Fitch Rates Lake Arrowhead CSD, California's $24MM COPs 'AA-'; Outlook Stable

The 'AA-' rating reflects the district's very good financial performance, affordable rates, and manageable capital plan. The rating also considers water supply challenges, increasing cost of purchased water that could result in rate pressure and high service area wealth levels. Debt service coverage and liquidity are expected to decline as a result of rising fixed costs from this issuance, but financial margins should improve with future rate increases.

For fiscal 2008, senior lien annual debt service (ADS) was a solid 2.4 times (x). However, with this issuance ADS coverage is expected to decline to the 1.7x range over the next five years. While the decline marks a change from where coverage has trended over the last three years, coverage is expected to rebound by fiscal 2012. Liquidity for fiscal 2008 was very good with nearly 380 days cash on hand. Liquidity is expected to also decline as cash reserves are drawn upon to fund capital needs, but coverage and liquidity should both improve with future rate increases.

The district's six-year capital improvement plan (CIP) totals a manageable $56 million. Approximately 27% of the CIP will be funded from this transaction with the remainder to be funded from cash reserves and restricted funds. Some of the major CIP projects include water supply expansion, wastewater treatment plant improvements, and inflow and infiltration improvements. Leverage ratios are low with debt to net plant at 30% and outstanding debt per customer at $860 in fiscal 2008. Debt ratios after this transaction will increase but should remain below average. Debt amortization is moderately slow.

The Board of Directors approved a 3% water and wastewater rate increase on June 30, 2009 that is effective on Jan. 1, 2010. Additional increases of 5% annually from fiscal 2011 through 2014 are also projected. Despite the approved and projected increases, rates should remain affordable. In addition to rate revenues, pledged revenues include an ad valorem tax and a 15 year supplemental water supply fee was enacted in August of 2004 both of which are collected on the County of San Bernardino tax rolls. The tax and supplemental water supply fee each contributed 15% of gross revenues in fiscal 2008.

The district derives most of its water from Lake Arrowhead. However, due to severe drought conditions from 1999 through 2004, lake levels dropped to historical lows. Consequently, the State Water Resources Control Board issued an order in 2006 that limits lake withdrawals to 1,566 acre-feet per year beginning in 2008. The district also entered into a memorandum of understanding with the Lake Arrowhead Association to maintain lake levels at no lower than 5,100 feet. To supplement the district's demand, it entered into a 10-year agreement (with an optional five-year extension) with the San Bernardino Valley Municipal Water District (SBVMWD) and Crestline-Lake Arrowhead Water Agency (CLAWA) for purchase of up to 7,600 acre-feet of imported water per year from the State Water Project. The cost of water at the time of the agreement with SBVMWD and CLAWA was $2,627 per acre foot and costs will increase over time as energy costs rise. Based on the initial cost, the cost of water over the entire contract period is an estimated $20 million-$25 million. The district's current average water demand is 2,500 acre-feet per year and is estimated to reach 3,300 acre-feet by 2030. Fitch believes that if the district is forced to purchase increased amounts it would increase operating expenses, but it should not materially affect financial performance.

The district provides water and wastewater services to a number of unincorporated communities surrounding Lake Arrowhead in the San Bernardino Mountains. The district encompasses about 15 square miles and serves about 8,300 water customers and 10,700 wastewater customers. Predominantly residential in nature, the district is located 23 miles north of San Bernardino and 75 miles east of Los Angeles. The Lake Arrowhead area is an affluent resort community primarily serving residents of Los Angeles, Orange, San Bernardino and Riverside Counties. More than one-half of the homes in the service area are second homes. Economic prospects for the district are favorable due to high wealth levels.

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