OREANDA-NEWS. Fitch Ratings affirms the 'AAA' rating on the following Beverly Hills Public Financing Authority, CA bonds:

--$18.5 senior lien water revenue bonds series 2008A;
--$36.8 subordinate lien water revenue bonds series 2012A.

The Rating Outlook is Stable.

SECURITY
The 2008A bonds are secured by a first lien on net water revenues after payment of operation and maintenance expenses.

The 2012A bonds are secured by a subordinate lien on net water revenues.

KEY RATING DRIVERS
STRONG SERVICE AREA: The utility provides an essential service to a wealthy residential area that also includes significant commercial, retail and lodging customers. The city is centrally located in the massive and economically diverse Los Angeles metropolitan area.

DISCIPLINED RATE SETTING: The Beverly Hills City Council has raised rates significantly in recent years to adapt to changes in usage patterns and increasing costs of imported water, adjusting rates as needed to provide solid financial results.

STRONG FINANCIAL PERFORMANCE: All-in debt service coverage (DSC) has averaged a very strong 2.6x over the three years ended fiscal 2015. Liquidity is healthy with 456 days cash on hand at the end of the year. Financial performance is expected to soften noticeably over the next couple of years due to state-imposed drought conservation but is unlikely to pressure the rating if the utility continues to adjust rates as needed.

HIGH DEBT BURDEN: Debt levels are high because the city has invested heavily to maintain and improve its aging water distribution and storage system, but this concern is largely offset by the utility's strong financial performance and ratepayers' extraordinary ability to pay. The utility currently has no borrowing plans, but needs may emerge as capital plans and cash flows become clearer.

SUBORDINATE WORKING LIEN: The closed senior lien and subordinate working lien are rated at the same level because the senior and all-in coverage (which would typically drive the subordinate lien rating) are sufficient to support the highest rating.

RATING SENSITIVITIES

FINANCIAL PERFORMANCE: The rating on Beverly Hills' water system bonds could come under downward pressure if financial performance is reduced on a sustained basis due to drought water conservation measures and not offset by rate adjustments.

RELIANCE ON LEVERAGE: Significant additional borrowing, related to the city's evolving capital plan, that increases an already elevated debt burden, could also put downward pressure on the rating.

CREDIT PROFILE

The water enterprise provides retail water service to a stable population of about 42,000 in an area that includes the city of Beverly Hills and about 20% of neighboring West Hollywood. The service area is very strong with Beverly Hills' median household income (MHI) at 163% of the national level and a significant commercial base that includes major luxury retail and lodging sectors. The customer base is reasonably diverse with the top 10 customers consuming about 10% of water sold. Large hotels make up the majority of the top customer list. Residential users account for about 85% of connections and 80% of revenues, providing diversification and stability to the customer base. The city is fully developed and not subject to growth pressures.

STRONG FINANCIAL PERFORMANCE
Financial performance is strong, though it varies with business and weather cycles. All-in DSC averaged a robust 2.6x in the three fiscal years ended June 30, 2015. Senior DSC averaged a very strong 4.5x over the period. Coverage remained strong despite drought conservation beginning in earnest in 2015 with senior DSC at 4.3x and all-in DSC at 2.5x. Free cash flow-to-depreciation averaged a very strong 216% over the past three years, providing ample funds to invest in the system. Liquidity is strong. The water enterprise reported unrestricted cash and investment of 31.2 million at June 30, 2015, equivalent to 456 days of operating expenses.

DROUGHT PRESSURES
All-in coverage is forecast to drop to just 1.2x in 2016 as emergency state drought regulations push water sales down deeply. However, a single year of weak financial performance is not a concern for a utility with Beverly Hills' ample reserves and strong rate flexibility. Moreover, the forecast appears particularly conservative, as it assumes no revenues from the city's approved drought penalty surcharges. Fitch expects the utility to collect significant penalty revenues and expects actual financial performance to be much closer to the utility's long-term performance than forecast.

The California State Water Board has ordered the city to reduce water use 32% from 2013 levels to help achieve a statewide goal of reducing per capita water use by 25%. The city was slow to reduce usage (cutting use just 20% in the first four months of the conservation order) and was one of a small number of California water purveyors fined by the state of California for very poor performance in reducing water use in 2015. The level of the state fine was small ($61,000) relative to the enterprise's $36 million of operating revenues in 2015, and the city has since implemented drought penalty rates that should improve compliance. However, a pattern of non-compliance and increasing regulatory oversight could be negative for credit quality.

IMPORT DEPENDENT, ADEQUATE SUPPLIES
The utility is dependent on imported water supplies from northern California and the Colorado River, creating some variability in supply and exposing the utility to periodic large price increases. The Metropolitan Water District of Southern California (Metropolitan, revenue bonds rated 'AA+' with a Stable Outlook) provides about 90% of Beverly Hills' water, and the wholesale agency planned well for the current period of drought, having invested in heavily in water storage projects in recent decades. Metropolitan reduced supply allocations by 15% in 2015, forcing retail water agencies to pay higher rates if they went over allocations. Given state drought regulations and a solid supply position coming into the drought, import dependence has not proven a problem in the current drought. However, Beverly Hills' supply position is weaker than the average U.S. water utility.

HIGH DEBT LEVEL
Debt levels are high. The utility's $61 million debt burden was more than twice the median for rated systems at $5,539 per customer at the end of 2015. Debt-to-net plant assets - which better captures both the area's high cost of living and the utility's significant resource base - is only slightly elevated at 52%, but quite high for a 'AAA' rated utility. The debt structure is uncomplicated and composed entirely of fully amortizing fixed rate debt. Amortization is rapid with 58% of debt repaid in 10 years and 91% over the next two decades.

The city does not currently plan any additional borrowing over the next five years, but its plans are quite uncertain at the moment. The city is considering major investments in local water supply production capabilities that would require borrowing. It may also need some borrowing to continue the already approved capital plan if water conservation measures reduce revenues available for capital spending. A significant increase in debt could put downward pressure on the rating.