January 4, 2016 - 12:08 PM EST
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Fitch Rates Central Arizona Water Conservation District, AZ Revenue Bonds 'AA'; Outlook Stable

Fitch Ratings has assigned a 'AA' rating to the following bonds:

--Approximately $50 million water delivery operation and maintenance (O&M) revenue bonds, series 2016.

Bonds are expected to price during the week of Jan. 18, 2016. Proceeds will finance transmission projects related to power delivery, pay costs of issuance, and fund a debt service reserve fund.

The Rating Outlook is Stable.

SECURITY

Bonds are payable from gross revenues only from two distinct revenue streams at the district - fixed operating & maintenance charges and bond replacement charges. The district's other revenue streams, including charges for federal debt repayment, power delivery and ad valorem taxes, are not pledged to bondholders.

KEY RATING DRIVERS

LARGE REGIONAL WHOLESALE SUPPLIER: Central Arizona Water Conservation District (CAWCD) distributes approximately 1.5 million acre-feet of water through the Central Arizona Project (CAP). The project provides an essential surface water supply in the state and water sales exhibit a high degree of consistency from year to year.

CONTRACT STRENGTH AND CUSTOMER DIVERSITY: Raw water is delivered in accordance with 63 long-term contracts to a service area of 5.3 million people, or 80% of the state's population. Payments from customers must be received prior to water delivery or CAWCD has the right to withhold water delivery. Pledged revenues for deliveries to 11 Indian communities (around 50% of total pledged revenues) are paid by the federal government.

HEALTHY OVERALL FINANCIAL PERFORMANCE: The district's overall financial performance is healthy with stable water delivery revenues, robust reserves and healthy debt service coverage. Variations in total debt service coverage of the federal repayment obligation have occurred due to declines in power revenues provided by excess energy sales.

LIMITED REVENUE PLEDGE: Bondholders have a limited pledge on district general fund revenues, which includes only O&M charges and the bond replacement charge. The majority of district revenues are restricted for specific obligations such as the federal repayment obligation, operations or capital investment.

MANAGEABLE DEBT POSITION: Debt-to-plant is high at 86%, as is typical for a wholesale entity, but debt per capita is low at $222, reflecting the large service area. The district has manageable capital needs and funds most of its required capital from ongoing revenues provided by the replacement charge and tax revenues.

RATING SENSITIVITIES

REVENUE PROTECTION IN WATER SHORTAGE: Low water levels in Lake Mead could trigger a shortage allocation as early as 2017, which would reduce the Central Arizona Project (CAP) allocation from 1.5 million acre-feet (MAF) to 1.18 MAF. The Stable Outlook reflects Fitch's expectation that the annual cost-based rate-setting process will protect revenue stability by recovering full costs through a higher charge per acre-foot of water sales.

CREDIT PROFILE

CAWCD was created by the Arizona legislature in 1971 to operate the Central Arizona Project (CAP) and repay the federal government for construction costs. The CAP transports 1.5 MAF of Arizona's allocation from the Colorado River to three counties in central and southern Arizona. The CAP is defined to include a 336-mile aqueduct, the New Waddell Dam, modified Roosevelt Dam and the Bureau of Reclamation's 24.3% share, or 547 megawatts (MW), of the Navajo Generating Station (NGS). The CAWCD and the Bureau of Reclamation entered into a Master Repayment Agreement that governs CAWCD's rights to operate, deliver water and collect revenues from the project and repay the federal government for reimbursable costs of the CAP. The reimbursable costs generally account for the portion of the project not allocated to the Indian communities.

ESSENTIAL COMPONENT OF ARIZONA'S WATER SUPPLY

The CAP is an essential component of Arizona's water supply that was built in order to alleviate the state's previous over-pumping of its groundwater supplies. The CAP now accounts for 39% of the state's water supply, and groundwater has declined to 40% with other surface sources and limited re-use providing the remaining supplies. The CAP provides strong water availability to support compliance with Arizona's Assured Water Supply program, which began in 1980 and requires new development in the state to demonstrate access to a continuous 100-year water supply.

CAWCD distributes CAP water to four customer groups: municipal and industrial (33% of sales in 2014), Indian communities (35%), agriculture (26%) and underground storage (6%). The municipal and industrial customer class includes 52 purchasers with 100-year entitlement contracts. The largest purchasers include the cities of Tucson, Phoenix, Scottsdale and Mesa. The next largest customer group is the 11 Indian communities that have long-term contracts with the Bureau of Reclamation for CAP water. Largest purchasers include the Gila River Indian Community and the Ak-Chin Indian Community. Indian communities can use their allocations for any purpose, including agriculture or leasing water rights to other parties.

