Fitch Rates Los Angeles, CA's Power Rev Bonds 'AA-'; Outlook Stable

AUSTIN, Texas--()--14: Fitch Ratings assigns an 'AA-' rating to the following power system revenue debt issued by the Los Angeles Department of Water and Power, CA (LADWP):

--Approximately $229 million power system revenue bonds, series 2014E.

Proceeds of the series 2014E bonds will fund a portion of the power system's ongoing capital program. The 2014E bonds are expected to price on Dec. 10, 2014.

In addition, Fitch affirms its 'AA-' ratings on the following outstanding parity debt:

--$7.89 billion power system revenue bonds;

--Bank note rating associated with commercial paper (CP) program;

--Bank bond rating associated with outstanding series 2001B and 2002A variable rate bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are special obligations of LADWP payable solely from power system revenues. LADWP's power system bonds do not have a debt service reserve fund.

KEY RATING DRIVERS

STRONG SERVICE AREA: LADWP's greater Los Angeles service territory is broad, mature and diverse with stable customer growth. Load growth has historically been steady and is expected to remain flat through 2020, offset by energy efficiency investments.

FAVORABLE RATE STRUCTURE ELEMENTS: The capture of around 45% of revenues through automatic cost recovery rate mechanisms partially mitigates Fitch's concerns regarding the lengthy and politically charged rate environment for this utility. Management expects to consider the next base rate increase in 2015.

HEALTHY FINANCIAL MARGINS: Financial margins are healthy at over 2.2x debt service coverage in fiscal 2013, or 1.7x fixed charge coverage including a large transfer made annually to the city's general fund. Unaudited results for fiscal 2014 indicate similar margins.

MANAGEMENT STABILITY: Management stability at the senior staff level partially mitigates concern over turnover at the general manager level and provides LADWP with a strong level of operational continuity and long-range financial and power supply planning.

EVOLVING POWER SUPPLY: California legislation requires costly changes to LADWP's power supply mix, both in operating and capital costs. LADWP continues to invest in generation resources and is well positioned to comply with the state's environmental goals.

STRONG CAPITAL INVESTMENT: Capital investment in the system has been strong in recent years, at over 200% of depreciation. LADWP projects high levels of investment will continue to be funded from a healthy mix of revenues and debt.

HIGH DEBT LEVELS: LADWP's anticipated debt issuance to fund its very large $8.6 billion capital plan is significant at an additional $4.5 billion over the next four years. The planned debt will increase leverage from already high levels.

RATING SENSITIVITIES

POTENTIAL LACK OF RATE SUPPORT: Failure to receive approval for future base rate increases needed to offset the department's expected higher operating and capital costs could pressure financial margins and potentially the rating.

CREDIT PROFILE

STRONG SERVICE AREA

Los Angeles is the commercial and cultural center of a very large, diverse economy. The area is starting to benefit from property market improvements despite an unemployment rate in the county that remains high at 8.6% in September 2014. LADWP provides retail electric service in the city of Los Angeles to 1.48 million customers, or a population of 3.9 million. The system had a peak of 6,396 megawatts (MW) in September 2014. The customer base is extremely diverse, with a strong commercial presence. However, retail sales have been flat in the past five years with the weak economy, conservation efforts and energy efficiency investments. Energy sales are projected to continue to be flat through 2020 with planned additional investment in energy efficiency programs.

GENERAL MANAGER TURNOVER

Marcie Edwards took over as General Manager in March 2014. She has extensive industry experience in both water and power. LADWP has a deep and experienced senior management team supporting the general manager position that will continue to pursue LADWP's overall agendas in its two business lines. However, Fitch continues to view stability in the general manager position as an important credit factor given the magnitude of industry issues facing both water and power utilities in California.

RATE ACTION DELAYED

LADWP's last power system base rate case occurred in the fall of 2012, when it received approval to increase power rates in the remaining months of fiscal 2013 (4.9%) and fiscal 2014 (6%). At that time, additional base rate increases were contemplated to occur in fiscals 2015 and 2016. Given the implementation difficulties with a new billing system in fiscal 2014, LADWP now expects to resolve these issues prior to seeking additional base rate increases in spring 2015.

Mitigating concerns regarding a base rate delay are LADWP's cost-adjustment factors which recover 45% of electric revenues and will increase automatically with increased costs. Fitch views the use of the adjustment factors as a positive credit factor in that these variable costs or designated capital costs require only Board approval and are not subject to the system's lengthy base rate approval process. However, much of the future planned capital spending will require rate increases to fund the related costs.

POWER SUPPLY REFORMATION REQUIRED; LADWP MAKING PROGRESS

Long-term changes to LADWP's power supply portfolio are required to meet California's environmental agenda. LADWP's coal-fired resources include the Intermountain Power Project located in Utah (LADWP's share is 1,116 MW) and the Navajo Generating Station in Arizona (477 MW). LADWP is pursuing strategies to mitigate the carbon impacts of both resources in order to comply with state legislation. LADWP reached its 20% renewable target beginning in 2010 and estimates that its 2014 renewable portfolio provided 22% of its power supply. LADWP is well positioned to meet the state-mandated goal of 33% by 2020 if investments in solar, geothermal, and energy efficiency proceed as outlined in the integrated resource plan.

HEALTHY FINANCIAL PERFORMANCE

Debt service coverage in fiscals 2013 and 2012 was healthy at over 2.4x in both years and over 1.8x following the transfer equal to 8% of utility revenues to the city's general fund. The stronger margins in these years followed debt restructurings in both years that provided upfront savings and debt service relief. Unaudited financial performance in fiscal 2014 indicates similar margins even with higher debt service paid in fiscal 2014. Margins benefitted from relatively level expenditures and cost recovery provided through the 6% base rate increase and cost recovery adjustments in the rate structure.

Liquidity at the end of fiscal 2013 was strong, with $1.08 billion (or 177 days of operations) in unrestricted cash, including $490 million in the debt reduction fund. Liquidity as of Aug. 31, 2014 had increased to $1.5 billion in unrestricted cash, including $497 million in the debt reduction fund.

Debt service is anticipated to grow to over $700 million by fiscal 2019 from $451 in fiscal 2014. LADWP's formal financial policies include a debt service coverage target of 2.25x (before transfer), a fixed charge debt service target of 1.7x, a minimum unrestricted cash reserve equal to 170 days cash, and debt-to-capitalization of less than 68%. The policy targets are not hard restrictions, but Fitch views them as an evolving indication of LADWP's goals for rate setting.

SIGNIFICANT CAPITAL NEEDS AND HIGH DEBT LEVELS

The sizable capital plan is being driven by LADWP's reinvestment in infrastructure to preserve reliability and generation development. The utility's increasing debt needs could pressure fixed costs and constrain financial flexibility. Fitch views LADWP's maintenance of a healthy portion of revenue-supported capital spending as a key component of the utility's financial flexibility. The current five-year capital plan has a healthy pay-as-you-go component, with 40% of the cost projected to be supported by cash flow.

For more information, see the Fitch report, 'Los Angeles Department of Water and Power - Power Revenue Bonds' Feb. 19, 2014, available at www.fitchratings.com.

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:

--'Revenue-Supported Rating Criteria', June 16, 2014;

--'U.S. Public Power Rating Criteria', March 18, 2014;

--'U.S. Public Power Peer Study', June 13, 2014.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841

U.S. Public Power Peer Study -- June 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749789

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=934015

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Contacts

Fitch Ratings
Contact:
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Stacey Mawson
Associate Director
+1-212-908-0678
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Contact:
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Stacey Mawson
Associate Director
+1-212-908-0678
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com