Central Arizona Water Conservation District

CREDIT OPINION Central Arizona Water Conservation District New Issue - Moody's assigns Aa2/stable to Central Arizona Water Conservation District Revenue Bonds New Issue Summary Rating Rationale Contacts Dan Steed AVP-Analyst dan.steed@moodys.com 415-274-1716 MIS Patrick Liberatore 415-274-1709 Analyst MIS patrick.liberatore@moodys.com Moody s Investors Service assigns a Aa2 rating reflecting the district s status as an essential water supplier to approximately 80% of Arizona s population; independent rate setting and a long history of setting rates as needed; overall strong management of the system and its capital needs; very healthy liquidity that is projected to improve; a satisfactory legal structure including a senior, gross lien on pledged revenues and a cash funded debt service reserve fund. Credit Strengths Autonomous rate-setting authority and a long history of regular, independently-set rate increases that provide sufficient coverage and solid liquidity Water delivery from Colorado River remains stable, despite persistent drought in the West Essential water supplier to majority of state s population Credit Challenges Persistent drought conditions over the long-term could pressure operations if available water allocation is cut Uncertainty over long-term resolution of Navajo Generating Station costs and power availability Rating Outlook The outlook is stable and driven by our expectation that the district s strong management team will continue to maintain sufficient debt service coverage and improve liquidity levels. This improvement will occur as the district increases rates over the forecast horizon in order to reach internal liquidity targets, cash finance capital projects and to provide additional cushion to offset uncertainties associated with the ongoing drought and potential costs associated with the Navajo Generation Station. Factors that Could Lead to an Upgrade Long term alleviation of regional water supply pressure Stronger coverage by net pledged revenues

Factors that Could Lead to a Downgrade Severity and duration of the drought impacts the district's access to cost effective water Weaker debt service coverage or liquidity Failure to continue to set rates at levels needed to mitigate power and water uncertainties Key Indicators Exhibit 1 Source: Moody's Investors Service Recent Developments Recent Developments are incorporated in the Detailed Rating Considerations Detailed Rating Considerations Service Area and System Characteristics: Essential Water Provider for Bulk of State s Population The Central Arizona Water Conservation District (CAWCD) is a multi-county entity encompassing Maricopa (Aaa stable), Pima (Aa2 stable) and Pinal counties. The district is the largest provider of renewable water supplies in Arizona, currently a portion of water supplied to roughly 5.3 million people, or about 80% of the state s population. CACWD was authorized in 1971 by the state legislature for the primary purpose of creating a single entity to enter into an agreement with the US Bureau of Reclamation for repayment to the US for the reimbursable cost of the Central Arizona Project (CAP). The district also serves as the operating agent of CAP. The CAP is a multi-purpose water resource project which was authorized by Congress in 1968 by the Colorado River Basin Project Act and was constructed by the US Bureau of Reclamation. The CAP is intended to deliver an average of approximately 1.5 million acrefeet of Arizona s annual share of Colorado River water to central and southern Arizona, partially replace existing groundwater uses and supplement surface water supplies. It also provides flood control, power, recreation, and fish and wildlife benefits. The major authorized project features include a 336-mile aqueduct system, New Waddell and Modified Roosevelt dams and the Navajo Power Project. The District began operating the CAP in 1983 and became responsible for full operation in 1993. Water delivery began in 1985. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2

