OREANDA-NEWS. Fitch Ratings has affirmed its 'AA+' rating on the following bonds issued by the city of Pasadena, CA on behalf of Pasadena Water and Power (PWP):

--$72.5 million outstanding water system revenue bonds, series 2007, 2010A, 2010B and 2011A.

The Rating Outlook for all bonds is Stable.

SECURITY
Bonds are payable from net revenues of the city's water fund and gross revenues of the capital improvement charges, which are a portion of the bill designated to fund the Water Master Plan, including debt service.

KEY RATING DRIVERS

MATURE SERVICE AREA: The city of Pasadena is a strong and mature service area centrally located within the greater Los Angeles region. Growth in customers is less than 1% annually.

STRONG COVERAGE DESPITE DECLINES: Debt service coverage (DSC) has been historically high at over 3.4x for the past five years. Lower revenues resulting from state mandated lower water sales to address the drought will reduce margins but DSC is expected to remain strong at over 2x.

RATE INCREASES EXPECTED: Pasadena is engaged in a full cost-of-service study. Rate redesign and rate increases beginning in fiscal 2017 are expected to absorb the revenue impact from lower water sales. Competitive rates and a strong community planning process should provide Pasadena with the rate flexibility to implement any needed rate action.

IMPORTED WATER SUPPLY DEPENDENCE: Pasadena is dependent on an imported water supply, as is much of the region, which is subject to availability challenges and cost pressure.

RATING SENSITIVITIES

PRESSURE FROM STATEWIDE DROUGHT: Reduced financial margins at Pasadena Water and Power beyond levels currently expected could result if water sales fall below assumed levels or if planned rate increases do not occur. These factors would result in downward rating pressure.

CREDIT PROFILE

Pasadena Water and Power, an enterprise of the city of Pasadena, provides retail services to 37,974 water system customers within the city limits and in the community of Altadena, with around 6,500 of its customers outside the city limits. The city is a mature community covering 23 square miles in Los Angeles County, 10 miles northeast of downtown Los Angeles. The built-out nature of the service area limits growth pressure from the standpoint of water supply demand and new infrastructure investment. There is limited customer concentration with the 10 largest customers accounting for around 10% of water sales.

The majority of the city's water supply is provided by the Metropolitan Water District (MWD; revenue bonds rated 'AA+' by Fitch), the regional wholesale provider of imported water which serves communities in the region. The city's purchases from MWD have hovered between 55% and 68% in recent years. The cost of the city's own treated groundwater is significantly lower than purchasing treated water from MWD but there are limitations on how much Pasadena can pump from the Raymond Basin, an adjudicated water basin.

REVENUES DECLINES EXPECTED FROM MANDATORY CONSERVATION

The city's water sales declined around 22% between the years 2007-2012, which is consistent with other regional utilities as a result of the economic recession, conservation efforts, and variable weather conditions. Water sales increased in the initial years of the drought with increases of 7% and 3% in 2013 and 2014, respectively, but fell 14% in fiscal 2015 with increased conservation efforts as drought severity grew.

In May 2015, as a response to the Governor's recent executive order to reduce annual water usage in the state by 25%, the State Water Resource Control Board (SWRCB) adopted rules requiring mandatory reductions in water usage for all of California's water providers. The city's required reduction is 28% over 2013 levels. To achieve this, Pasadena enacted Level 2 of its water shortage plan adopted by City Council in 2009, which is designed to achieve a 20% reduction in water usage. As of August 2015, Pasadena is reporting water sales 30% below 2013 levels.

Pasadena is conservatively budgeting for 20% lower water sales in fiscal 2016 (on top of the 14% reduction that occurred in fiscal 2015). Revenues are expected to decline with the lower sales, given Pasadena's primarily volumetric rate structure.

STRONG DSC SHOULD CONTINUE; RATE INCREASES NEEDED

Given Pasadena's strong financial position going into the drought and the legal settlement that reduced the annual transfer to the general fund beginning in fiscal 2015, financial performance is expected to be robust with continued DSC over 2.1x, even if water sales remain at the low levels assumed in fiscal 2016. This level is below Fitch's 'AA' category median of 2.5x but will be adequate to maintain the rating, assuming continued strong liquidity.

DSC has been historically strong at over 3.4x in the past five years, declining slightly to 3.2x in fiscal 2015 (estimated, unaudited) with the lower sales. The reduction of the general fund transfer from 6% of revenues to around 3% of revenues in fiscal 2015 helped preserve revenues at the utility. The 2015 transfer reflects a cost of service study done in 2014 that was accepted as the basis for the water fund's share of general fund costs. The adjustment was driven by a legal settlement regarding the legality of the transfer under California's Proposition 218 that requires water rates not exceed direct costs of providing water service. The general fund repaid $7.1 million to the water fund in fiscal 2015, which improved unrestricted cash reserves to $38.3 million, or 356 days cash on hand.

Rate increases and rate restructuring are both expected to result from the city's cost of service study taking place in fiscal 2016. Management anticipates that the rate redesign will consider options regarding further separation of revenues from volume sales.

MANAGEABLE CAPITAL SPENDING

In accordance with Pasadena's master plan outlined in 2002, capital spending has been robust since that time. Capital spending has averaged over 200% depreciation for a number of years and increased to 386% in fiscal 2014, compared to Fitch's 'AA' category median of 152%.

Five-year projected capital needs are $74 million for continued infrastructure reinvestment. Phase 1 of the city's recycled water project represents another $20 million. The recycled water project will be constructed between fiscals 2017-2019 and will build-out the delivery system of recycled water purchased from the city of Glendale to an initial small number of large industrial and irrigation customers in Pasadena. The overall capital plan is estimated to be funded from 65% debt issuance. Pasadena's current debt burden is moderate and, while leverage will increase with possible new debt issuance in 2017, it should remain manageable.