Fitch Affirms Pasadena's Water Revenue Bonds at 'AA+'; Outlook Stable

Published : Friday, November 8, 2013 | 11:42 AM

Fitch Ratings affirms the ‘AA+’ rating on the following Pasadena water revenue bonds:

–$79.1 million outstanding water system revenue bonds, series 2007, 2010A, 2010B and 2011A.

The Rating Outlook for all bonds is Stable.

Security

Bonds are secured by net revenues of the 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

Strong, Built-Out Service Area: The city of Pasadena is a strong and diverse service area centrally located within the greater Los Angeles region.

Strong Coverage; Healthy Liquidity: Debt service coverage is high at over 3.0x for the past five years. Cash reserves were spent down on capital in fiscals 2009-2011 but have since improved as a result of rate increases.

Robust Capital Spending: Capital investment in the system has been very strong in recent years and was predominantly funded from pay-as-you-go revenues keeping debt levels moderate.

Responsive Rate Structure: The water rate structure includes adjustable components that link revenues directly with spending and protect the utility from variable water purchase costs.

Imported Water Supply Dependence: Local groundwater supply has increased but the city is still dependent on an imported water supply, as is much of the region, which is subject to availability challenges and cost pressure.

Strong Community Process: Pasadena Water and Power has a strong process of community involvement in long-range planning at the utility, which Fitch views as a positive attribute and is likely to align community rate support for the chosen agenda.

Rating Sensitivities

Alligned Capital Spending With Rates: Fitch expects continued linkage between rates and approved capital spending to occur that will support financial ratios in the range of current performance.

Credit Profile

Mature Service Area

Pasadena Water and Power, an enterprise of the City of Pasadena, provides retail services to 37,219 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 of Pasadena 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 and new infrastructure investment. There is no customer concentration with the largest ten customers accounting for around 8% of water sales.

Water Supply Considerations

The majority of the city’s water supply is provided by the Metropolitan Water District (MWD; revenue bonds rated ‘AA+’ by Fitch Ratings), the regional wholesale provider of imported water to serve communities in the region. The city’s purchases from MWD declined slightly in fiscal 2012 to 59% from 63% with the construction of a treatment plant that allowed the city to bring four wells back into service in 2011 and 2012. The cost of the city’s own treated groundwater is significantly lower than purchasing treated water from MWD.

Reduced Water Sales In Recent Years

Water sales declined between fiscal 2007 – 2011, which is consistent with other regional utilities as a result of the economic recession, conservation investments and water rationing. The revenue impact of the declines was been mitigated somewhat by rate increases and lower water purchase costs. Water sales appeared to stabilize in fiscal 2012 at the new lower level. Sales are unlikely to increase again, given the state’s goal of 20% per capita water use reduction statewide by 2020. However, additional conservation efforts could reduce sales further, increasing the importance of rate design to recover fixed costs.

Responsive Rate Structure And Rate Flexibility

Pasadena’s rate structure includes three components of rates: the commodity charge (the majority of the average bill), which adjusts with actual purchased water costs, the capital improvement charge that supports the long-term capital plan including debt service, and the customer and distribution charge that covers other fixed and variable costs. Pasadena implemented large rate increases during fiscal 2010 and 2011 to compensate for lower sales. No additional rate increases, other than changes to the commodity charge that reflect MWD rate changes, until fiscal 2016.

Strong Debt Service Coverage; Improved Liquidity

Debt service coverage is strong at 4.0 times (x) in fiscal 2013, or 3.5x after the general fund transfer (fiscal 2013 unaudited numbers). Coverage levels are consistently high, providing strong cash flow for capital spending. Cash reserve levels dropped to exceptionally low levels for the rating at $2.2 million, or 29 days cash at the end of fiscal 2010 as a result of continued capital spending during periods of lower revenues from lower water sales. Liquidity was supported by inter-fund loans from the city’s power system (rated ‘AA’ by Fitch). Rate increases improved liquidity to 74 days cash in fiscal 2012 and 175 days cash in fiscal 2013 (unaudited). The loan from the power system was repaid in full in fiscal 2012.

Fitch expects debt service coverage to remain strong at over 3.0x before the general fund transfer, or 2.5x after the general fund transfer. The transfer to the general fund is currently at the maximum level allowed by city charter. A ratepayer has filed litigation against the city in October 2013 regarding the legality of its transfer from the water fund to the general fund. Potential outcome is unknown but any potential changes to the transfer are expected, at this time, to be credit neutral.

Robust Capital Spending

In accordance with Pasadena’s master plan outlined in 2002, capital spending has been substantial during the past decade resulting in a reduction in the system’s average age of plant from 18 years in 2006 to 14 years in 2010. Average annual capital improvement plan (CIP) costs per customer are double that of Fitch’s medians for rated utilities. Much of the capital spending was funded from pay-as-you-go revenue sources but the city also issued Build America Bonds in fiscal 2011. Capital spending averaged $12 million annually in fiscal years 2008 and 2009 then moderated somewhat at around $7 million in fiscals 2011 and 2012. The total cost of the overall master plan is expected to be 65% debt financed, with the remaining 35% funded by system revenues. Fitch views the system’s capital structure as a credit positive.

Five year projected capital needs are in the range of $100 million, with much of the balance attributable to the recycled water project. The project will be constructed between fiscals 2015-2017 and will build-out the delivery system of recycled water purchased from the City of Glendale to industrial and irrigation customers in Pasadena. The availability of recycled water will reduce the city’s imported water purchases further.

Additional information is available at ‘www.fitchratings.com‘.

Applicable Criteria and Related Research:

–’Revenue-Supported Rating Criteria’(June 2013);

–’Water and Sewer Revenue Bond Rating Guidelines’ (July 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=807520

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