Water is supplied to customers pursuant to either long-term (100-year) or short-term (annual) service agreements. Long-term federal contracts (Native American, 36% of water deliveries), Municipal and Industrial subcontracts (M&I, 34%) and agricultural settlement pool contract (25%) subcontracts represent a total 1.5 million acre-feet (AF) available annually. Water operation and maintenance delivery costs for the 11 tribes is paid by the federal government. Debt Service Coverage and Liquidity: Solid Coverage on a Gross Basis; Ample Liquidity Projected to Improve Over Next Five Years Debt service coverage on a gross basis is strong given the relatively small amount of debt and healthy revenue performance. Based on fiscal 2014 audited results (FYE 12/31), Moody's adjusted coverage of annual debt service beginning in 2017 by gross revenues (operating revenues plus investment income) is 15.1 times and expected to increase to over 22 times by 2020. On a net basis, although coverage is expected to be only sum sufficient over the forecast horizon this weakness is offset by the following: a fully funded debt service reserve fund, a senior lien on pledged revenues set aside with the trustee with funds equal to debt service 30 days prior to payment date, the legal ability of the district to access unrestricted general fund reserves for operations and finally, the legal covenant to implement a dedicated replacement charge equal to one times debt service. Key projection assumptions through 2020 include flat water deliveries and modest revenue growth supported by annual water delivery rate increases, including an above average increase in 2020. The history of willingness to increase rates is a strong management feature and an important component of the rating. Since 2010, the district s board of directors has relied on the district s Long-Range Financial Plan to assist in setting rates for water service over a multiyear period. As a result, water service charges are set every other year, including firm rates for the next year, provisional rates for the following year, and advisory rates for the subsequent four years. The provisional rates become firm the subsequent year unless updated by the Board prior to the commencement of the second year during the rate update process. Projected increases for the portion of rates pledged to bondholders average 3% over the four year advisory period. The total water delivery rate is also expected to increase an average of 3% through 2019 then increase by 13% in 2020. The above average increase in 2020 is due to the large increase in the pumping energy rate component associated with the closure of one of three units at the Navajo Generation Station by 2020. Liquidity Importantly, the system has historically maintained a solid cash position and projections indicate liquidity will improve through 2020. Excluding reserves restricted for repayment of federal obligations, the system's strategic cash reserves equaled a strong 615 days cash on hand in fiscal 2014. Not including legally available cash reserves set aside for specific purposes including future storage, the Navajo Generation Station decommissioning in 2045 and other extraordinary costs, days cash on hand is still healthy 311. Although solid, this liquidity position is a low point for the district due to a combination of paying incentives to agricultural customers for meeting water delivery goals, and to a lesser degree, energy market fluctuations. We view these cash levels as prudent as they provide the district with sound flexibility to mitigate any unanticipated operating and capital costs while also allowing ample cushion to provide for pay-go financing for the system's CIP. The district is confident strategic cash reserves will gradually increase and reach targeted levels by 2020. Affordable Capital Improvement Plan; Manageable Debt Profile The system's capital improvement plan (CIP) totals approximately $260 million for fiscal years 2015 through 2020 including the current issuance. The current CIP focuses primarily on system maintenance and improvements with nearly no projects dedicated for growth related projects. A substantial portion of the CIP funding is expected to be provided from ongoing revenues dedicated for capital purposes. Future debt plans include the potential of issuing about $40 - $50 million for power purposes although the date and amount are tentative as of this writing. The fiscal 2014 debt to operating revenues ratio is high at 4.5 times due to the nearly $1.2 billion federal repayment obligation. Final maturity of the federal repayment obligation is 2045 and debt service (about $56 million annually) is level through 2027 before declining gradually. The federal repayment obligation is secured from funds generated primarily by sales of Navajo Surplus power and capital charges. In the event these funds are insufficient, the district makes up the difference from General Fund reserves collected through property taxes ($61 million in FY 2014) and interest earnings; property taxes are not pledged to the current revenue bonds. Including debt service on the current sale (beginning in 2017), the federal repayment and employee-related healthcare costs, long-term fixed obligations comprise a somewhat high but manageable 24% of FY 2014 general fund revenues including property taxes. 3

Debt and Legal Covenants The system's solid financial operations and satisfactory working capital levels noted above help mitigate a legal structure that includes a covenant to establish rates equal to O&M and debt service and a 1.2 times MADS additional bonds test. The debt service reserve requirement will be cash funded equal to the standard three-prong test. DEBT STRUCTURE The district s debt consists only of fixed-rate obligations DEBT-RELATED DERIVATIVES The district has no debt-related derivatives PENSIONS AND OPEB CAWCD contributes to the Arizona State Retirement System, an agent multiple-employer public employee defined benefit pension plan. In fiscal 2014, CAWCD paid $10.6 million in pension costs (3.5% of total operating revenue). As of June 30, 2014 the pension plan is 76.9% funded. During 2014 the district contributed only 29.7%of its OPEB annual required contribution; the full ARC equals about 0.3% of operating revenues. Effective January 1, 2016 the district will no longer offer OPEB to new employees. Management and Governance The District s publicly elected 15-member board of directors has unregulated rate-setting authority. Each are elected for staggered six-year terms by voters in each of the three member counties. The number of directors from each county is based on population: Maricopa (10), Pima (4) and Pinal (1). Legal Security The bonds are secured by a gross, first lien pledge of revenues from the district s Fixed O&M charges and the Bond Replacement Charges. Pledged Revenues are applied first to debt service on a monthly basis on a one-sixth of interest, one-twelfth of principal basis, and second to district O&M expenses. The district covenants to establish rates equal to O&M and debt service and the additional bonds test is equal to 1.2 times MADS. The debt service reserve requirement will be cash funded equal to the standard three-prong test. Use of Proceeds Proceeds will be used to finance capital improvements and construction related to the district s Palo Verde to Morgan Transmission Line Project, Hassayampa Tap Connection Project and Electric District No 2 to Saguaro Transmission Line Rebuild Project as well as finance other capital projects. The Morgan Transmission Line project is expected to provide an alternate means of providing power to the CAP system while the Saguaro Project will be focused on replacing wooden transmission poles with steel monopoles and is expected to improve the district s reliability to transmit power needed for the efficient operation of the CAP system. Obligor Profile The Central Arizona Water Conservation District (CAWCD) is a multi-county entity encompassing Maricopa (Issuer rating Aaa, stable), Pima (GOULT Aa2, stable) and Pinal counties. The district is the largest provider of renewable water supplies in Arizona, currently supplying water to roughly 5.3 million people, or about 80% of the state s population. Methodology The principal methodology used in this rating was US Municipal Utility Revenue Debt published in December 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology. Ratings Exhibit 2 CENTRAL ARIZONA WATER CONSERVATION DISTRICT Issue Rating Water Delivery O&M Revenue Bonds, Series 2016 Rating Type Sale Amount Expected Sale Date 4 Aa2 Underlying LT $50,000,000 01/11/2016

Rating Description Revenue: Government Enterprise Source: Moody's Investors Service 5

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