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

Fitch Ratings affirms the rating on the following power system revenue debt issued by the Los Angeles Department of Water and Power, CA (LADWP):

--$7.06 billion power system revenue bonds at 'AA-';

--Bank notes associated with commercial paper (CP) program at 'AA-';

--Bank bonds associated with outstanding variable rate bonds at 'AA-'.

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, both in 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 $8.2 billion capital plan is significant at around $5 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 would likely 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 that remains high at 8.5% in November 2013. LADWP provides retail electric service in the city of Los Angeles to 1.48 million customers, or a population of 3.8 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'S ANNOUNCED RESIGNATION

Ron Nichols, the general manager at LADWP since January 2011, recently announced his resignation effective Jan. 31, 2014. During his tenure, Mr. Nichols encouraged and provided additional transparency in the communication of cost drivers during rate case discussions with both the community and regulators. He also provided a high level of technical experience and a degree of stability in the position, which had experienced high turnover in the years prior.

LADWP has a deep and experienced senior management team underneath 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.

UNCERTAINTY REGARDING NEXT RATE CASE

Fitch's concern is that with turnover at the general manager level, the rate case timeline previously anticipated may be 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, which would require approval prior to July 1, 2014. Given that a new general manager may want to review the rate proposal, there could be some delay from this schedule. Fitch believes a new general manager will be named shortly.

Mitigating concerns regarding a base rate delay are LADWP's automatic adjustment factors that recover over 50% of electric revenues and will increase automatically with increased costs. Fitch views the use of the automatic adjustment factors as a positive credit factor in that these variable costs or designated capital costs only require Board approval and are not subject to the system's lengthy base rate approval process.

POWER SUPPLY REFORMATION REQUIRED; LADWP MAKING PROGRESS

The diversity and cost competitiveness of the department's existing power supply mix continue to be credit strengths. LADWP owns 4,731 MW of net dependable power generation capacity, 3,383 MW of which is natural gas-fired and the remainder of which is hydroelectric or renewable. It jointly owns and contracts capacity rights to another 2,770 MW of net dependable capacity (coal-fired, nuclear, large hydro and wind), including its participation in the Intermountain Power Agency (IPA) and Southern California Public Power Authority (SCPPA).

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, 2011 and 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 2.7x 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 2.3x 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 1.7x 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.

Debt service returns to $450 million in fiscal 2014 from $343 million in fiscal 2012 and is anticipated to grow to $540 million by fiscal 2016. Management's forecast assumptions appear reasonable, but depend on rate increases beyond those approved through 2014, preservation of the transfer at the 8% level, and successful cost controls.

SIGNIFICANT CAPITAL NEEDS AND HIGH DEBT LEVELS

LADWP's current five-year capital plan is estimated at $8.2 billion for 2014-2018. The department's anticipated borrowing over the next five years is approximately $5 billion. The sizable capital plan is being driven by LADWP's reinvestment in infrastructure to preserve reliability and generation development. The capital plan has a healthy pay-as-you-go component, with 39% of the expenditures projected to be supported by cash flow.

Estimated costs of the five-year capital plan increased in the past couple of years as LADWP clarified its costs of regulatory compliance, in particular on renewable projects and generation improvements related to the state's mandated removal of once-through cooling. The five-year plan now includes a portion of the costs to rebuild 2,162 MW of existing capacity at units that do not use ocean water cooling by 2029. The utility's 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.

For more information, see the Fitch report, 'Los Angeles Department of Water and Power - Power Revenue Bonds' expected to be published the week of Feb. 3, 2014.

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 3, 2013;

--'U.S. Public Power Rating Criteria', Dec. 12, 2012.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818471

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