SAN FRANCISCO--()--Fitch Ratings assigns an 'AA-' rating to the following series of power system revenue bonds issued by the Los Angeles Department of Water and Power (LADWP):
--Approximately $520.9 million, series 2013A.
Series 2013A bond proceeds will refund fixed-rate outstanding 2003 A-1 and A-2 bonds for savings. Savings are expected to be taken up front, primarily in fiscals 2015, 2016, 2017. Bonds are expected to price on Feb. 20-21, 2013.
In addition, Fitch affirms the following parity outstanding bonds issued by LADWP:
--$6.81 billion power system revenue bonds at 'AA-';
--Bank note rating on commercial paper (CP) program at 'AA-';
--Bank bond ratings on outstanding variable rate bonds at 'AA-'.
The Rating Outlook is Stable.
The bonds are special obligations of LADWP payable solely from power system revenues. LADWP's power system bonds do not have a debt service reserve fund.
STRONG SERVICE AREA: LADWP's greater-Los Angeles service territory is broad, mature and diverse with stable customer growth. Load growth has historically been steady, notwithstanding a slight decline in electric and water sales in recent years due to the economic recession.
FINANCIAL IMPROVEMENT: Following some weakening in LADWP's financial margins in fiscals 2010 and 2011 as a result of cost increases and limited rate action, financial improvement is occurring in fiscal 2013.
FAVORABLE RATE STRUCTURE ELEMENTS: LADWP's rate structure has favorable automatic cost recovery mechanisms, including recovery of renewable power costs, which partially mitigates Fitch's concerns regarding the lengthy and politically charged rate environment for this utility.
REGULATORY PRESSURE: LADWP faces an array of cost pressures associated with the state's environmental agenda, including increased renewable purchases, and compliance with AB32 (greenhouse gas reduction legislation and the Clean Water Act (once-through cooling). The new rules will require costly changes to LADWP's power supply mix, both in operating and capital costs.
EXTREMELY LARGE CAPITAL NEEDS: The scope and timing of the power system's five-year $7.3 billion capital program reflects substantial infrastructure replacement needs and the cost of state regulatory requirements. With ongoing rate support, LADWP should have the capacity to absorb large planned additional debt.
WHAT COULD TRIGGER A RATING ACTION
RATE PRESSURE: Failure to receive approval of future rate increases beyond fiscal 2014 required to offset the department's higher operating and capital costs would likely pressure financial margins, and potentially, the rating.
RATE INCREASES DEFERRED LAST TWO YEARS; APPROVED IN OCTOBER
Rate approvals in October 2012 implemented a 4.9% rate increase in November 2012 for the remainder of fiscal 2013, and will implement a 6% rate increase in fiscal 2014. LADWP's five-year forecast includes further rate increases in the 6%-8% range in each of the following three years. However, management expects that these may be reduced through further cost reductions.
The rate approval followed delayed consideration of LADWP's rate proposals during the last two years. Although LADWP's rates are among the lowest in the state, the recent delays in rate consideration is a credit concern and reflect rate sensitivity. Longer-term rate increases will be needed to fund large capital needs. Fitch does not expect delays in cost recovery to occur but if financial margins decline on a consistent basis due to lagging rate actions, it could put downward pressure on the rating.
Importantly, the utility's new rate structure includes modifications to the existing pass-through mechanisms that are expected to provide greater revenue stability. Changes include the removal of the cap on the adjustment factor for fuel and variable purchased power costs, revenue decoupling that will protect LADWP from the potential revenue effects of energy conservation and lower electric sales, and a pass-through mechanism that recovers a portion of the power reliability program component of the capital plan.
FINANCIAL PERFORMANCE EXPECTED TO STABILIZE IN FISCAL 2013
Financial performance in fiscals 2011 and 2012 has been mixed with a tightening of margins. Although net revenues stayed flat in the absence of any rate increase, debt service has increased by $150 million or 56% from fiscal 2008 to 2011, reflecting sizable additional debt issuance in recent years. Debt service coverage, as calculated by Fitch, was 2.08x in fiscal 2011 as compared to over 2.5x in the previous four years. Debt service coverage improved in fiscal 2012 to 2.6x as a result of debt restructuring to lower debt payments in that year once delays in rate consideration necessitated across the board expenditure reductions.
Fitch also evaluates LADWP's coverage metric including payment of the 8% transfer to the general fund as an operating expense, which reduced coverage in fiscal 2011 to 1.4x and in fiscal 2012 to 1.9x. Liquidity at the end of fiscal 2012 remained strong with $908 million in unrestricted cash, including $490 million in the debt reduction fund. LADWP's reserve policy targets a minimum of $300 million in operating cash.
LADWP's internal policy target of 2.25x minimum debt service coverage (before transfer) provides a healthy cushion for rate setting that takes into account the general fund transfer. Debt service coverage in fiscal 2013 is estimated by LADWP to remain steady at 2.5x, (1.9x after transfer), reflecting the mid-year rate increase that should provide sufficient revenues to cover the rebound in debt service costs. Debt service returns to $425 million in fiscal 2013 from $343 million in fiscal 2012.
SIGNIFICANT CAPITAL NEEDS AND HIGH DEBT LEVELS
LADWP's current five-year capital plan is estimated at $7.3 billion for 2013-2017. The capital plan increased in the last couple years, reflecting clarity regarding the cost of compliance with the Clean Water Act. The five-year plan now includes a portion of the costs to rebuild 2,162 MW of existing capacity as units that do not use ocean water cooling by 2029. The capital plan also includes approximately $1.5 billion in spending to meet the state's renewable portfolio standard of 33% by 2020 (LADWP is currently at 20%); $2.6 billion for LADWP's power reliability program; and approximately $3.2 billion to fund generation investment, demand-side management, and other objectives of the integrated resource plan.
Capital spending will be funded, in part, by an additional $4.2 billion in debt issuance. Higher debt financing requirements have prompted LADWP to revise its policy of a maximum 60% debt-to-total capitalization ratio to 68%, and will continue to drive revenue requirements higher to pay escalating debt service costs.
POWER SUPPLY REFORMATION REQUIRED; LADWP MAKING PROGRESS
The diversity and cost competitiveness of the department's existing power supply mix continue to be credit strengths. LADWP owns 4,980 MW of power generation, 3,399MW of which is natural gas-fired and the remainder of which is hydroelectric or renewable. It has rights to another 3,421 MW of generation (coal-fired, nuclear, large hydro and wind), including its participation in the Intermountain Power Agency (IPA) and Southern California Public Power Authority (SCPPA).
The attractive cost of the portfolio resources has allowed LADWP to offer low retail rates to its customers. However, long-term changes to LADWP's power supply portfolio are being implemented to comply with regulatory mandates created by state environmental regulations that will require higher rates. LADWP reached its 20% renewable target in 2010 and should be well positioned to meet the state-mandated goal of 33% by 2020 if investments in solar, geothermal and energy efficiency proceed as outlined in the resource plan. LADWP is positioned, with the carbon allowance it received, to meet the requirements of AB32 legislation at limited cost through 2020.
For additional information see Fitch Report, 'Los Angeles Department of Water and Power - Power Revenue Bonds', dated Oct. 4, 2012.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria, this action was informed by information from CreditScope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', June 12, 2012;
--'U.S. Public Power Rating Criteria', Jan. 11, 2012.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria