Mar. 18, 2010 (Business Wire) -- Fitch Ratings assigns an 'AA-' rating to the following Los Angeles Department of Water and Power, CA's power revenue bonds:
--$616 million series 2010-A (federally taxable - direct payment - Build America Bonds);
--$104 million series 2010-B.
Bond proceeds from the series 2010A bonds will fund ongoing projects in the overall capital plan. The series 2010A bonds will be issued as taxable, Build America Bonds. Proceeds from the series 2010B bonds will be used to refund LADWP's certain outstanding bonds for level savings. Bonds are expected to price via negotiated sale in April, 2010.
In addition, Fitch affirms the following LADWP ratings:
--$5.1 billion in outstanding power system revenue bonds at 'AA-';
--$200 million in commercial paper at 'F1+'.
The Rating Outlook is Stable.
RATING RATIONALE:
--Los Angeles Department of Water and Power (LADWP) has a diverse power supply portfolio that has historically provided competitively priced energy. However, the city's ambitious renewable goal of 40% by 2020 and the state's greenhouse gas reduction legislation will require significant and costly changes to the power supply mix.
--Load growth in the broad and mature service territory has historically been strong, averaging 1.1% annually over the past five years until the recent economic recession triggered a slight decline in sales in fiscal 2008 and flat sales in fiscal 2009.
--Retail rates are competitive with a series of cost adjustment mechanisms. A potential adjustment under consideration to the cost adjustment mechanism could provide for full cost recovery on a more timely basis than permitted by the current methodology.
--The sizable $5.1 billion five-year capital plan is being driven by LADWP's reinvestment in system infrastructure to preserve reliability and generation development, including a substantial investment in new renewable generation. Funding estimates include a healthy 39% to be funded from pay-go in order to maintain the utility's financial target of less than 60% debt to capitalization.
--LADWP appears to have the debt capacity to absorb the additional $2.5 billion in debt expected over the next five years. Debt service coverage is projected to remain above of 2.25 times (x).
--Liquidity levels are healthy and following adoption of formal financial policies in June 2009, LADWP no longer expects to draw down its unrestricted cash reserves to fund its capital spending, mitigating Fitch's previous credit concerns regarding liquidity.
KEY RATING DRIVERS:
--The utility is considering a key change to its rate structure that will allow for full collection of unrecovered costs to date by the end of fiscal 2011. The previous 0.1 cent/kWh cap on quarterly movements in the cost adjustment factor has not recovered the utility's full costs. The Board is expected to consider an increase in the cap to 0.8 cents/kWh.
--While Fitch acknowledges LADWP is facing long-term cost pressure related to its large capital plan and associated environmental mandates, the utility does appear to be well positioned to meet its initial 20% renewable goal in 2010 and has begun to notably decrease its carbon output. Timely rate recovery and support of needed rate increases by the community and regulatory body (City Council) will be key drivers for the rating.
--The city increased its transfer from the power system to 8% from 7% in fiscal 2009. No additional increases in the transfer to the general fund are anticipated. Further increases could diminish financial flexibility at the utility.
SECURITY:
Bonds are secured by net revenues of Los Angeles Department of Water and Power's power system.
CREDIT SUMMARY:
The rating reflects the fundamental credit characteristics of the electric utility, including a competitive power supply portfolio, a broad and mature service territory, competitive retail rates, a well diversified customer base, and a healthy, albeit slightly tightening, financial position. Further supporting the rating are community and political support for the utility's sizable capital plan and the rate increases that will be needed to support the planned capital investment. Fitch views the community and City Council support as a key credit driver as the capital plan is large, but should be manageable. The electric department's anticipated borrowing over the next five years is around $2.5 billion, not including the series 2010 bonds. The sizable $5.1 billion five-year capital plan is being driven by LADWP's reinvestment in system infrastructure to preserve reliability and generation development, including a substantial investment in new renewable generation. The capital plan has a strong pay-go component with 39% of the expenditures projected to be supported by cash flow.
