OREANDA-NEWS. August 31, 2015. Fitch Ratings has assigned an 'AA+' rating to the following bond issued by the San Diego County Water Authority, CA (SDCWA or the authority):

--\\$151.6 million water revenue refunding bonds series 2015A.

Proceeds of the bonds will advance refund outstanding series 2008A and 2010A bonds for level savings. The bonds are expected to price on Sept. 10, 2015.

In addition, Fitch affirms the following outstanding ratings:

--\\$581.7 million outstanding water revenue certificates of participation (COPs), series 1998A, 2005A, and 2008A at 'AA+';
--\\$620.5 million water revenue bonds, series 2010A and series 2010B (taxable) issued by the San Diego County Water Authority Financing Agency (the agency) on behalf of the authority at 'AA+';
--\\$512.7 million water revenue bonds, series 2011A, 2011B and 2013A at 'AA+';
--\\$86.6 million subordinate lien water revenue refunding bonds, series 2011S-1 at 'AA';
--\\$50.0 million extendable CP notes at 'F1+'.

The Rating Outlook on all bonds and COPs is Stable.

SECURITY

Bonds and COPs are payable from the authority's water system net revenues. The CP notes are on parity with the series 2011S-1 bonds and have a subordinate lien on net revenues.

KEY RATING DRIVERS

PRUDENT AND STABLE FINANCIAL MANAGEMENT: The authority adheres to prudent financial management practices and engages in comprehensive long-term planning. Sound oversight has produced relatively stable financial results even with the significant declines in water sales.

BROAD SERVICE AREA: The authority provides wholesale water service to 24 member agencies across San Diego County.

WATER SUPPLY DIVERSITY: Water supplies have been diversified as a result of significant capital investments made over the last two decades, improving water supply reliability but increasing costs.

MEMBER SUPPORT FOR RATES: Fitch anticipates that continued member support for costs associated with supply diversification will facilitate rate increases to preserve financial margins at consistently healthy levels.

RATE STRUCTURE STABILITY: The structure of the authority's revenues, with a high use of fixed charges, provided stability through a recent period of significantly declining water sales.

HIGH DEBT: Capital spending has been substantial in recent years to acquire additional water supplies, primarily funded by debt. As a result, the authority's debt levels are high and amortization slow.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: Pressure on San Diego County Water Authority's financial margins could occur if water sales fall below already low budgeted levels in fiscal 2016 and projected levels in 2017. The authority plans to use reserves in its rate stabilization fund to offset lower water revenues in fiscals 2016-2018 but reserves are expected to remain healthy and above internal minimum targets.

CREDIT PROFILE

SDCWA provides wholesale water service to an estimated population of 3.2 million, or almost all of San Diego County (implied general obligation rating of 'AAA' by Fitch Ratings). SDCWA sells water to 24 wholesale members that, in turn, either serve retail customers directly or sell to other wholesale providers. The customer base has been stable. However, water sales have fluctuated significantly, which is consistent with other regional utilities as a result of the economic recession, mandatory curtailments related to the drought, ongoing conservation programs, and variable weather conditions.

SDCWA has budgeted for an 18% decline in water sales in fiscal 2016. In comparison, SDCWA withstood a 31% decline during the last drought over the four year period in fiscals 2008 through 2011. In the next few years, debt service coverage from ongoing revenues is expected to experience drought-related pressure. Debt service coverage from ongoing revenues is expected to remain healthy, above 1.4x, and coverage including recognition of transfers from its rate stabilization fund in fiscals 2016-2018, if needed, should continue to meet SDCWA's 1.5x policy target.

WATER SUPPLY AVAILABILITY AND THE CALIFORNIA DROUGHT

Over the past two decades, SDCWA has pursued water supply investment and diversification. Following the drought in California in the late 1980's, SDCWA's governing board laid out a plan to improve water supply diversification and reduce risk related to a sole supplier (at the time Metropolitan Water District of Southern California [Metropolitan] accounted for 95% of SDCWA's water supply). As a result, SDCWA now has water supply sources that include purchases of Colorado River water from Imperial Irrigation District, recycled water and conservation programs, increased local storage capacity and desalination. Significant investments in supply diversification have allowed SDCWA to continue to meet water demands in its service area during the current drought.

