SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings downgrades the following Heber Light & Power (HL&P) revenue bonds to 'A+' from 'AA-':
--$9.5 million electric revenue bonds, series 2010 and 2012.
The Rating Outlook on all bonds is Stable.
The bonds are secured by a lien on net revenues derived by the company from the operation of its electric system.
KEY RATING DRIVERS
SMALL BUT GROWING UTILITY: Heber Light and Power (HL&P) owns and operates a small electric generation and distribution system in a quickly growing, largely residential area located about 50 miles east of Salt Lake City.
CAPITAL AND DEBT CONCERNS DRIVE DOWNGRADE: The downgrade reflects relatively significant projected capital needs and related borrowings through 2018 that were not previously anticipated and are expected to weaken debt metrics and decrease the system's available cash below previously projected levels. Meaningful rate increases will be required to support credit quality.
GOVERNANCE CONCERNS: The downgrade also partly reflects concerns regarding the utility's governance following reports of fraudulent activities by a former employee and issues regarding the board's process and actions to increase their own pay. While the issues do not appear to be material to the financial position of the utility, the previous rating was supported by assumed solid governance practices that do not appear to have been maintained.
DIVERSE GENERATION HEDGES OPERATIONS: Power supply needs are met through a diverse resource base comprised of owned and contracted resources providing the system with flexibility and hedging its balancing and scheduling responsibilities.
STRONG COVERAGE LEVELS: Fitch-calculated debt service coverage (not including impact fees) remains strong at 3.2 times (x) in fiscal 2013 (draft audit). Including impact fees, debt service coverage rises to 4.1x.
REDUCED RATE FLEXIBILITY: Ratepayer sensitivity to rate increases may be heightened given recent issues related to the system's governance. An inability or unwillingness to increase rates to meet the system's revenue requirements would exert negative pressure on the rating.
SMALL, QUICKLY GROWING RETAIL ELECTRIC PROVIDER
HL&P owns a vertically integrated electric generation and distribution system serving a quickly growing, largely residential service area. The system served approximately 11,641 customers in 2013, which is an increase of 18% over 2011 figures.
HL&P's service territory largely consists of four municipalities located approximately 50 miles east of Salt Lake City and 25 miles from Provo City. The local economy benefits from its proximity to these regional economic centers as well as the nearby Park City and Dear Valley ski areas.
GOVERNANCE ISSUES RAISE CONCERN
Two recent and unrelated events have raised concerns regarding HL&P's governance. The first is the alleged embezzlement of utility funds by a former employee that reportedly took place over several years. The second pertains to board actions to increase their own pay that were determined to be noncompliant with Utah law and HL&P by-laws by the State of Utah Office of the Attorney General's Civil Review Committee; HL&P disputes the findings. While neither event is considered material to the financial position of the utility, the previous rating was supported by assumed good governance practices that do not appear to have been maintained. Additional issues related to the management and oversight of the utility could result in additional negative rating action.
SIGNIFICANT CAPITAL PLAN
HL&P's most recent capital improvement plan through 2018 includes several needed projects including establishing a second point of interconnection with PacifiCorp, acquiring additional generation, and system maintenance and upgrades.
The plan calls for approximately $8.4 million in debt, or approximately 51% of currently projected financing needs. Debt metrics, which are currently strong, are expected to weaken to levels below earlier projections, following the projected debt issuance. In addition, management stated that currently solid cash reserves are expected to decline as the utility spends down cash to build needed infrastructure. The rating reflects Fitch's expectation that cash balances will remain in excess of the HL&P's stated policy of 12.5% of operating revenues (approximately $1.7 million in fiscal 2013).
Financial forecasts project annual rate increases of 4.5% from 2014 through 2018 to maintain financial metrics at current levels and support cash funding of various capital investments.
POWER SUPPLY AND SYSTEM OPERATIONS
Power supply needs are met by HL&P's diverse resource base, consisting of owned resources and purchased power from several entities. Management is currently evaluating options for adding additional natural gas fired, peaking capacity. A decision on whether to self-build or purchase existing units is expected over the near term.
HL&P provides its own scheduling and balancing services. This operating risk is managed with the flexibility provided by its 9.8 MW of local, natural gas-fired generation; the option of an 11.3 MW Intermountain Power Project contract; and its participation in the UAMPS power pool.
Natural gas purchases for its owned generation do not extend beyond three to six months, thereby limiting the financial and counterparty risk associated with forward positions but exposing the utility to a certain degree of market risk.
STRONG COVERAGE LEVELS
Fitch-calculated debt service coverage, without including impact fees, was strong at 3.36x and 3.20x (draft audit) in fiscals 2012 and 2013, respectively; with impact fees, coverage levels increase to 3.87x and 4.1x.
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' (March 18, 2014);
--'Revenue-Supported Rating Criteria' (June 3, 2013).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
Revenue-Supported Rating Criteria