Fitch Rates Grant County PUD, WA's Priest Rapids Hydroelectric Project Revs 'AA'

NEW YORK--()--Fitch Ratings has assigned an 'AA' rating to the Public Utility District No. 2 of Grant County, WA's (the district) approximately $182.2 million Priest Rapids Hydroelectric Project Revenue and Refunding Bonds, Series 2015 A (non-AMT), B (AMT) and M (taxable clean renewable energy bonds).

The bonds are being issued to fund capital improvements at the project (approximately $90 million in new money) and to refund a portion of outstanding project debt for savings.

The bonds are scheduled to sell via negotiation on Oct. 7, 2015.

In addition, Fitch affirms the following ratings at 'AA':

--$742.9 million Priest Rapids Hydroelectric project Revenue and refunding bonds;

--$117.8 million Priest Rapids Development revenue bonds;

--$166.7 million Wanapum Development revenue bonds;

--$194.8 million Electric System revenue bonds.

The Rating Outlook is Stable.

SECURITY

The Priest Rapids Hydroelectric Project bonds are payable from net project revenues.

The electric system bonds are payable from the electric system revenue bond fund after payment of distribution system operating expenses, inclusive of Priest Rapids Project resource costs.

KEY RATING DRIVERS

LOW-COST POWER: The district provides exceptionally low-cost hydroelectric power from the Priest Rapids and Wanapum hydro development (collectively, the Priest Rapids Project or PRP) to its retail distribution system (the distribution system) and long-term contractual purchasers.

AMPLE GENERATION CAPACITY: The distribution system is entitled to 63.3% of the physical output of the PRP and has the ability to access 30% more through a financial entitlement, which is more than sufficient to meet its current and anticipated retail customer load.

DAM FRACTURE ADEQUATELY MANAGED: The Wanapum Dam has returned to full operations, after generating at a lower level in 2014 due to reservoir draw downs needed to repair a fracture found in the dam. Strong financial metrics and ample liquidity enabled the district to withstand associated lower wholesale sales and allowed the utility to fund needed repair costs through a mix of reserves and debt issuances.

EQUITY FUNDING WILL DECREASE DEBT: The district has begun to use its ample liquidity and equity built at the distribution system to fund a portion of PRP's capital plan. The change from full debt funding of PRP to partial equity funding is a favorable development, as it decreases consolidated debt levels, which were forecasted to increase substantially, and keeps down project costs and the associated cost of power.

HYDROLOGICAL VARIABILITY POTENTIALLY MITIGATED: The distribution system is a net seller into the wholesale power market, which subjects it to variability in hydrological conditions and market prices. The district anticipates entering into a five-year enhanced slice strategy with Shell Energy North America, LP (SENA) that trades hydrological risk for counterparty risk. Given SENA's solid parent, Royal Dutch Shell rated 'AA' with credit watch negative, Fitch views the tradeoff as credit neutral.

INDUSTRIAL CUSTOMER CONCENTRATION: The 10 largest retail customers account for 38% of the distribution system's retail revenues, which creates some customer and revenue concentration risk. The distribution system is readily able to sell its excess power into the wholesale market, which somewhat offsets the risk of unexpectedly losing a larger customer.

RATING SENSITIVITIES

MANAGEMENT OF SLICE CONTRACT: the Public Utility District No. 2 of Grant County, WA's ability to effectively manage its operations together with the new slice contract with Shell Energy North America (SENA) will be key to maintaining stable financial performance. Monthly netted payments that are substantially larger than anticipated and negatively affect financial metrics would put downward pressure on the rating. Entering into future enhanced slice strategies, after the SENA contract terminates, with low-rated counterparties, could create additional risks and also provide downward rating pressure.

CREDIT PROFILE

The district's electric utility operations are comprised of its distribution system and its hydroelectric generating project, PRP. PRP is separately financed and accounted for relative to the distribution system. It has a nameplate generating capacity of 2,104 MW, provided from the Priest Rapids and the Wanapum hydroelectric developments. The distribution system is entitled to 63.3% of the PRP physical output and the remaining generated power is sold through a combination of annual auctions and long-term take-or-pay contracts. The distribution system has the ability to take up to a maximum of 93.3% of PRP's combined output (63.3% physical and 30% financial), which provides flexibility as the system's retail load continues to grow.

