NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings on outstanding Philadelphia, PA gas works revenue bonds:
--$145.4 million gas works revenue bonds, various series, (1975 general ordinance) at 'BBB+';
--$870.5 million gas works revenue refunding bonds, various series (senior 1998 general ordinance) at 'BBB'.
The Rating Outlook is Stable.
Outstanding 1975 general ordinance bonds are secured by a closed first lien on net revenues of the gas works utility. The 1998 general ordinance bonds are secured by net revenues of the gas works utility subordinate to the prior pledge of the 1975 general ordinance bonds.
KEY RATING DRIVERS
LARGE GAS DISTRIBUTION SYSTEM: PGW is the largest municipally-owned gas distribution utility in the nation, serving slightly more than 500,000 accounts located entirely within the City of Philadelphia (general obligation bonds rated 'A'/Stable). The system provides natural gas to a considerably diverse and largely residential customer base that exhibits no concentration among users.
SATISFACTORY FINANCIAL PERFORMANCE: Financial metrics have remained at an acceptable level over the last several years, principally due to prior rate increases and sustained improvement in collection of billings. Fitch calculated debt service coverage has averaged a sound 1.5x over the prior three years while liquidity has remained in excess of 50 days of cash on hand.
REGULATION OF RATES: The Pennsylvania Public Utility Commission (PUC) regulates PGW's retail rates, which generally limits the utility's overall financial flexibility. However, the relationship between the PUC and the utility has remained constructive over time.
REDUCED RELIANCE ON DEBT FUNDING: PGW's ability to generate positive cash flow after meeting debt service and transfer obligations in recent years has eliminated its historical reliance on short-term debt to fund operations. Debt levels remain elevated, but Fitch expects leverage ratios will continue to improve going forward, particularly given the recent implementation of an infrastructure surcharge dedicated to funding capital projects.
PRIORITY LIEN RECOGNIZED: The 'BBB+' rating on the 1975 general ordinance bonds reflects their priority lien in the flow of funds, which is closed to future bond issues, as well as the distinct separation between the 1975 and 1998 ordinances.
PENDING SALE OF PGW: Fitch believes the recently announced agreement to sell the Philadelphia Gas Works (PGW) to UIL Holdings Corporation does not heighten the risk to the utility's existing bondholders as the sale cannot be completed without the payment or legal defeasance of all outstanding revenue bonds pursuant to the terms of the bond resolution.
WEAKER CASH FLOW: Diminished cash flow, most likely as a result of slower collections, high bad debt expense, inadequate rate relief or lower usage, leading to additional leverage in excess of what is currently programmed into the current capital program would be viewed negatively.
LARGE DISTRIBUTION SYSTEM
PGW is the largest municipal gas distribution utility in the nation, providing natural gas through a diverse mix of supply arrangements as well as its own storage and natural gas liquefaction facilities. Ample storage capacity allows the system to procure and store a sizeable portion of its winter supply during the less expensive summer months.
CHALLENGING DEMOGRAPHICS COMPOUND HIGH RATES
The system's high rates, the city's challenging demographics and the state's regulation of gas rates continue to constrain PGW's operating flexibility. Residential rates are comparatively higher than all other gas distribution systems operating within the state due to historically weak collections and extensive utility-sponsored discount programs that benefit low-income customers. The city's poverty rate stands at 26%, twelfth-highest among the nation's 50 largest cities, and overall income levels approximate just 75% of the state and national averages. In addition, the city's May 2014 unemployment rate (7.7%) remains elevated relative to state and national averages.
Approximately 95% of the system's 501,000 customer accounts are residential, with the balance comprised of commercial and industrial users. Positively, accounts receivable have shown considerable improvement in recent years and collection of billed revenues has averaged a more stable 96% since 2005. Collections prior to 2005 were significantly weaker.
Rates and charges of PGW are set by the Pennsylvania PUC. The PUC's ratemaking methodology is designed to ensure that PGW recovers its costs, meets its rate covenant of 1.5x coverage on senior and subordinate lien obligations, and continues to fund a required $18 million annual utility payment to the city. PGW's relationship with the PUC is reportedly constructive, as evidenced by the recent authorization of a distribution system improvement charge and the continued approval of quarterly gas cost rate adjustments.
PGW's most recent base rate filing was approved in July 2010. The approval permitted PGW to maintain virtually all of a $60 million extraordinary rate increase granted by the PUC in 2008, and to receive an incremental rate increase of $16 million annually to fund other post-employment benefit costs. Management does not anticipate making a request for another base rate increase during the current forecast period, but rate increases beyond 2018 are currently being considered.
SOUND FINANCIAL PERFORMANCE
Financial metrics generated in more recent years are satisfactory for the given rating category and much improved relative to historical results, primarily due to more timely cost recovery and improved collections. Fitch calculated debt service coverage of both senior and subordinate lien obligations has averaged an acceptable 1.5x over the prior three fiscal years, compared to 1.1x between fiscals 2006 - 2009.
Unrestricted cash diminished some in fiscal 2012, but with 70 days of cash on hand, PGW's cash position remains adequate for the system's operating profile and sound for the given rating category. Moreover, the decline in unrestricted cash in fiscal 2012 was attributable primarily to management's prudent decision to reduce leverage by accelerating the repayment of approximately $20 million in bond principal.
PGW is also authorized, pursuant to a city ordinance, to issue up to $150 million in commercial paper (CP) notes for working capital, although no borrowings under the authorization have occurred since fiscal 2009. Multiple letters of credit available to support up to $60 million of CP are currently in place through March 2015, increasing PGW's days liquidity on hand to about 111 days at fiscal year-end 2013. However, the city expects to replace its existing letters of credit this month with two additional facilities totaling $120 million. The letters of credit, which will be available for both working capital purposes and capital expenditures, will reportedly have three-year terms, through 2017. PGW routinely utilized the CP authorization to fund operations prior to fiscal 2009 when operating margins were notably weaker.
Leverage ratios are expected to remain elevated, although management's ongoing commitment to reducing its reliance on short-term and long-term financing to fund capital expenditures is a positive consideration. Despite some improvement in recent years, equity/capitalization (24.8%) remains weak, but not inconsistent with the given rating category. Fitch expects leverage ratios to incrementally improve going forward.
The current capital program covers fiscal years 2015-2020 and totals a manageable $624.2 million, the vast majority of which will be for main replacement. PGW's ongoing annual program to reduce its inventory of cast iron mains by a minimum of 18 miles per year will compose about 65% of planned spending through the current planning period.
PGW expects to use its commercial paper program to finance a portion of its capital program. The balance of planned spending will come from excess operating cash flow and existing reserves, including the drawdown of its $44 million construction fund balance.
The recent imposition of a distribution system improvement charge (DSIC) that began July 1, 2013 will provide additional cash flow dedicated to funding capital projects. The DSIC is a supplemental rate Pennsylvania utilities can levy pursuant to PUC approval to recover distribution system repair, improvement and replacement costs that were not incorporated into the prior rate case. PGW is levying the maximum rate of 5% of amounts billed to customers for distribution service, projected to yield about $22 million annually. PGW's ability to levy the DSIC is considered by Fitch to be a constructive development in a state with a historically challenging regulatory regime.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2014' (June 13, 2014);
--'U.S. Public Power Peer Study Addendum - June 2014' (June 13, 2014);
--'U.S. Public Power Rating Criteria' (March 18, 2014).
Applicable Criteria and Related Research:
U.S. Public Power Peer Study -- June 2014
U.S. Public Power Peer Study Addendum - June 2014
U.S. Public Power Rating Criteria