SAN FRANCISCO--()--Fitch Ratings affirms its 'A-' rating on the following certificates of participation (COPs) issued by Lodi, CA on behalf of its electric system:
--$19.5 million COPs, series 2002D;
--$60.7 million COPs, series 2008.
The Rating Outlook is Stable.
The bonds are secured by net revenues of the electric system.
KEY RATING DRIVERS
WEAKER FINANCIAL PERFORMANCE PROJECTED: Lodi's financial performance weakened in fiscal 2011 and 2012. Projected performance should remain relatively weak through fiscal 2016, but consistent with the current rating.
ADEQUATE LIQUIDITY: Liquidity levels are satisfactory for the rating though down significantly compared to fiscal 2010. Modest reductions in cash are projected over the medium term, but balances are expected to remain at adequate levels.
LIMITED CAPITAL NEEDS: Projected capital spending is limited and primarily driven by distribution system maintenance with somewhat flexible timing. No additional capital financing is anticipated.
LEC PROJECT COMPLETION: The rating takes into account the forecasted reduction in Lodi's exposure to the spot market following the very recent commercial operation of the Lodi Energy Center (LEC), which is expected to supply approximately 20% of LEU's energy needs.
RENEWABLE COMPLIANCE: Lodi has met California's renewable power supply standards for the initial compliance stage and plans on acquiring future renewables through its participation in NCPA to meet the 2020 requirement of 33%.
STABILIZING SERVICE AREA: The city has shown signs of economic stability including a decreasing though still high unemployment rate, stabilizing home prices, and the recent addition of major sales tax generators.
WHAT COULD TRIGGER A RATING ACTION
LOWER THAN PROJECTED CASH: Maintaining adequate liquidity is a significant mitigant for projected imbalanced financial operations over the medium term. Lower than projected cash balances would likely result in negative rating action.
Lodi's electric utility provides retail service to a relatively stable customer base of approximately 25,400 in and around the city of Lodi. The city encompasses approximately 14 square miles, with a population estimated at 63,549, and is located in the San Joaquin Valley of California, approximately 35 miles south of Sacramento. The revenue stream is generated by residential, commercial and industrial customers, contributing 39%, 35% and 22% of revenues, respectively, with a non-specified category making up the remainder.
The utility does not own any generation assets, but rather purchases power through its membership in the Northern California Power Agency (NCPA), from the Western Area Power Administration (WAPA) and from various short and long-term power purchase contracts. Lodi is one of the 10 NCPA power pool members, whereby each member provides its resources to NCPA for pool operations, and NCPA dispatches all resources to provide total requirements to the pool members, at the lowest reasonable cost. In addition, Lodi is a member of the Transmission Agency of Northern California (TANC), and participates in the California-Oregon Transmission Program (COTP).
WEAKER FINANCIAL PERFORMANCE IN 2011 AND 2012
Financial metrics declined in fiscals 2011 and 2012 following significantly stronger performance in fiscal 2010. Operating margins turned negative in fiscal 2011 with an operating deficit of approximately $3 million as expenditures held relatively flat while sales fell 3% and revenues declined by $7.5 million due to a still weak economy and mild weather. Fiscal 2012 saw a modest rebound in sales and revenues as economic conditions improved, resulting in an operating surplus of approximately $1 million.
Management's financial projections for fiscal 2013 through fiscal 2018 rely on a modest 1% annual increase in sales. Lower than anticipated sales could result in a larger use of cash reserves than projected, which could pressure the rating.
LIQUIDITY LEVELS REMAIN ADEQUATE
LEU's audited liquidity levels (including LEU's cash reserve held at NCPA) were lower at the end of fiscal 2011 and 2012 at 124 days cash and 92 days, respectively. The reduction from 158 days in fiscal 2010 was largely the result of an accounting change effective in fiscal 2011 that separates cash held for debt service (approximately $6.5 million or the equivalent of 41 days cash) from the unrestricted cash balance. LEU's weakened financial performance accounted for a relatively smaller though still significant cash reduction of $3.3 million from the end of fiscal 2010 to the end of fiscal 2012.
DEBT SERVICE COVERAGE PROJECTED TO REMAIN LOW ON AN ALL-IN BASIS
Fitch calculated debt service coverage, which includes the PILOT as an operations and maintenance expense, has fluctuated widely falling to a low of 1.38x in fiscal 2011 compared to 2.31x and 1.42x in fiscal years 2010 and 2012, respectively. When adjusted to incorporate the general fund transfer (direct cost allocation amount), coverage drops to 0.97x and 1.02x in fiscal years 2011 and 2012, respectively, while remaining relatively strong at 1.83x in fiscal 2010.
Management's financial projections through fiscal 2018 reflect adequate coverage levels (not including PILOT) that stay around 2.0x through fiscal 2016 before increasing to nearly 3.0x in fiscal 2017 as debt service costs decrease by approximately $3 million. However, after adjusting for planned capital expenditures and PILOT, coverage drops to a low 0.90x in fiscal 2014 and remains below 1.0x until fiscal 2017.
Fitch notes that while the forecasted coverage ratio is below 1.0x starting in fiscal 2014, after adjusting for capital expenditures and PILOT, the city intends a modest use of approximately $1.7 million of reserves to balance operations until financial margins improve in fiscal 2017 when scheduled debt service declines to $5.3 million from $8.3 million. Capital needs are limited and no additional debt is anticipated over the projection period.
OPERATIONAL LEC TO REDUCE MARKET EXPOSURE
The utility is participating in the NCPA Lodi Energy Center, which is a 280 MW combined cycle natural gas plant that is expected to be the most efficient plant in the region. LEU's share is 11.7% or about 32 MW. LEC started commercial operation on November 27th and is projected to run at a 40% capacity factor under current market conditions, which amounts to approximately 20% of Lodi's power needs, reducing Lodi's estimated short and medium term contracts by approximately 50% with remaining contracts for spring months and off peak periods.
FAVORABLE RENEWABLE POSITION
LEU is placed favorably with respect to energy from renewable resources and has existing resources to meet the initial regulatory compliance period in 2013. LEU's qualified renewable resources totaled 20.4% in 2011 with nearly all of the eligible supply derived from geothermal (45% including large hydro). Management intends to acquire additional supply through LEU's participation in NCPA to meet the 33% requirement for 2020.
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