The Wanapum and Priest Rapids hydroelectric developments historically issued separate debt that was payable from each respective development's net revenues. The district combined the two developments under PRP in 2010 and now issues debt payable from the combined development. The hydroelectric developments are operated under a single Federal Energy Regulatory Commission that expires in 2052. Development-specific debt is still outstanding, but is on parity with combined PRP debt.

Fitch views the distribution system and the separately secured hydro developments as a single, integrated system, given that the project debt is legally bound to the distribution system, making it the ultimate obligor.

WANAPUM DAM FRACTURE

PRP is back to operating at full capacity, after power generation was reduced in 2014 due to the discovery of a fracture across one of Wanapum Dam's spillway monoliths. The upper reservoir was drawn down to relieve the pressure and allow for investigation and needed repairs. The reservoir drawdown reduced power generation at the dam, which was 13% lower than 2013 production. However, production was within normal variability levels that occur with fluctuating annual river flows and at the lowest drawdown level, the hydro development was capable of generating at between 50-60% of capacity.

The district determined that a mathematical error in the original dam design caused the fracture. The cost of the repairs was $23 million in increased operations and maintenance costs, funded from reserves, and $58 million in capital expenditures, funded from a 2014 debt issuance, for a total cost of $81 million. Increased debt service costs will be passed along to PRP power purchasers.

DISTRIBUTION SYSTEM ANTICIPATES NEW HEDGING PROGRAM

The distribution system anticipates entering into an 'enhanced slice strategy' agreement by year-end with SENA. Under the five-year contract, the district will provide SENA with the remaining slice portion of output from PRP that the distribution system is entitled to (43.3% through June 30, 2016 and 53.3% thereafter). During that tenure, SENA will provide the distribution system with firm power sufficient to meet its retail load forecast, adjusted for the portion of load that will be met with other owned resources. District management feels the contract reduces hydrological risk and provides the utility with a moderate net benefit over the life of the contract. The contract cannot be terminated by either party prior to contract maturity, except in the event of default.

Fitch feels the enhanced slice contract trades hydrological risk for counterparty risk. Given that SENA has a solid parent company rating, the tradeoff is considered credit neutral. If the district continues the enhanced slice program after the five-year contract, entering into the program with lower-rated counterparties could create additional risks and put downward pressure on the rating.

STRONG FINANCIAL PERFORMANCE

Financial performance of the distribution system generally displays some fluctuation depending on river runoff. Hydrological conditions in 2013 and 2014 were average, with runoff at 103% for both years. This came after two years of exceptionally high water runoff of above 120%, resulting in 2013 and 2014 financial metrics that, while still robust, were down from the high point reached in 2012 that was also bolstered by reduced debt service subsequent to a refunding. Fitch-calculated debt service coverage (DSC) in 2014 for the distribution system was a strong 3.79x and coverage of full obligations was 1.55x, as compared to 2012's 6.48x and 2.31x, respectively.

On a fully consolidated basis, including the distribution system and PRP financials, DSC was very stable in 2012 through 2014, with DSC of 1.8x in each year and coverage of full obligations of 1.7x.

While unrestricted funds on a consolidated basis decreased noticeably at year-end 2014, as the district used funds to support needed repairs and operations at the Wanapum dam and equity funding a portion of PRP capital improvements, unrestricted fund balances still remain very strong at $190.4 million, or 398 days. Multiple years of above-average hydro conditions and implemented rate increases bolstered the utility's liquidity position to a very strong 527 at year-end 2013, allowing the district to use funds on hand to support a portion of the Wanapum Dam fracture's costs. DCOH are projected to recover to a pre-fracture level by year-end 2016.

Consolidated projections show DSC dipping slightly in 2015, to 1.74x DSC, due to continued reduced generation in Q1 2015 and a low water year (estimated at 90% of average), but should remain in the range of 1.8x through 2017.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

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

U.S. Public Power Rating Criteria (pub. 18 May 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007

Additional Disclosures

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Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991006

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Stacey Mawson
Director
+1-212-908-0678
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Lina Santoro
+1-212-908-0522
or
Committee Chairperson
Alan Spen
Managing Director
+1-212-908-0594
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Stacey Mawson
Director
+1-212-908-0678
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Lina Santoro
+1-212-908-0522
or
Committee Chairperson
Alan Spen
Managing Director
+1-212-908-0594
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com