Positive credit developments have occurred since Fitch's last credit review. The Board of Commissioners, the governing body of the utility, approved formal financial policies in 2009 that include a debt service coverage target of 2.25x, a minimum unrestricted cash reserve of $300 million, and a debt to capitalization of less than 60%. The reserve level of $300 million, when combined with the debt reduction fund of over $500 million, is expected to provide healthy liquidity as LADWP executes its large capital plan. A pending change to the rate structure that is being considered for approval by the Board on March 18, 2010 is also viewed as a positive credit development in that it brings LADWP much closer to a position of full cost recovery on a timely basis. The Board approval of an increase of the maximum cap on the quarterly adjustment of the 'energy cost adjustment factor' (ECAF) component of its rates is subject to City Council review. The ECAF is the rate component that recovered highly variable costs related to fuel, renewable energy, energy efficiency programs, and general fund transfer. The previous cap of 0.1 cent/kWh allowed at each quarterly adjustment was producing large unrecoverd cost balances on an ongoing basis. Given the upward pressure on most of these cost inputs, the unrecoverd costs are only expected to increase over time. The Board action increased the quarterly cap to 0.8 cents/kWh, which is currently projected to achieve full cost recovery by the end of fiscal 2011. Rate flexibility has been a credit concern in the past and given the current economic environment may continue to be limited although LADWP's retail rates are below most other providers in the region.
Financial performance has been consistently strong. Debt service coverage for fiscal year-end 2009 was 3.1x, or 2.3x after the general fund transfer. Debt service coverage is projected to decline closer to LADWP's minimum target of 2.25x as new debt is issued to finance a large portion (approximately two-thirds) of the capital plan. However, actual financial performance typically exceeds projected levels. LADWP's liquidity was strong with $445 million in unrestricted operating cash and $547 million in the debt reduction fund, which acts as a hedge for the utility's variable-rate debt exposure and can be used in the future to economically defease debt or to pay current debt service costs. The combined liquidity resulted in just under $1 billion in reserves, or 177 days cash. LADWP expects to issue approximately $2.5 billion in new money revenue bonds in the next five years to fund its extensive capital plan. This will result in a substantial increase to the utility's debt burden, although debt levels are relatively low compared to other large, urban vertically integrated utilities. Annual debt service on the revenue bonds is projected to increase from approximately $274 million in fiscal year 2009 to more than $500 million by fiscal year 2013. As a component of the rate structure, debt service costs are expected to increase from around one cent per kWh currently to two cents.
The 'F1+' rating on the power system revenue CP notes is based on the liquidity support provided by Banco Bilbao Vizcava Argentaria, S.A. (rated 'AA-/F1+'; Positive Outlook by Fitch), acting through its New York Branch, in the form of a Revolving Credit Agreement (the Agreement) in the amount of $200 million. The Agreement provides liquidity support to make payment on the principal of the notes in the event of a failed remarketing. The Agreement does not support interest payments on the notes. The rating also considers the long-term 'AA-' rating and Stable Outlook assigned to the power system revenue bonds. The rating will expire on the earlier of Sept. 5, 2010, the Revolving Credit Maturity Date, as defined in the Agreement, unless such date is extended, or upon any prior termination of the Agreement. LADWP currently has $200 million of CP outstanding.
Considerations for Taxable/Build America Bonds Investors
The following sector credit profile is provided as background for investors new to the municipal market.
Public Power Bonds - key credit points:
Public power utility bonds in most cases are unsecured debt obligations supported solely by a pledge of net revenues generated by the utility including other legal structural protections, such as rate covenants, and debt service reserve fund requirements. Public power utilities (municipal and cooperative) are effectively owned by their customers with a mission to provide essential, reliable, relatively low cost electric service. The average rating is 'A+', compared to their corporate counterparts' average rating of 'BBB+', with approximately 31% rated at or above 'AA-' and 8% rated at or below 'BBB+'. The key credit underpinning supporting the high average rating is their self regulating authority (or local rate setting ability). Municipal utilities are generally not subject to state/federal regulatory oversight as compared to corporate utilities. This regulatory autonomy provides for a more timely recovery of costs (operating and debt service) through electric rates, and also gives public power issuers the ability to set financial targets/policies as well as renewable energy goals/standards. In addition, public powers predominantly residential customer composition provides for more stable energy sales and in turn more predictable financial performance. Those with below average ratings or low investment-grade or below-investment-grade ratings generally have a limited economic base, above average leverage (or debt burden) resulting in a high cost structure that may constrain financial flexibility.
Applicable criteria available on Fitch's web site at 'www.fitchratings.com' include:
--'Revenue-Supported Rating Criteria', (Dec. 29, 2009)
--'Public Power Rating Guidelines', (June 11, 2009).
Additional information is available at 'www.fitchratings.com'.
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