NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns a 'BBB-'rating to the Puerto Rico Electric Power Authority's (PREPA) planned issuance of $600 million series 2013A power revenue bonds. The 2013A bonds are scheduled to price the week of Aug. 5, 2013, via negotiated sale. Fitch also affirms PREPA's outstanding $7.95 billion in parity power revenue bonds at 'BBB-'.
The Rating Outlook is Stable.
SECURITY
The power revenue bonds are secured by a senior lien on net revenues of the electric system.
KEY RATING DRIVERS
SOLE POWER PROVIDER: PREPA is essential to the Commonwealth of Puerto Rico as it is the sole provider of electricity on the island. PREPA is the largest municipal power system in the U.S., in terms of customers (1.47 million) and revenues ($4.9 billion).
RECENT DOWNGRADE: Fitch recently downgraded PREPA's debt rating (see press release dated July 1, 2013) to 'BBB-' from 'BBB+' due to persistently slimmer operating margins, cash flow and debt service coverage in recent years. The weakened financial position and lower debt rating reflect the impact of the ongoing economic recession, declining electricity usage, high fuel costs and growing account receivables, as well as Fitch's expectation that stronger financial performance is unlikely over the near term.
WEAK FINANCIAL POSITION: Fitch-calculated debt service coverage, after adjusting for contributions in lieu of taxes (CILTs), has remained close to 1.0x in recent years (0.91x unaudited for fiscal 2013), and is not expected to improve through fiscal 2016. Coverage rose to 1.16x in fiscal 2012 but reflected the refunding of scheduled debt maturities. Total debt and leverage metrics have risen steadily since 2009.
RECEIVABLES REMAIN HIGH: Total receivables remain high at 29% of revenues for fiscal 2013, an ongoing negative credit factor. Government, municipal and private customer receivables have returned to growth in fiscal 2013 despite efforts of the Government Development Bank of Puerto Rico (GDB) and the Commonwealth to improve collections. Persistently high fuel costs and the weak economy continue to drive receivables higher.
GDB LIQUIDITY SUPPORT: PREPA's reliance on borrowings from the GDB and other banks to periodically cover operating costs, debt service and the CILT payment remains a concern for Fitch. Beyond fiscal 2013, PREPA is projecting improved cash flow, adequate to cover total costs.
REPARATIVE FISCAL INITIATIVES: PREPA, in concert with the GDB and the legislature, has worked to put in place various initiatives aimed at improving revenue collections (reduce energy theft; reduce transfers to municipalities, etc.) and reducing operating costs. In aggregate, these measures could improve operating cash flow by up to $120 million per year by fiscal 2014.
DIVERSIFYING POWER SUPPLY: A credit positive is management's focus on reducing dependency on costly oil-fired generation to reduce fuel costs and comply with environmental mandates. Via a combination of renewable power purchases and conversion of existing plants to dual fuel generation (oil and natural gas), oil generation dependency has declined from close to 100% pre-2000 to roughly 67% currently. If remaining plant conversions are completed, annual fuel costs could decline 40% ($1 billion) by 2018.
BROAD BUT WEAKENED SERVICE AREA: PREPA's retail customer base is diversified and not as heavily dependent on tourism as other islands. However, the Commonwealth (GO debt downgraded to 'BBB-', Negative Outlook by Fitch) remains economically weak, with a declining population base, growing budget deficit and high debt burden.
RATING SENSITIVITIES
WEAKER THAN EXPECTED FINANCIAL PERFORMANCE: The current rating takes into account PREPA's weakened balance sheet, marginal debt service coverage and ongoing decline in energy sales through fiscal 2013. However, failure to stabilize operating margins as projected, or a continued heavy reliance on borrowings to adequately meet costs (in particular debt service) could result in further negative rating action.
CREDIT SUMMARY
PREPA is one of the largest public power systems in the U.S., and the sole provider of power to the Commonwealth of Puerto Rico, an island of about 3.7 million people. The authority has historically operated independent from the commonwealth and has been allowed to pass through the costs of fuel and purchased power costs on a monthly basis.
Higher generating reserves are required for PREPA as an island system that has a total of 5,839 megawatts (MW) of owned and purchased capacity compared with the 2013 peak load of 3,265 MW. Concentration of resources in oil exposes PREPA to volatile fuel costs and environmental mandates.
Fitch views the utility's efforts to diversify its energy mix positively, as the continued reduction in oil generation dependency should alleviate some of the pressure on future financial margins. Fitch will be monitoring PREPA's progress to stabilize its financial position and achieve stronger operating cash flow - sufficient to cover total costs, including debt service.
WEAKENED FINANCIAL PROFILE
The past six years of economic recession, coupled with rising fuel costs have contributed to a significant decline in electricity sales and reductions in PREPA's operating and cash flow margins through fiscal 2013. Net account receivables have returned to historically high levels, after progress had been made in reducing municipal receivables in fiscal 2009 and 2010. CILTs, in essence a utility transfer to government and municipal customers, have also continued to escalate unabated through the period.
While debt service coverage for fiscal 2008-2013 ranged from 1.23x to 2.12x, coverage of full obligations, which includes CILTs as an operating expense, was closer to 1.0x and declined to less than 1.0x in fiscal 2008, 2011 and 2013. Liquidity significantly tightened and additional borrowings were periodically necessary to meet total obligations.
Fiscal 2012 debt service coverage improved to 2.12x, or 1.16x adjusted for CILT payments, however, the improvement was mainly due to lowered debt service payments via refinancing, rather than improved cash flow.
A reluctance to raise base rates continues to persist, as base rates remain unchanged since 1989. Additionally, the lackluster Puerto Rican economy remains a negative credit factor as recovery may prove to be elusive.
REASONABLE OPERATING STRATEGY
PREPA has developed a reasonable plan to restore prospective financial margins. In concert with the GDB and with the support of legislative initiatives, PREPA will be implementing measures to improve revenue collections and reduce operating costs (non-fuel). These measures, if successful, could improve operating margins by $120 million per year by 2014.
Additionally, with PREPA's completed conversion of the Costa Sur generating facility to dual-fuel (25% of energy mix) fuel costs should begin to decline in fiscal 2014. Average customer bills, as measured by revenues/kwh sales, should see some rate relief due to the lower fuel cost component by fiscal 2014.
NO MEANINGFUL IMPROVEMENT EXPECTED THROUGH 2017
Based on these initiatives and a somewhat aggressive electric sales growth forecast (CAGR 0.9% per year 2014-2017), PREPA's debt service coverage is projected to range from 1.31x-1.39x. Adjusting for CILT payments (actually netted against customer electric bills), debt service coverage will hover at just over 1.0x, as annual debt service payments are scheduled to increase over the same period.
PREPA's equity-to-total capitalization ratio is not likely to improve notably going forward (-6.1% as of fiscal year-end 2012) given the authority's $1.5 billion five-year capital expenditure program and plans for debt funding.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013);
--'U.S. Public Power Peer Study Addendum -- June 2013' (June 13, 2013);
--'Revenue-Supported Rating Criteria' (June 3, 2013);
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Peer Study -- June 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710397
U.S. Public Power Peer Study Addendum: January 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=700013
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=797965
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