SDCWA enacted stage 2 of its drought plan in July 2014 that requires mandatory conservation by its members. However, the state's recent action to require mandatory conservation by all retail water utilities is the action that will significantly reduce SDCWA's expected water sales in fiscal 2016. SDCWA is prudently planning for an 18% reduction in water sales in fiscal 2016. SDCWA will use a portion of its \\$119 million rate stabilization fund, an estimated \\$29 million, to offset lower revenues from reduced water sales in fiscals 2016 through 2018.

Strong balances available in the rate stabilization fund should allow SDCWA to mitigate drought related pressure while keeping the calendar 2016 rate increase to a moderate 5.4%. The increase recovers higher costs related to a partial year of deliveries from the Carlsbad desalination project, but is modest in comparison to earlier rate projections.

Water sales could exceed SDCWA's conservative estimates, which would reduce the need to rely on rate stabilization fund transfers to meet its policy target. While the state's initial conservation mandates did not give consideration for local water supply investments such as Carlsbad, the governor has recently indicated the rules may allow these supplies to be included in the future. In this event, SDCWA's members may have lower conservation tiers in consideration of their access to a drought-tolerant water supply at Carlsbad.

CARLSBAD DESALINATION PROJECT

SDCWA is required to purchase 48,000 acre-feet (af) annually from the Carlsbad Desalination Project when construction is complete in late calendar 2015, which will provide around 7% of the authority's total water supply. The cost of the project water, estimated at around \\$2,000 per af, is significantly higher than water purchased from SDCWA's wholesale provider -- the Metropolitan Water District of Southern California (Metropolitan, revenue bonds rated 'AA+' by Fitch) -- whose current tier 1 treated water rates are \\$923 per af. However, SDCWA views the regulatory and hydrological uncertainty of Metropolitan's imported supply as providing a high risk to its customers. The authority has indicated to its member agencies that a total rate increase of 10% - 12% may be necessary to fund the incrementally higher cost of the Carlsbad project, in return for the drought tolerant supply.

LARGE CAPITALS INVESTMENTS AND DEBT

The authority invested a significant \\$1.9 billion in capital over the past decade. As a result of the investment, debt levels are high at 75% debt to net plant and \\$741 per capita. However, debt levels are comparable to other utilities in the region where water supply investments are capital intensive and considerable investments have been made in recent years. The debt also reflects the high point in the authority's capital lifecycle. Debt issuance over the next five years is expected to be modest (between \\$50 million and \\$75 million) to fund a portion of the much more manageable \\$396 million five year capital improvement plan.

FINANCIAL MARGINS EXPECTED TO REMAIN HEALTHY

Financial performance in fiscal 2014 was strong as a result of higher than budgeted water sales. Debt service coverage was 1.68x from all revenues, or around 1.5x after \\$22 million in revenues were placed into the rate stabilization fund. Actual water sales were 522,453 af as compared to 475,000 af budgeted. Fitch's coverage calculations include the authority's share of the county's 1% property tax receipts as revenues along with the authority's fixed charges received through the infrastructure access charge and water standby availability charge. Coverage in fiscal 2015 is expected to be similarly strong due to comparable water sales before a large (estimated \\$31 million) deposit to the rate stabilization fund.

Cash reserves are healthy, with operating reserves and rate stabilization funds providing \\$109.6 million, or 87 days cash on hand at the end of fiscal 2014, down from \\$130 million at the end of fiscal 2013. This level of reserves is considered adequate for the authority's wholesale agency risk profile. These reserve levels do not include another \\$86 million that the governing board has designated for water purchases to fill San Vicente Reservoir over the next three to five years. This cash is unrestricted but designated and is not included in Fitch's days operating cash calculation.