SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed its 'A' rating on the following electric revenue bonds issued by Modesto Irrigation District (MID or the district), CA:
--$293.4 million outstanding electric revenue bonds, series 2004B, 2006A, and 2009A.
The Rating Outlook is revised to Positive from Stable.
SECURITY
The bonds are secured by a pledge of net revenues of MID's electric system.
KEY RATING DRIVERS
INTEGRATED RETAIL SYSTEM: MID is a publicly owned utility that provides retail electricity to approximately 114,000 customers in and around the city of Modesto, CA.
IMPROVED FINANCIAL POSITION: The Positive Outlook reflects MID's healthy operating margins in fiscals 2011 and 2012 (unaudited) and the resulting improvement in financial metrics to levels above average for the rating. Rate increases, a modest rebound in sales, and beneficial water conditions that reduced purchased power costs contributed to the solid financial performance.
RATE STRUCTURE IMPROVES COST RECOVERY: MID recently adopted two rate mechanisms that adjust annually to recapture costs from securing renewable energy and complying with California's regulation of greenhouse gas emissions. Fitch views the added flexibility positively although MID's overall rates are relatively high and concerns regarding future rate flexibility remain.
VOLATILE POWER COSTS: Power supply needs are largely met through purchased power resulting in costs that fluctuate with market pricing. Financial impacts are mitigated to some extent through longer-term purchase contracts and the building of additional owned generation.
ENVIRONMENTAL COST PRESSURE: Power costs may increase over the medium term if environmental regulations require the installation of costly pollution control equipment on the San Juan coal-fired plant. However, a recently proposed agreement between the primary parties appears to reduce the likelihood of a material financial impact.
HIGH DEBT LEVELS: Direct debt levels are exceptionally high. Direct debt service is approximately 21.5% of operating expenditures (fiscal 2011) and rises to 33.4% if MID's off-balance sheet debt is included in the ratio.
RATING SENSITIVITY:
FINANCIAL STABILITY: Maintenance of the utility's relatively strong liquidity and coverage levels along with the implementation of proposed rate increases for capital projects would likely result in consideration for an upgrade over the next two years.
RESOLUTION ON COAL UNIT: The Outlook could be revised to Stable if an unexpected, unfavorable resolution to the current environmental regulation issues affecting the San Juan coal-fired plant materially increase MID's cost of power.
CREDIT PROFILE
MID provides retail electric service to approximately 114,000 customers in the San Joaquin Valley in central California (90 miles east of San Francisco), which is a service area composed of approximately 168 square miles, mostly located in Stanislaus County. The district also supplies water for irrigation use to a portion of the county and treated water to the city of Modesto; however, water revenues are accounted for separately from the electric system.
POWER SUPPLY
MID's power supply portfolio is weighted towards purchased power, including purchases that consist of owned resources through M-S-R Public Power Agency (MSR), MID's long-term purchase power contract associated with its investment in the recently operational Lodi Energy Center (LEC), and short-term market purchases. In fiscal 2011, approximately 32% of MID's power supply was provided by owned generating resources, including hydro and natural gas resources. However, the capacity represented by MID's own resources, which are predominantly natural gas-fired peaking resources, is higher (48%). These resources provide a hedge against market prices and provide reliability to the service area in the hot summer months.
RENEWABLES AND GREENHOUSE GAS REGULATIONS
MID is well positioned to meet California's 33% renewable mandate by 2020. Approximately 25% of MID's electricity qualified as renewable in 2011 with wind accounting for most of that amount. Additional contracts for solar, wind, and other renewables are projected to increases MID's renewable energy supply to 29% in 2013.
California's cap-and-trade program, part of the state's regulations under AB32 designed to reduce greenhouse gas emissions to 1990 levels by 2020, became enforceable on Jan. 1, 2013. The cap-and-trade program included a free allocation of carbon allowances as part of the transition process. Management stated that MID's allocated allowances accounted for approximately 90% of forecasted emissions. MID has subsequently acquired sufficient allowances to meet its forecasted needs through the medium term. The cost of purchasing the allowances is offset by MID's greenhouse gas adjustment, which was adopted into the rate structure in November 2011.
ENVIRONMENTAL REGULATION COST PRESSURE
MID's investment through MSR in the coal fired San Juan Unit 4 is the source of some uncertainty following Environmental Protection Agency's (EPA) ruling to reduce regional haze emissions from the plant. On Feb. 15, 2013, the primary parties to the dispute announced a proposed agreement that would require the installation of selective noncatalytic reduction technology on San Juan Units 1 and 4 by early 2016 and the retirement of Units 2 and 3 by the end of 2017. Fitch views the agreement, should it receive final approval, positively as it presents a less costly alternative to meeting the EPA's requirements than the previously proposed installation of selective catalytic reduction technology.
IMPROVED FINANCIAL PROFILE
MID's financial performance improved markedly in fiscal 2012 (unaudited) following rate increases, limited sales growth, and lower than budgeted purchased power costs from an above average water year. Fitch-calculated debt service coverage in fiscal 2011 improved to 1.7 times (x) and is expected to exceed that level in fiscal 2012. These metrics compare favorably to below 1.0x coverage in fiscals 2007 through 2009 (not including transfers in from the rate stabilization fund).
Liquidity also rebounded over the past two fiscal years. The unrestricted cash balance at year-end fiscal 2011 was $131.8 million (184 days operating cash), including $53 million in rate stabilization funds. Fitch expects cash to increase in fiscal 2012 based on unaudited figures. Fitch views the maintenance of adequate reserves as particularly important given the lack of fuel adjustment pass through in the rate structure.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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 12, 2012);
--'U.S. Public Power Rating Criteria' (Jan. 11, 2012).
Applicable Criteria and Related Research
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027
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