintenance expenditures declined 10% from 2011, which had been reduced 3% from 2010. Water sales in 2012 included 225,000 maf of replenishment water sales to members once Metropolitan removed its allocation restrictions in late fiscal 2011. PLANNING ASSUMPTIONS ANTICIPATE LOW WATER SALES Metropolitan is assuming between 1.7 - 1.75 maf in water sales in future years, which represents lower forecasted sales than those used for financial planning and rate setting in previous years. Sales could dip below the forecasted amounts in certain years although Metropolitan is assuming that demand will normalize around this 1.7 maf level even with additional supply development being done by its members with Metropolitan's support. Fitch believes these sales assumptions are reasonable given the confluence of events that reduced annual sales from over 2.0 maf prior to 2010, including hardened conservation and efficiencies achieved during the 2007-2009 drought, wet weather conditions in 2010 and 2011 that improved local water supplies and reduce demand for outdoor use, local investment in new supplies and the ongoing economic downturn across the service area. Year to date sales in fiscal 2013 are slightly ahead of budgeted sales of 1.7 maf. Metropolitan remains well positioned with its water storage and water supply rights to meet a substantially higher demand from its members, should it occur. The ongoing uncertainty in water sales presents some level of risk to revenues, given the highly volumetric rate structure, while its expenditures are largely fixed. With the relatively flat assumed water sales, improvement in financial performance relies on rate increases and expenditure reductions. In April 2012, the Board adopted rate increases of 5% for each of the next two calendar years. This was the lowest of the three staff proposals, reflecting rate sensitivity among the member agencies given the sizable rate increases to date. The lower revenues than those provided in the other rate options will be mitigated in the budget through lower spending on storage programs, staffing, and equipment replacement. Expenditure reductions have been achieved in fiscal 2013. Debt service coverage is projected at 1.97x in fiscal 2013 and 1.53x fixed charge coverage, which is significantly better than budget due to slightly higher water sales to date and lower one-time State Water Project costs. The 'AA+' rating assumes that Metropolitan will generally operate, at a minimum, at or around its financial targets of 2.0x on senior lien debt and 1.2x fixed charge coverage. Given the cyclicality of demand, certain years will likely generate stronger metrics. CASH RESERVES FOR RISK Metropolitan continues to have a degree of financial flexibility provided by its reserves of $648.9 million in unrestricted cash and the operating and maintenance fund. However, reserves are used to mitigate other risks, such as providing self-liquidity for $99.9 million in variable rate bonds, $22.9 million posted as collateral with swap counterparties. The unrestricted cash amount above excludes additional unrestricted cash of$67.5 million that is set-aside for disputed amounts paid by the San Diego County Water Authority (SDCWA), which are the subject of ongoing litigation. To the extent the litigation is decided in favor of SDCWA and Metropolitan Water District must make a payment to SDCWA, Fitch anticipates that any settlement would be collected from other member agencies in a timely manner. The litigation relates to the rate methodology used to allocate costs between members. Although it is consistent with the district's history to have customer equity issues arise regarding rate-setting at such a large wholesale agency with so many members, Fitch views the increasing tension between the two entities as a potential credit concern. REGIONAL SUPPLY CHALLENGES RESULT IN LOWER MEMBER WATER DEMAND The previous five years have brought significant developments to the water supply mix in Metropolitan's service area and the demand profile from members for its water. Drought conditions and regulatory changes to pumping on the State Water Project have prompted Metropolitan and its members to work together to develop new local supplies that will reduce the regional demand in Southern California for imported water sold by Metropolitan. The significant increases in Metropolitan's water rates to its members over the past six years have made local alternatives cost effective that had previously not been considered viable. Metropolitan's members are not required to buy minimum amounts of water from Metropolitan but instead use the imported water supply to supplement existing and new local sources. In addition, Metropolitan's rate structure is heavily weighted towards volumetric pricing, so fluctuations in demand have a direct impact on revenues. Metropolitan's role in the region is crucial in that it supplies 40% - 60% of Southern California's water supply in six counties with a service area population of 18 million. As the supplemental provider and with imported water costs typically higher than local supplies, Metropolitan absorbs much of the regional demand variability due to conservation and efficiency investments as well as economic pressures. Although a regional economic recovery may increase demand, Metropolitan's members are required to meet a legislative requirement to reduce per capita usage by 20% in 2020, so investments in recycling and conservation may continue to place longer-term downward pressure on Metropolitan's water sales and revenue base. For more information on Metropolitan Water District, see Fitch's Report, 'Metropolitan Water District', dated April 25, 2012.