2009-11-10 22:52:02 -
Fitch Ratings assigns an 'AA' rating to the Los Angeles Department of Water and Power's (LADWP) $500 million water system revenue bonds, 2009 series B and series C. The bonds are scheduled to price the week of Nov.
16 via negotiated sale. Fitch also affirms the 'AA' rating on LADWP's approximately $2.1 billion of outstanding parity water revenue bonds.
The
Rating Outlook on the bonds is Stable.
The 'AA' rating reflects LADWP's strong debt service coverage levels, sound management planning practices, diversity of water supplies, and the economic strength and depth of the service area. Credit concerns include ongoing pressure on water supply and water supply costs resulting from drought conditions and operating constraints. Additional credit concerns include a sizable capital improvement program (CIP) that seeks to address environmental regulations and aging infrastructure, a large debt burden that will increase substantially in the next five years, as well as a lengthy rate process.
Coverage levels and liquidity ratios are on the lower end of the 'AA' category, while debt levels are high. Board adoption in 2009 of financial policies that target 2.0 times (x) debt service coverage, minimum cash reserves of $200 million, and debt/capitalization of no more than 60% are viewed as a positive credit development. The flexibility of the rate structure to respond to large reductions in water sales and remain revenue neutral, the discontinuation of the general fund transfer, and a movement over the next five years to a capital funding structure with 40% provided from revenues all contribute to the 'AA' rating.
LADWP provides retail water service to a population within the city of Los Angeles of just over four million. Water supply is derived from three primary sources, including deliveries via the Los Angeles Aqueduct from the Owens Valley and Mono Basin through gravity-flow aqueducts (18% of supply in fiscal 2009), local groundwater (10%), recycled water (1%), and imported water purchased from the Metropolitan Water District of Southern California (MWD; revenue bonds rated 'AA+'/Negative Outlook by Fitch), which typically provides the remaining water supply not available from the other sources (71%). Recent declines in LADWP's water supply are the result of continued drought conditions in California, which affect deliveries from the Owens Valley and Mono Basin as well the availability and price of purchased water from MWD. Due to critically dry hydrological conditions, MWD implemented mandatory 10% reductions in deliveries to its members, including LADWP, effective July 1, 2009.
LADWP continues to address contamination in its local groundwater supply in the San Fernando basin, which is currently restricting the amount of water available from this supply source. As a result of these developments, LADWP enacted a mandatory 15% reduction in usage from its retail customers as well as implementing its shortage rate schedule in order to remain revenue neutral in the face of lower volumetric sales.
Customers have exceeded the mandatory 15% reduction target with retail conservation approaching 25%.
In fiscal 2008 and 2009, LADWP purchased more water from MWD than typical and at higher cost to supplement its other water sources.
Purchased water costs of $188 million in fiscal 2008 were 52% higher than fiscal 2007 and rose another 14% in fiscal 2009. Purchased water costs are recovered through LADWP's rate structure via the water procurement adjustment factor, which is not subject to a cap. LADWP has a complex rate structure, with five different adjustment factors, such as the water procurement factor, designed to recover specific costs, and tiered base rates designed to shape demand. The use of the automatic adjustment factors is viewed as a positive credit factor in that variable costs or designated capital costs are recovered directly and not subject to the system's lengthy rate approval process ultimately requiring approval by the City Council. However, certain rate adjustment factors are subject to a cap of $0.50 that does not provide any upward flexibility above what is currently collected. LADWP expects to consider an increase in the cap.
Financial performance in fiscal 2009 was slightly below, but in line with, projections considered during Fitch's last rating review in January 2009. Debt service coverage of 1.81x in fiscal 2009 has declined steadily over the past five years from debt service coverage over 3.0x in fiscals 2003 and 2004. Debt service coverage, on an accrual (audited) basis, is projected to dip to 1.7x in fiscal years 2010 and 2011.
Although this trend will fall below the 2.0x threshold, the rating reflects management and Fitch's expectation that a return to LADWP's stated goal of 2.0x will occur by fiscal 2012. Liquidity is slightly better than anticipated with $152 million in unrestricted cash in fiscal 2009, or 96 days operating cash. Unrestricted cash is projected to increase to LADWP's target of $200 million by fiscal 2014.
The transfer to the general fund, historically around 5% of revenues, has been found in a court decision to violate Proposition 218 and, as a result, LADWP will not make future transfers from the water system to the general fund. The result is a savings to the water system of approximately $30 million annually. LADWP intends to use the additional cash flow to provide pay-go funding of capital in the future, which is viewed as a key credit driver. Even with the expected increase in pay-go funding, debt levels, currently above average at $3,285 per customer, are expected to increase to approximately $6,000 by fiscal 2014. The impact of the increasing debt burden will be amplified by the slow amortization of existing debt with only 31% of principal maturing within 20 years. Capital needs are estimated at $3.1 billion for fiscal years 2010-2014, with 79%, or $1.9 billion in addition to the series 2009B and 2009C bonds, of planned capital expenditures expected to be bond funded.
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Fitch RatingsKathy Masterson, 415-732-5622, San FranciscoDoug
Scott, 512-215-3725, AustinorMedia Relations:Cindy
Stoller, 212-908-0526, New YorkEmail:
cindy.stoller@fitchratings.com : mailto:cindy.stoller@fitchratings.com
