Fitch Affirms Los Angeles (CA) Dept of Water and Power, Power System Revs at 'AA-'

SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms its 'AA-' underlying rating on the Los Angeles Department of Water and Power's (LADWP) (CA) power system revenue bonds at 'AA-' and the rating on LADWP's outstanding commercial paper notes at 'F1+'. The Rating Outlook is Stable.

The 'AA-' rating reflects the fundamental credit characteristics of the electric utility, including a diverse and competitive power supply portfolio, a broad and mature service territory, competitive retail rates, and a healthy, albeit tightening, financial position. Further supporting the rating is community and political support for the utility's sizable capital plan and the rate increases that will be needed to support the planned capital investment. Fitch views the community and City Council support as a key credit driver as the capital plan is extremely large and anticipated borrowing over the next five years tops $4 billion, which will almost double the utility's outstanding debt burden. The sizable $5.3 billion five-year capital plan is being driven by LADWP's reinvestment in system infrastructure to preserve reliability and generation development, including sizable investment in new renewable generation.

Credit concerns center on the execution of the substantial capital plan, a lengthy multi-level rate review process, and long-term cost pressure resulting from a changing power supply portfolio. Fitch expects the long-term cost pressure will be driven primarily by LADWP's renewable portfolio standard (which is similar to the state requirement for investor-owned utilities) and the greenhouse gas legislation recently adopted by the state that will likely prompt long-term changes to the power supply mix of all utilities in the state.

Going forward, Fitch will be monitoring LADWP's rising leverage and declining debt service coverage, given the political sensitivity to raising electric rates and the future cost pressures noted above. Debt service coverage is still strong for fiscal year-end 2007 at 2.8 times (x). However, debt service coverage is projected to decline closer to LADWP's minimum target of 2x, as new debt is issued to finance a large portion (approximately two-thirds) of the capital plan. In addition, LADWP's liquidity is projected to decline from current levels. Unrestricted reserves at year-end fiscal 2007 were $449 million, or 82 days operating cash. As funds are spent to support the capital plan, LADWP projects reducing available cash reserves to its minimum target of $150 million, or just 30 days operating cash, which is below the Fitch peer utility median of 55 days cash. However, in addition to its unrestricted reserves, LADWP also has substantial restricted reserves, including approximately $500 million in a debt reduction fund. This fund acts as a hedge for the utility's variable rate debt exposure and can be used in the future to economically defease debt or to pay current debt service costs. While Fitch anticipates the further deterioration in financial margins described above, deterioration beyond the utility's own financial policies, if it were to occur, could prompt a negative rating action. The Stable Outlook reflects Fitch's anticipation that rate increases and other necessary actions will be taken to preserve the utility's financial position.

In 2008, City Council adopted a package of three rate increases, the first of which became effective May 19, 2008 (2.9%); the next two increases will become effective on July 1, 2008 (2.9%) and July 1, 2009 (2.7%). The rate increases are accompanied by the implementation of a pass-through that will recover a portion of the reliability program designed to reinvest approximately $2 billion of capital spending in order to preserve reliability. The rate increases and the new reliability pass-through, along with the Energy Cost Adjustment Factor (ECAF), a component in rates that is adjusted quarterly to recover actual purchased power and fuel costs, are expected to be sufficient to fund the sizable capital needs of the system. Future rate increases beyond fiscal 2011 are currently estimated in the 3% range. Although LADWP has competitive rates compared to both regional investor-owned and municipal utilities, Fitch views the lengthy and multi-level rate process, which includes verification with an independent financial consultant and consultation with 88 neighborhood councils in addition to Board and City Council approval, as a potential limiting factor on the utility's true rate flexibility.

Los Angeles Department of Water & Power (LADWP) is the largest municipal retail electric system in the country, providing service to more than 4.02 million people in a service area of 465 square miles. Only 30% of energy sales are to residential customers, reflecting a strong commercial presence in the city, which accounts for 57% of revenues. The customer base is diverse.

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