Fitch Ratings affirms the 'AA+' ratings on the following Santa Margarita/Dana Point Authority, CA (the authority) general obligation (GO) and GO refunding bonds:

--$32.66 million revenue bonds, series 2009B (Improvement District Nos. 2, 2A,3 and 4 GO refunding bonds);
--$37.825 million revenue bonds, series 2009A (Improvement District Nos. 2, 3and 4 GO bonds);
--$62.77 million revenue bonds, series 2004A (Improvement District Nos. 3, 3A,4 and 4A GO bonds).
The Rating Outlook is Stable.

The bonds are special revenue obligations of the authority payable from ad valorem property taxes on taxable land within improvement districts (IDs)located in Santa Margarita Water District (the district) with no limit on the tax rate. Each ID's obligation is several and not joint, and the property tax levy for debt service is allocated among the district's IDs based on the benefit each receives from the bond-financed facilities. Each of the ID's share of the countywide 1% property tax levy, proceeds from property foreclosures, and investment earnings are also pledged as security.

Stable, Wealthy Customer Base: The district provides essential water and sewer services to largely built-out, affluent, residential communities.
Healthy Operations: The district's water and sewer operations are financially healthy, with strong general fund balances and substantial liquidity.
Analysis of Individual IDs: Based on an analysis of each the IDs, whose obligations are several and not joint, Fitch views ID No. 4 as the least strong due to high debt levels and continued moderate AV declines. However, these weaknesses are mitigated by rapid amortization, high wealth levels, and lack of additional debt plans.
Moderate Tax Base Declines: The bonds are secured by an ad valorem property tax pledge from taxable land only, which experienced assessed valuation declines in the last few years, though some IDs have seen stabilization. In addition, the
bonds are also secured by certain other revenues from each of the IDs.
High Overall Debt Levels: While direct debt levels are low to moderate, overall net debt levels for IDs 3 and 4 are high. However, high debt levels are mitigated by rapid amortization and no additional debt plans.
Limited Additional Capital Needs: The ID's future capital needs are limited as the system's infrastructure is relatively new and amortization of principal for the IDs is rapid.

The district is located in the southeastern portion of Orange County (lease revenue bonds and pension obligations bonds rated 'AA' with a Stable Outlook by Fitch) and is the county's second largest water district serving about 155,000 residents in a 97-square mile service area. The district comprises 14 IDs (including six sub-IDs) which fund water and sewer capital improvements via separate funding obligations. The service area economy is largely residential and substantially built out. Because pledged revenues are based on land AV and not improvements, the impact of home value declines on the district have been somewhat mitigated. Compared to state and national levels, county incomes are very high and unemployment at 8.5% as of May 2011 is below average. The district serves the communities of Coto de Caza, Rancho Santa Margarita, and San Clemente, which all have extremely high wealth levels and high home values.
The district's water and sewer financial operations are strong, reflecting low customer concentration, limited capital needs, and solid financial performance.
Fiscal 2010 ended with an unreserved general fund balance of 61% of spending compared with a five-year average of 47%. Unaudited fiscal 2011 results are similar. Restricted funds include a rate stabilization reserve with a balance of $9 million as well as a repair and replacement reserves totaling $7.5 million and $2 million respectively. Revenues have consistently outpaced expenditures with net income increasing to $11 million at fiscal year-end 2010. Operations are financed by a combination of user fees and property taxes. As an importer of water, the district is reliant upon costly water from Metropolitan Water District of Southern California (MWD; rated 'AA' by Fitch). However, its rates include an automatic pass-through of wholesale increases as well as a consumer price index adjustment.
Based on an analysis of each of the five IDs, ID 4 appears to be the most vulnerable due to highest overall debt levels, largest recent decline in AV, and highest current delinquency rate (though its total collection rate remains above 100%). However, amortization of principal is rapid at 81% within 10 years.
Although the ID has $145.8 million in remaining debt authorization, management does not anticipate issuing any additional debt.
Direct debt levels are generally low for the IDs, while overall debt is high.
The district has no plans to issue further debt for these IDs despite over $300 million in remaining debt authorization is available as they are all substantially developed. Concentration is low to moderate in all IDs, and total tax collection rate in each has consistently been over 100%.

Primary Analyst
Shannon Groff
Fitch, Inc.
650 California Street, 4th Floor,
San Francisco, CA 94018
Secondary Analyst
Alan Gibson
Committee Chairperson
Karen Krop
Senior Director
(New York Ratings team)
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