Threats to Rate Raising Flexibility for California Water Bond Issuers after Drought Response Measures

Water consumption in California has been cut significantly since the state of California imposed mandatory water use restrictions last year. The restrictions were in response to dwindling water supplies caused by four years of drought conditions in California and other areas of the western United States. While the restrictions were effective in cutting water consumption throughout the state, water revenues collected by local water providers fell, impacting the level of revenues available to pay debt service for those water agencies who pledged revenues to repay their water revenue bonds. For most high-grade California water bond issuers, the impact on their credit quality from lower revenues has been mitigated by their ability to raise prices, cut costs or tap into other resources to maintain strong net revenue levels available for debt service.

 The impact for some local water districts in California has been more drastic, even though water supplies in the state improved over the winter months. We are following the case of the Yorba Linda Water District in suburban Orange County. In response to a decline in revenues that followed the mandatory cutbacks, the district proposed a $25 per month rate increase. Despite objections from some customers, the district adopted the rate increase, as it felt the higher rate was necessary for the district to maintain its financial solvency. Some disgruntled customers still objected, and gathered enough signatures to place a referendum on the rate hike before district voters. However, the district opined that the referendum was invalid, and proceeded to implement the rate hike. A lawsuit against the district has now been filed, and a local court is expected to rule on the legality of the referendum next month.

 Other California water districts and investors in California water bonds are watching the case because of the potential precedent it could set in allowing customers to roll back rates, which could limit districts’ ability to generate sufficient operating revenues and to comply with issuers’ bond covenants. For example, the Yorba Linda District has a rate covenant that requires the district to raise sufficient revenues to pay its operating costs and cover its annual debt service by 1.1 times. A successful referendum by customers could both impact the ability of the district to meet the covenant and dilute the credit quality of its outstanding debt. While our analysis of the credit quality of water revenues bonds includes the issuer’s economic and financial strength, fiscal flexibility, ability to provide a sufficient amount of water to its customers, and rate setting flexibility, we also review the political support for or impediments to reasonable rate increases. We had noted a Fitch rating report that cited Yorba Linda’s managerial turnover and “heightening political risk” after a previous rate hike. 

Sources:  Los Angeles Times, Orange County Register, Fitch Ratings, Yorba Linda Water District Revenue Bond Official Statement