News Column

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

June 20, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- 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 $200 million power system revenue bonds, series 2014C.

Proceeds of the series 2014C bonds will refund outstanding series 2005A bonds for savings. Savings are expected to be taken up front, primarily in fiscals 2017 and 2018. Final bond maturity will not be extended. The 2014C bonds are expected to price on July 1, 2014.

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

--$7.5 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 modest, below 1%, given extensive investments in energy efficiency programs.

FAVORABLE RATE STRUCTURE ELEMENTS: The capture of around 50% of revenues through automatic cost recovery rate mechanisms partially mitigates Fitch's concerns regarding the lengthy and politically charged rate environment for this utility.

FINANCIAL MARGIN IMPROVEMENT: Financial margins were healthy in fiscal 2013 due to a mid-year rate increase and are expected to remain in line with the rating category.

MANAGEMENT STABILITY: Management stability at the senior staff level partially mitigates concern over turnover at the general manager level and appears to provide LADWP with a level of operational continuity.

EVOLVING POWER SUPPLY: California legislation requires costly changes to LADWP's power supply mix, in both operating and capital costs. LADWP continues to invest in generation resources to position itself 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 $7.5 billion capital plan is significant at an additional $3.8 billion over the next five years. The planned debt will increase leverage from already high levels.

RATING SENSITIVITIES

POTENTIAL LACK OF RATE SUPPORT: Failure to receive approval of future 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 8.5% in April 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 5,782 megawatts (MW) and load factor of 53.6% in 2013. The customer base is extremely diverse, with a strong commercial presence. However, retail sales have been soft in the past five years with the weak economy, conservation efforts and energy efficiency investments. Load growth is projected to be minimal 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 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 (6.0%). 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 that began in fiscal 2014, LADWP now expects to resolve these issues prior to seeking additional base rate increases.

Mitigating concerns regarding a base rate delay are LADWP's cost-adjustment factors that recover over 50% 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.

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 the required interim 20% renewable target in 2010-2012 and should be 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 resource plan.

IMPROVED FINANCIAL PERFORMANCE

Financial performance in fiscals 2011 and 2012 was mixed with a tightening of margins. Although net revenues stayed flat in the absence of any rate increase, debt service has increased by $150 million or 56% from fiscal 2008 to 2011, reflecting sizable capital spending and debt issuance in recent years. Debt service coverage in fiscal 2012 was 2.9x as a result of debt restructuring to lower debt payments in that year once delays in rate consideration necessitated across-the-board expenditure reductions. Debt service coverage in fiscal 2013 was lower at 2.4x as a result of higher debt service, although revenues experienced some improvement from the mid-year rate increase.

Fitch also evaluates LADWP's coverage metric including payment of the 8% of revenue transfer to the general fund debt service coverage after transfers was 1.8x in fiscal 2013. Liquidity at the end of fiscal 2013 remained strong with $1.08 billion (or 178 days of operations) in unrestricted cash, including $490 million in the debt reduction fund. Future debt service coverage is projected by LADWP to remain at or above this target with assumed rate increases that should provide sufficient revenues to cover the rebound in debt service costs.

SIGNIFICANT CAPITAL NEEDS AND HIGH DEBT LEVELS

The sizable $7.5 billion 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 39% 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:

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

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

U.S. Public Power Rating Criteria

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

Revenue-Supported Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835678

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Fitch Ratings

Primary Analyst

Kathy Masterson, +1 512-215-3730

Senior Director

Fitch Ratings, Inc.

111 Congress Avenue, Suite 2010

Austin, TX 78701

or

Secondary Analyst

Stacey Mawson, +1 212-908-0678

Associate Director

or

Committee Chairperson

Dennis Pidherny, +1 212-908-0738

Managing Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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