Fitch Rates Otay Water District, California COPs 'AA-'; Outlook Stable.

SAN FRANCISCO -- Fitch assigns an 'AA-' rating to Otay Water District, California's $42 million revenues certificates of participation (COPs), series 2007. In addition, Fitch assigns an underlying 'AA-' rating to Otay Water District's outstanding series 2004 COPs. The series 2007 COPs are structured as 30-year COPs with level debt service and a 10-year par call. The COPs are expected to sell via competitive sale on or around Feb. 20, 2007. Harrell & Company Advisors is the District's financial advisor. The Rating Outlook is Stable.

Proceeds of the series 2007 COPs will finance an expansion of Otay's water distribution system, including construction of a pipeline to a water treatment plant located in an adjacent water district and two 10-million-gallon reservoirs. The projects will improve supply diversity and reliability of Otay's water supply. COPs are secured by net revenues of Otay's water system, including certain tax receipts.

The 'AA-' rating reflects Otay's diversification of its imported water supply, strong financial performance, strategic planning practices, and substantial revenue funding of ongoing capital needs related to growth in the service territory. Credit concerns are limited as reflected by the rating but include reliance on growth-dependent capacity fees to meet debt service coverage, ongoing regional water supply constraints, and the need to develop local water sources in light of growth pressures.

The Otay Water District serves a population of 189,000 in southeastern San Diego County, including rapidly growing areas of the city of Chula Vista. Otay provides water to approximately 52,000 connections. Water connections have grown 4% annually over the past five years and are projected to grow around 3% annually. The top 10 customers account for 13% of water sales and the system has minimal agricultural water sales.

Similar to most retail water suppliers in the county, Otay purchases nearly all of its treated potable water from San Diego County Water Authority (SDCWA; rated 'AA' by Fitch), resulting in supply concentration. However, Otay has an extensive reclaimed water distribution system, and current demand for reclaimed water, approximately 3.5 million gallons per day (mgd), exceeds the 1 mgd Otay can currently provide from its wastewater treatment facility. In March 2007, Otay will complete construction of a six-mile pipeline to connect with a City of San Diego wastewater treatment facility that is expected to provide a sufficient supply of reclaimed water to meet Otay's current and projected needs. As a result, Otay will be able to reduce its purchases of more expensive treated water from SDCWA, resulting in a direct reduction to purchased water costs. The pipeline being funded from COP proceeds will further diversify Otay's supply of treated water, reducing outage risk related to a single facility. Following completion of the pipeline and related reservoirs in 2010, Otay will have a 10-day emergency supply in its entire service territory.

Otay's tiered rate structure is designed to encourage conservation. The average residential bill of $46.60 is slightly below the county average of $49.58. As with most southern California water systems, rates will likely experience steady increases but water supply cost increases will affect most regional providers. Otay's Board of Directors appears willing to make necessary rate increases in order to preserve the current financial strength of the district.

Otay's financial performance has been strong with debt service coverage of 7.5 times (x) in fiscal 2006, but slightly below 1.0x without capacity fees. Although connection fees are projected to remain a sizable revenue source (around $14 million or 19% of revenues) in future years, this concern is mitigated by the fact that financial forecasting incorporates conservative growth estimates and that capacity fees are currently used to fund a significant portion of the capital plan. Debt service coverage is projected to remain above 3.0x, or around 1.0x without connection fees. Otay also receives a portion of the County's 1% property tax and those revenues are available for any purpose. Unrestricted cash reserves are healthy with $40 million at the end of fiscal 2006, or 313 days of operating expenditures. Debt levels are expected to remain low; Otay has significant growth-related capital needs, but only 34% of the $219 million six-year capital plan is expected to be funded from debt.

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