CA’s Electric System Revs ‘A+’; Outlook Stable
–(BUSINESS WIRE)–Fitch Ratings assigns the following rating to the Imperial Irrigation District, CA’s (IID) bonds:
–$78,065,000 electric system refunding revenue bonds, series 2011B ‘A+’.
The bonds are structured as fixed-rate, level debt service with a final maturity in 2041. The bonds are expected to price during the week of June 6 in a negotiated sale. Proceeds will be used to refund outstanding commercial paper that funded construction costs related to the repowering of El Centro, to pay costs of issuance, and to fund a debt service reserve fund. The debt service reserve fund for the series 2011B bonds will be funded at 50% of maximum annual debt service.
Fitch also affirms the following ratings for IID:
–$239.1 million electric system refunding revenue bonds, series 2008A at ‘A+’;
–$64.9 million electric system revenue certificates of participation (COPs) (prior lien) series 2003 at ‘A+’;
–$63.8 million pension obligation bonds (taxable), series 2001 at ‘A+’.
The Rating Outlook is Stable.
–The ‘A+’ rating reflects IID’s robust financial performance, ample liquidity and a primarily agrarian electric service territory, which includes the Imperial Valley and the Coachella Valley. The majority of the load is now in the Coachella Valley, located adjacent to the Palm Springs area.
–The rating also takes into account IID’s substantial summer peak load, which is challenging to meet from a power supply perspective. To manage the summer peak, IID has built additional peaking capacity in the service area, begun to use more call options and has updated its gas and risk management strategies, which appear to be more effective in limiting IID’s exposure to cost volatility associated with such an extreme peak demand.
–Financial performance has been very strong in the last two fiscal years due to lower than anticipated purchased power costs. As a result, IID has built its reserves and placed $100 million into a rate stabilization fund that will be used to absorb potential cost variability over the next few years. Debt service coverage and liquidity levels are both very strong.
–Credit concerns include rate flexibility in the service area, although this is partially mitigated by lower purchased power costs have relieved cost pressure in the last couple of years. Additionally, a deferral of planned capital expenditures has also delayed the pressure to increase rates.
–The five-year electric system capital plan includes approximately $710 million in projects. Approximately half of the cost is expected to be debt financed, which will double IID’s debt in the next five years.
KEY RATING DRIVERS:
–Favorably, the Board of Directors is scheduled to consider unfreezing the Energy Cost Adjustment Factor (ECAF) that adjusts to recover actual purchased power and fuel costs in a timely manner. Notwithstanding the low purchased power and natural gas prices in the current economic environment, a responsive cost adjustment mechanism would be a valuable tool to have in place when cost pressure returns.
–Maintaining strong debt service coverage and liquidity levels, albeit not necessarily at the high point experienced in the last two years, will be the key to preserving credit quality as purchased power prices begin to increase at some point in the future.
The bonds are secured by net revenues of the electric system. The 2003 COPs are prior lien obligations. The prior lien indenture has been closed and all subsequent debt is on parity with the 2011B bonds. The prior lien and parity lien obligations are rated on par, given the closed nature of the prior lien and IID’s strong coverage of all its debt obligations.
The pension obligation bonds are paid as an operating expense of the electric system. The electric system is obligated for 51.5% of the debt service and the remaining amount is paid from the water system (rated ‘AA-‘ by Fitch).
The district has a unique service territory that includes the Imperial Valley (located near El Centro, CA) and the Coachella Valley. IID provides electric service to 146,646 customers. Load demand has declined slightly in the past two years due to economic conditions and a cooler summer in 2010. The Imperial Valley includes large areas of agricultural production and an economy that is linked to that of Mexicali, MX, located just south of the service territory. The economy in the Imperial Valley has been seriously affected by the current economic downturn and devaluation of the Mexican peso. However, the region continues to play a key role in providing food supply to the U.S. The Coachella Valley includes development in and around La Quinta, CA, which includes vacation and retirement property. Both areas have significant peak energy demands in the summer, given the hot climate, which presents power supply management challenges. The system experiences a peak of 1,004 megawatts (MW) in the summer as compared to demand around 300 MW in the winter. IID has taken steps to minimize the cost fluctuations associated with its power supply which is heavily weighted toward natural gas and the cost of meeting its summer peak.
The district’s financial performance has been stronger in the past two years following a period where financial margins tightened. Relief was provided by lower wholesale power purchase and natural gas costs, which are both large drivers of IID’s overall cost structure. As a result, IID was able to set aside $100 million in revenues from fiscal 2009 and 2010 into a rate stabilization fund (RSF). This fund will be used to offset ratepayer costs and to support capital spending over the next four years. Debt-service coverage remains strong, with debt-service coverage at over 2.0 times (x) after the deferral of rate stabilization fund revenue. However, on a cash flow basis, debt service coverage inclusive of RSF revenues was much stronger at over 4.0x in both years. As an irrigation district, there is no general fund transfer, so these coverage levels are not diluted and the excess cash flow can be invested back into the system.
The district’s informal target is to maintain a minimum of 2.0x debt-service coverage and a capital structure of at least 40%-60% equity. The financial forecast provided by IID indicates that it should continue to meet those targets over the next five years. Liquidity has grown substantially. Unrestricted reserves of $193 million (211 days operating cash) provide a healthy reserve and include the rate stabilization fund. Management has targeted keeping $100 million in working capital.
Rates are competitive and no base rate increases have been needed in the past two years. Historically, rate flexibility as measured by an ability and willingness to raise rates has been a credit concern. The district does have the ECAF in its rate structure, which is designed to recover the majority of its variable costs, including fuel and purchased power. However, the pass-through requires board action for each six-month adjustment; it is not automatic. In June 2011, the Board will consider allowing the ECAF to ‘float’ on a full cost recovery basis and consideration will be given to how frequently the adjustment will need board approval. Initially this would result in a rate decrease to customers. Fitch will look for consistency in the application of the floating ECAF when purchased power and natural gas costs begin to rise to be considered a true cost recovery component. If used in a variable mode, it has the potential to ensure greater stability in IID’s financial performance during times of expenditure pressure.
IID has a five-year capital plan estimated at $710 million, which is expected to be approximately 53% financed from debt. This projected level of borrowing will result in an increase in the electric utility’s debt burden from its current $440 million in debt outstanding. The capital improvements are needed to invest in generation assets in the service area and to invest in transmission and distribution improvements. Construction costs are financed with IID’s commercial paper program and then re-financed with long-term debt. IID is in the process of repowering El Centro Unit 3, an older natural gas unit. The repower project has an estimated budget of $248 million and will add approximately 100 MW of local capacity. The new unit, currently under construction, is anticipated to be in commercial operation by May 2012.
Senior management at IID has exhibited an usually high turnover rate in the last four years. Despite continuity in the five-member Board, the management turnover is a credit concern given the magnitude of issues for both the power and water business of IID.
Additional information is available at ‘www.fitchratings.com‘
In addition to the sources of information identified in Fitch’s Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
–‘Revenue-Supported Rating Criteria’, Oct. 8, 2010;
–‘Public Power Rating Guidelines’, June 11, 2009.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria