Fitch Affirms Pasadena, CA's Electric System Rev Bonds at 'AA'; Outlook Stable
The Rating Outlook is Stable.
The bonds are secured by a first lien on net revenues of the Pasadena electric system.
KEY RATING DRIVERS
STABLE, MATURE SERVICE AREA: Pasadena, a mature city located within the greater Los Angeles region, exhibits strong economic indicators, a stable population base and a diverse economy.
STRONG FINANCIAL METRICS: The city's retail electric system, operated by PWP, generates consistently strong financial ratios. Although there has been some decline in ratios due to substantial debt issuance, debt service coverage (DSC) is sufficient for the rating category and is expected to remain above a healthy 2x coverage level.
LARGE CAPITAL PLAN UNDERWAY: PWP's capital plan includes completing the construction of a new gas-powered plant, which is 85% debt funded. While the plant helps diversify PWP's power supply and moves the utility away from coal reliance, the initial bond issuance increased leverage by almost 50% and additional debt issuances are anticipated in fiscal 2017 and 2018. Favorably, a three-step rate increase schedule was implemented in fiscal 2015, which should help maintain strong metrics.
FLEXIBLE RATE STRUCTURE: Retail rates include components to allow for the pass-through of increases in energy and transmission costs, which provides flexibility to adapt to unexpected cost pressures. In addition, city council has shown support for base rate increases when requested, as evidenced by the recently implemented rate schedule.
PROACTIVE ENVIRONMENTAL TARGETS: PWP's integrated resource plan (IRP) historically set efficiency and conservation goals at a more ambitious level than earlier state mandates. These proactive targets strongly position the utility to meet the state's most recent and somewhat ambitious greenhouse gas and renewable goals. PWP's proactive approach to garner ratepayer support for its environmental program is an additional positive attribute of the IRP.
INCREASED INTERFUND TRANSFERS: Transfers to the city's general fund (GF) have been steadily increasing in recent years and, starting in fiscal 2015, internal policy will increase the transfer to 10%, which is somewhat high compared to peers. Management has stated that the transfer should remain at 10% for the foreseeable future. City charter caps the transfer at 16%.
MANAGEMENT OF RATE STRUCTURE: Pasadena Water & Power's ability to manage its electric rates and maintain robust financial metrics in the wake of increased debt levels, stringent environmental targets and sizable general fund transfers is key to maintaining stable financial performance. Weaker than expected rate increases or continued increases in the general fund transfer that reduce coverage levels could result in negative rating pressure.
PWP is a retail electric system serving over 65,000 residential, commercial and industrial customers within the city's 23-square mile area. A mature community located 10 miles northeast of downtown Los Angeles, the city possesses a diverse employment base with above-average wealth and education levels.
The majority of PWP's energy sales are derived from residential (29%) and commercial and industrial customers (68%) and, to a smaller extent, wholesale sales (2.7%). Preliminary fiscal 2015 results show a continued decline in energy sales, as a result of the utility's conservation program and a continued decrease in wholesale sales. PWP has been actively managing its energy resources to avoid oversupply, which has led to less market purchases and a reduction in off-system sales.
DIVERSIFIED RESOURCE MIX
The electric system is fully integrated and includes generation, transmission and distribution facilities. In addition to its owned and operated generating units, PWP receives a majority of its total energy needs through ownership participation in various joint power agencies (JPAs). Of its 347 MW of capacity, approximately 6.3% is locally-owned steam and gas generation and 82.4% is from a variety of long-term JPAs, including coal-fired, hydroelectric and nuclear-generating units.
The Intermountain Power Project (IPP) is PWP's largest source of power, and accounted for approximately 50.4% of PWP's energy load in 2014, but it is also the utility's largest source of carbon emissions. The IPP agreement is set to expire in 2027 and California mandate prohibits renewal if the resource continues to be coal based. Discussion is underway to transition from coal to gas-based generation at the IPP site. PWP is evaluating its options as to how it will participate in the repowering.
The GT5 Repowering Project, in which PWP is building a 71 MW (65 MW net) combined cycle plant to replace the existing Broadway 3 steam plant, is currently underway. The project is on schedule and on budget, with construction expected to be completed in February 2016 and commercial operation beginning in May of that year.
The series 2013 bonds provided $60 million in initial funding for the project and a line of credit has been used to fund ongoing additional costs. Management anticipates issuing approximately $70 million-$80 million in debt after GT5 is in operation, expected in late spring to early fall 2016, to take out the short-term debt and fund some additional distribution system capex.
STRONG HISTORICAL PERFORMANCE
Financial performance for 2014 is somewhat weaker than historical levels, as anticipated, but still remains strong compared to 'AA' rated peer-medians. The decrease in coverage was expected and in conjunction with a large debt issuance to fund the construction of the utility's new combined cycle power plant. Projections show DSC remains relatively stable, inclusive of current and anticipated debt, through 2018.
INCREASING COST OF ENVIRONMENTAL REGULATION
PWP implemented its IRP in 2009, which was adopted by city council and was vetted with the citizens and ratepayers of Pasadena. The IRP was updated in 2012 and more recently, in 2015. Fitch views PWP's proactive approach to garner ratepayer support of its environmental program as a credit strength and positive attribute of the IRP. The IRP calls for PWP to derive 40% of its power supply from renewable resources by 2020 (more conservative than the state's previous energy mandate of 33%) and 50% by 2030 to stay compliant with recently enacted state goals. PWP achieved several of the IRP's midway targets in 2010 and has been compliant with the state's renewable portfolio standard (RPS) targets, achieving 28% RPS in calendar year 2014.
The replacement of traditional, carbon-emitting resources with renewable energy will potentially increase the utility's costs. This could strain retail rate flexibility. However, ratepayers and the city council are supportive of the IRP and PWP's environmental goals. It is expected that there would be support for timely rate increases in the future.