Tapping into Yield: Colorado’s Special Purpose Water & Sanitation Districts

The municipal bond market offers investors a diverse array of credits, sectors, and structures. For many retail investors, a risk-averse mentality leads them to focus on the highest quality bonds in the market. In Colorado, general obligation school district bonds offer investors the desired safety and comfort through a dedicated property tax revenue stream as well as state support. However, for those risk-tolerant investors willing to work a little harder in search of yield, Colorado’s special purpose water and sanitation districts represent a lesser-known but compelling opportunity.

Water & Sanitation Districts

Colorado’s municipal bond market helps finance the development of critical water infrastructure for the state’s arid conditions. Over 400 special districts for water, sanitation, storage, irrigation, and stormwater management exist across the state to serve unincorporated, rural, and suburban communities. These quasi-governmental entities are authorized under Title 32 of the Colorado Revised Statutes and provide critical services such as drinking water delivery, wastewater treatment, and drainage control. Regional Authorities, such as the CO Water Resources & Power Development Authority, provide support and financing for projects.

In contrast to city-owned utilities (e.g., Denver Water or Aurora Water), these special districts operate independently, often serving newly developed or fast-growing areas. The districts often issue revenue bonds secured against service charges paid by residential and/or commercial customers, tap fees and, at times, property tax revenues.

Why They Matter

As Colorado continues to experience population growth and increasing demand on water infrastructure, these districts are on the front lines maintaining and expanding water utilities. From the Denver Metro Area to ski towns in the San Juans, water and sanitation districts help fund:

• Pipelines, reservoirs, storage tanks, treatment plants and watershed improvements

• Tech upgrades for compliance with state and federal regulations

• Infrastructure to serve new housing developments

In a mountainous state with the headwaters of countless rivers, water infrastructure is crucial for the sustenance and continued growth of Colorado’s population.

Analyzing Water District Bonds

Considering the nuanced shapes and sizes that special district bonds can have, diligent credit research helps analyze credit risks. Here are some key metrics and considerations:

• Debt Service Coverage Ratio (DSCR): Stronger districts will generate 1.5x or greater DSCR from net operating revenues.

• Rate Base & Growth: Is the user base growing? Does the district have flexibility to increase rates? What is the districts’ reliance on tap fee revenues versus recurring usage fee revenues?

• Capital Expenditures: Be aware of future projects that might require additional borrowings? Is a portion of district revenue being allocated to capital improvements? How old is the districts infrastructure?

• Liquidity: Cash on hand and days of operating reserves.

• Water Rights: Senior water rights are a valuable and protective asset.

• Regulatory Compliance: Environmental and quality standards from the Colorado Department of Public Health and Environment (CDPHE) can drive capital needs.

• Intergovernmental Partnerships: Districts may have cooperation agreements in place with local cities and counties, potentially mitigating credit risk.

Risk and Reward

Water and sanitation bonds are a critical source of funding for water infrastructure across Colorado. They typically carry lower ratings (BBB or A) and, depending on the size of the issuance, can be non-rated. For investors seeking tax-exempt income, they can offer attractive yields relative to traditional GO bonds. Investors are compensated for taking on risks such as:

• Smaller and less diversified user bases

• Liquidity risk associated with smaller issue size, buyer interest

• Exposure to growth assumptions or housing cycles

• Operational mismanagement or delayed rate adjustments

• Regulatory shifts requiring expensive system upgrades

Your CO Muni Specialists

For more information on how Yule Creek evaluates Colorado’s essential infrastructure credits, including water and sanitation districts, and how local insight can help you uncover yield in overlooked sectors, please visit our website or reach out for a consultation.

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Sources:

• Colorado Special District Handbook; Colorado Department of Local Affairs, 2023: https://dola.colorado.gov

• Colorado Water Plan; Colorado Water Conservation Board, 2023: https://cwcb.colorado.gov

• CDPHE Drinking Water Watch: https://cdphe.colorado.gov

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Disclosures:

This content has been prepared for informational purposes only and should not be considered as investment, tax, or legal advice. Opinions and forward-looking statements expressed are subject to change without notice. We recommend all investors consult with a financial and/or tax advisor regarding their individual circumstances before making investment decisions.

Investing in bonds exposes the investor to the risk of loss of principal. Lower and non-rated securities are more volatile and less liquid than investment-grade bonds. Liquidity risk relates to the timing of converting a security into cash without affecting the market price. Municipal bonds and preferred stocks tend to be less liquid than government or corporate bonds. Higher-yielding, longer-maturity, lower-rated, non-rated, or certain bond restrictions (minimum denomination requirements) may limit or reduce the liquidity of bond holdings.

Please visit our website for a complete list of disclosures and risks: www.yulecreek.com.