Fitch affirms Nacimiento Water Project bonds as A+
Fitch Ratings this week has affirmed the rating for the Nacimiento Water Pipeline Project revenue bonds at ‘A+’. The two rated bonds are as follows:
- $144.5 million Nacimiento Water Pipeline Project revenue bonds, series 2007A (tax-exempt);
- $38.6 million Nacimiento Water Pipeline Project revenue bonds, series 2007B (taxable).
In addition, Fitch assigns an ‘A+’ rating to the city of El Paso de Robles, CA’s water revenue obligations. The rating outlooks on both the authority and city obligations are stable, Fitch said in a press release.
The Nacimiento Water Project bonds are backed by take-or-pay water delivery entitlement contracts with five San Luis Obispo County water providers: the city of San Luis Obispo, Paso Robles, Atascadero Mutual Water Company, the Templeton Community Services District and San Luis Obispo County Service Area 10A. Contract payments are senior obligations payable from participants’ gross water revenues.
The city’s rating considers obligations payable from a senior lien on the city’s water system revenues; the city’s utility currently has no debt outstanding beyond its contractual obligations to the authority.
Key ratings drivers
WEAKEST LINK ANALYSIS: Fitch’s analysis centers on the three primary participants (SLO, Paso Robles and Atascadero), which pay 96% of debt service and whose contributions could not be fully recouped through step-up provisions. The ‘A+’ rating reflects the credit quality of Paso Robles, the weakest of the primary participants.
IMPROVING FINANCIAL PERFORMANCE: Financial performance of most participants has been strong, but rate controversy and weak water sales forced Paso Robles to slowly build rates up to cover full debt service. Debt service coverage (DSC) – treating the city’s contractual obligation to the authority as debt service – is unlikely to meet the 1.25x rate covenant until 2015.
STRONG RESERVES ALLOW ADJUSTMENT: Each of the primary participants has significant reserves. Paso Robles has used some of its very strong reserves as it slowly adjusted to full debt service, but liquidity remains very strong with 1,096 days cash on hand at the end of fiscal 2013.
VARIABLE REVENUES, FIXED EXPENSES: Paso Robles has approved rates that should provide adequate coverage by fiscal 2015, but the new rates are entirely volumetric, creating a mismatch between high fixed costs and the variable water rate structure.
HIGH DEBT BURDEN: The participants all have high debt burdens due to the project, which is quite large relative to the utilities’ customer bases.
SIGNIFICANT SERVICE AREA: The project is of vital economic importance to California’s Central Coast region. The project provides increased water supply reliability and allows for future demand growth, improving the economic prospects of the region.
SOLID LEGAL FRAMEWORK: Authority debt service is supported by take-or-pay water delivery entitlement contracts that provide strong bondholder protection despite variable water supply and demand conditions.
NACIMIENTO PIPELINE LEAK: Pipeline water deliveries are currently suspended due to a leak in a small segment of the pipeline. Management believes remaining bond proceeds will be sufficient to repair the pipeline before next summer’s watering season.
Rating sensitivities
OBLIGOR FINANCIAL PERFORMANCE: The rating is sensitive to changes in credit quality of the underlying obligors, particularly Paso Robles given it has the lowest credit quality of the primary participants.
IMPORTANT PIPELINE REPAIR: The rating could come under downward pressure if pipeline repairs are delayed, unsuccessful or significantly more expensive than expected.
SIGNIFICANT WORSENING OF DROUGHT: Rating pressure could also develop if the extreme drought worsens, forcing multi-year water rationing that reduces financial performance of the primary participants on a sustained basis.
Credit profile
The participating water agencies are located on California’s central coast about halfway between Los Angeles and San Francisco. The project consists of a 45-mile pipeline that connects the agencies to Lake Nacimiento, a reservoir in the sparsely developed region near the border between San Luis Obispo and Monterey counties. The connection provides the region with an additional 15,750 acre feet of water annually.
Paso Robles performance improves slowly
Financial performance has been poor as expected over the past two fiscal years in Paso Robles due to weak water sales, a recessionary dip in connection fee revenues and tardy rate adjustments. The utility generated less than 1.0x DSC in fiscals 2011 and 2012 when treating the system’s contractual payments to the authority as debt service instead of operating and maintenance costs. Coverage reached 1.0x in fiscal 2013 and is expected to be about the same or better for fiscal 2014. DSC gradually increases over the city’s five year forecast, surpassing the rate covenant in the current fiscal year and improving to better than 2.2x in fiscal 2019.
Paso Robles faced significant opposition to fixed capital charges it tried to impose to support project costs, including protests under California’s Proposition 218 and legal challenges. The rate controversy delayed the city’s plan to gradually raise rates to fully cover debt service costs by about four years. After scrapping its initial rate plan, the city has imposed a five-year, fiscal 2012 – 2016 rate package that will provide adequate DSC when fully phased-in, but leaves it with very weak performance and vulnerable to various risks in the early years of its financial forecast.
The Paso Robles water system’s financial liquidity appears adequate to withstand the gradual implementation of rates to support full debt service. The city water utility entered the period of debt repayment with a very robust $23 million of unrestricted cash and investments on hand at the end of fiscal 2011. It has used some reserves to make pay debt service as rate implementation was delayed. However, it has spent reserves down less quickly than expected and ended fiscal 2013 with a very robust $18 million of unrestricted cash and investments.
The utility has deposited $1.5 million of the funds with the financing authority due to its failure to meet its rate covenant. Fitch believes the utility’s cash position will remain healthy, but reserves are expected to decline over the next five years as the utility invests in water treatment capacity.
The delay in increasing rates has forced the city to delay construction of a water treatment plant that would allow it to fully utilize its share of Nacimiento water. The city has been using the pipeline water for groundwater recharge in the meantime. The city plans to spend about $10 million over the next several years to finance construction of a scaled back treatment plant to utilize the water. In addition, it expects to issue about $9 million in debt in fiscal 2018 to replace water tanks on the city’s west side. Debt per customer is forecast to rise from $6,163 at the end of fiscal 2014 to about $6,412 in fiscal 2018.
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