Fitch Affirms Modesto Irrigation District, CA's Electric Revs at 'A'; Outlook Positive

SAN FRANCISCO--()--Fitch Ratings has affirmed its 'A' rating on the following electric revenue bonds issued by Modesto Irrigation District (MID or the district), CA:

--$293.4 million outstanding electric revenue bonds, series 2004B, 2006A, and 2009A.

The Rating Outlook is Positive.

SECURITY
The bonds are secured by a pledge of net revenues of MID's electric system.

KEY RATING DRIVERS

INTEGRATED RETAIL SYSTEM: Modesto Irrigation District (MID) is an independent, publicly owned utility that provides retail electricity to approximately 113,931 customers in and around the city of Modesto, CA.

IMPROVED FINANCIAL POSITION: The Positive Outlook reflects MID's steady improvement in financial performance since fiscal 2010, driven largely by rate increases and a modest recovery in sales. Fiscal 2012 financial metrics were better than rating category medians for coverage of full obligations and days cash on hand.

RATE STRUCTURE IMPROVES COST RECOVERY: MID's current rate structure adjusts annually to recapture costs from securing renewable energy and complying with California's regulation of greenhouse gas emissions. Fitch views the added flexibility positively although MID's overall rates are relatively high and concerns regarding future rate flexibility remain.

PROPOSED ENVIRONMENTAL AGREEMENT: A proposed agreement regarding environmental regulation of MID's coal based generation resource reduces the likelihood that the installation of costly pollution control equipment will materially affect the district's financial position.

PURCHASED POWER COSTS: Power supply needs are largely met through purchased power, which results in costs that fluctuate with market prices. Financial impacts are mitigated to some extent through longer-term purchase contracts and owned generation.

HIGH DEBT LEVELS: Debt metrics have improved to some degree, but remained below rating category medians in fiscal 2012. Leverage remains high with equity to capitalization at approximately 13% at the end of fiscal 2012.

RATING SENSITIVITY:

FINANCIAL STABILITY: Maintenance of the utility's relatively strong liquidity and all-in coverage levels, particularly as the district determines future funding requirements, would likely result in consideration for an upgrade.

RESOLUTION ON COAL UNIT: The rating may be negatively affected if an unexpected, unfavorable resolution to the current environmental regulation issues affecting the San Juan coal-fired plant materially increase MID's cost of power.

CREDIT PROFILE
MID provides retail electric service to approximately 114,000 customers in the San Joaquin Valley in central California (90 miles east of San Francisco), which is a service area composed of approximately 168 square miles, mostly located in Stanislaus County. The district also supplies water for irrigation use to a portion of the county and treated water to the city of Modesto; however, water revenues are accounted for separately from the electric system.

IMPROVED FINANCIAL PROFILE

MID's financial performance has improved markedly since fiscal 2010 as rate increases and a modest recovery in sales have increased operating margins. Fitch-calculated debt service coverage in fiscal 2012 improved to 1.79 times (x) and coverage of full obligations was at 1.42x. Fitch expects coverage levels to decline in fiscal 2013 but remain adequate for the rating, as purchased power costs rose due to reduced energy received from the San Juan coal generation plant and the lower hydroelectric production due to California's on-going drought.

The district's cash levels have also strengthened over the past few years. The unrestricted cash balance at year-end fiscal 2012 was $174 million (230 days operating cash) compared to $120.5 million (167 days) in fiscal 2010. Fitch expects cash to continue to increase but at a much more modest rate over the next few years, based on management's financial projections.

NEW BOARD AND GM

MID appointed Roger VanHoy as the new general manager (GM) in August 2013 after serving in an interim role since the previous GM retired in December 2012. In addition, a new majority was elected to the board of directors in November 2013 when the tenured incumbents decided not to run for re-election. Fitch views the transitions as credit-neutral given that no significant changes to the district's business strategy or financial and debt management policies have been proposed.

ENVIRONMENTAL REGULATION

MID's investment through M-S-R Public Power Agency (MSR) in the coal fired San Juan Unit 4 is the source of some uncertainty following Environmental Protection Agency's (EPA) ruling to reduce regional haze emissions from the plant. On Feb. 15, 2013, the primary parties to the dispute announced a proposed agreement that would require the installation of selective non-catalytic reduction technology on San Juan Units 1 and 4 by early 2016, and the retirement of Units 2 and 3 by the end of 2017.

Fitch views the agreement, should it receive final approval, positively as it presents a less costly alternative to meeting the EPA's requirements than the previously proposed installation of selective catalytic reduction technology. Final approval is not expected until late fall of 2014.

POWER SUPPLY

MID's power supply portfolio is weighted towards purchased power, including purchases that consist of owned resources through MSR, MID's long-term purchase power contract associated with its investment in the Lodi Energy Center (LEC), and short-term market purchases. In fiscal 2012, approximately 24.4% of MID's power supply was provided by owned generating resources, including hydro and natural gas resources. However, the capacity represented by MID's own resources, which are predominantly natural gas-fired peaking resources, is higher (45%). These resources provide a hedge against market prices and provide reliability to the service area in the hot summer months.

RENEWABLES AND GREENHOUSE GAS REGULATIONS

MID is well positioned to meet California's 33% renewable mandate by 2020. Approximately 25% of MID's electricity qualified as renewable in 2012 with wind accounting for most of that amount. Additional contracts for solar, wind, and other renewables are projected to increase MID's renewable energy supply in future years.

California's cap-and-trade program became enforceable on Jan. 1, 2013. Management stated that MID's allocated allowances accounted for approximately 90% of forecasted emissions. MID subsequently acquired sufficient allowances to meet its forecasted needs through the medium term. The cost of purchasing the allowances is offset by MID's greenhouse gas adjustment, which was adopted into the rate structure in November 2011.

Additional information is available at www.fitchratings.com.

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:
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012);
--'Revenue-Supported Rating Criteria' (June 12, 2012).

Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=823892
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Contacts

Fitch Ratings
Primary Analyst:
Matthew Reilly, +1-415-732-7572
Director
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst:
Kathy Masterson, +1-415-732-5622
Senior Director
or
Committee Chairperson:
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst:
Matthew Reilly, +1-415-732-7572
Director
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst:
Kathy Masterson, +1-415-732-5622
Senior Director
or
Committee Chairperson:
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com