LIMITED BONDHOLDER PLEDGE; STRONG RATE SETTING

The district's water rates consist of 1) fixed operations, maintenance and replacement charges, 2) pumping energy charges and 3) capital charges. Pledged revenues are limited to the fixed O&M rate and the bond replacement charge (initially estimated at $2.60 per acre-foot) component of the overall 'Big R' charge. The bond replacement charge is sized to provide sufficient revenues to pay level debt service on the series 2016 bonds. Remaining replacement charges are sized sufficient to pay for ongoing capital improvements needed on the CAP.

The operations, maintenance and replacement charges are established each year by dividing forecasted costs by the amount of acre-feet scheduled for delivery to all customers, although the rate is paid directly only by the district's municipal and industrial customers, the Indian communities and excess water users. The operations, maintenance and replacement charges attributable to agricultural water sales are covered by the district's property tax revenues. In the event of a shortage declaration on the Colorado River, the CAP allocation would decrease by 320,000 acre-feet in a Tier I declaration. If this occurs, the established operations, maintenance and replacement rate would increase to compensate.

Pumping energy charges are paid by all customers and directly recover energy costs related to the transmission of CAP water through the aqueduct. Pumping energy charges in 2015 are roughly equal to the operations, maintenance and replacement charges. Energy charges represent a significant cost of CAP operations. The final charge, the capital charge is assessed on water sales to municipal and industrial customers and excess water users to repay Arizona's repayment obligation to the federal government for a portion of the CAP construction costs. The Indian communities are not assessed this charge, since Arizona is not repaying the amount of construction costs attributable to the federal share of the CAP.

The overall cost of delivered untreated water to municipal and industrial customers in 2015 was $179 per acre-foot, which includes the $22 per acre-foot capital charge. The charge to the Indian communities was $157 per acre-foot and the charge to agriculture purchasers was $75 per acre-foot, which represents just the pumping energy charge.

IMPORTANCE OF NAVAJO GENERATION STATION

The Bureau of Reclamation is the largest owner (547 MW) of NGS, a 2,250 MW coal-fired generation plant located in northeastern Arizona on the Navajo reservation. NGS provides 90% of the CAWCD's power supply. Furthermore, the owned capacity exceeds the district's own energy requirements and revenues from excess energy sales are used to pay a portion of the federal repayment obligation. These revenues declined from $46.8 million in fiscal 2011 to less than $30 million in fiscals 2012-2014 as a result of lower natural gas commodity prices and softening energy prices across the region. As a result, the district capital charge has increased from $15 in fiscals 2010-2013 to $22 per acre-foot in fiscal 2015. NGS's ability to remain operational and meet increasing U.S. environmental standards affecting coal-fired generation plants will have a direct impact on the district's financial margins and the overall cost of water.

HEALTHY OVERALL FINANCIAL MARGINS

Overall financial performance of the district's general fund is healthy. Fitch calculated total debt service coverage of the federal repayment obligation (including tax receipts) was 2.25x in fiscal 2014. Mid-year results in fiscal 2015 indicate still strong coverage of approximately 1.8x. Such strong coverage levels reflect the district's practice of collecting replacement revenues typically sufficient to fund ongoing capital needs from rates and tax receipts that were increased in fiscal 2013 to bolster reserves. The bond funding of transmission-related projects is atypical, and reflects the large cost of the projects and the potential impact to rates if funded on a pay-as-you-go basis.

Total debt service coverage levels have fluctuated, declining to a low-point of 1.29x in fiscal 2012. The lower coverage reflects a decline in excess power sales revenues, driven by the expiration of a contract with Salt River Project (SRP) and declining energy market prices. Excess power revenues are used to repay the district's federal repayment obligation; the revenues offset the amount of repayment that must be collected in district capital charges. Excess power revenues declined from $46.8 million in fiscal 2011 to $21.6 million in fiscal 2012, then improved to around $29 million in fiscals 2013 and 2014. They are expected to remain around this level, based on a minimum contractual payment under a new contract with SRP.

The district has very strong liquidity levels. Reserves of $119 million of general fund unrestricted cash and investments at the end of fiscal 2014 equaled 235 days operating cash. This does not include other strategic reserves that are board-designated. Total strategic reserves were $201 million at the end of fiscal 2014, which is slightly below the district's target of $221 million. In addition to its strategic reserves, the district began funding an extraordinary cost reserve when it raised its tax rate in fiscal 2013. The extraordinary cost reserve is building cash to mitigate potential future energy costs, including NGS related or other unanticipated costs.

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=997472

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997472

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Teri Wenck, CPA
Director
+1-512-215-3742
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
[email protected]


Source: Business Wire (January 4, 2016 - 12:08 PM EST)

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