TEXT-Fitch cuts Glendale Water & Power, Calif. water revs
July 13 - Fitch Ratings downgrades the following ratings of Glendale Water and Power (GWP): --$50.0 million water revenue bonds, series 2008 downgraded to 'A+' from 'AA'. The Rating Outlook remains Negative. SECURITY The bonds are secured by a first lien on GWP's water system net revenues. KEY RATING DRIVERS NARROW FINANCIAL MARGINS; NO RESERVES: The rating downgrade reflects the utility's lack of liquidity and significant intra-fund borrowing from the city's electric fund to finance capital improvements. The Negative Outlook reflects the narrow financial margins available to support debt service in fiscal 2013. LACK OF FINANCIAL FLEXIBILITY: The planned repayment of the $21.8 million loan from the electric fund will require most of the system's excess cash flow for the next five years. GWP does not expect a positive cash position in the water fund until fiscal 2017. LIMITED RATE FLEXIBILITY: GWP adopted a multi-year base rate increase package in March 2012 to improve its financial situation. The modest 2% increases in the first two years appear to indicate limited rate flexibility at the utility. CAPTIAL SPENDING SHOULD DECLINE: GWP's future capital needs are primarily related to repair and replacement investments, following the past few years of high investments in new meters and a reservoir replacement. Fitch assumes that additional capital spending will be funded from long-term borrowing or additional rate increases but not at the expense of the recovery of system liquidity. WATER DEMAND IMPROVED: Following multiple years of water sales declines related to weather and conservation efforts, GWP experienced higher sales in fiscal 2012, which has provided stronger revenues. Forecasted financial performance relies to a limited degree on continued sales at this level. While a reasonable assumption, weather patterns could result in lower sales again. STABLE SERVICE AREA: The city of Glendale (the city) is mature city and enjoys a diverse local economy as part of the greater Los Angeles area. The service area and customer base are stable, despite recent weather-related declines in sales. WHAT COULD TRIGGER A RATING DOWNGRADE FURTHER FINANCIAL DETERIORATION: The 'A+' rating anticipates debt service coverage of at least 1.25 times (x) in fiscal 2013 when debt service increases related to the 2008 bonds. Failure to achieve this minimum performance or continued funding of capital at the expense of system liquidity could result in further rating pressure. CREDIT PROFILE Lack of Reserves Prompt Downgrade GWP's cash balances have been declining over the past few years as reserves were spent to fund capital improvements and were effectively reduced to $0 by fiscal 2011. In addition, as reserves were depleted and bonds were not issued to fund its planned capital needs as originally anticipated, the city continued funding capital with borrowed funds from the electric fund instead of curtailing capital spending. Since fiscal 2011, the water fund borrowed $21.8 million from the electric fund to fund its capital plan. As a result, GWP has no liquidity and a large liability to retire. The water fund expects to repay the electric fund over the next five years, a short timeframe for major capital expenditures. While the borrowing costs are low - the interest rate the city receives on its pooled investments - the repayment will consume most of the water system's excess cash margins, limiting the ability of the water fund replenish cash reserves over the next several years. Limited Financial Flexibility; Outlook Still Negative Limited financial flexibility is a concern and could lead to potential further rating pressure. The series 2008 bonds (the only system debt outstanding apart from the electric fund loan) has principal payments that begin in fiscal 2013, increasing debt service from $2.3 million to $3.5 million at a time when financial margins will likely be slim. Debt service coverage is projected by management at 1.85x in fiscal 2013, but then should increase as approved rate increases of 4% and 5% are implemented in fiscals 2014 and 2015, respectively. The termination of the $4 million transfer from the water fund to the general fund provides some cash flow relief beginning in fiscal 2012 but will be needed to assist in repaying the electric fund instead of boosting reserve balances. Pressure on debt service coverage could also occur as a result of the planned $35 million bond issue in fiscal 2013 or 2014. However, given GWP's past difficulty in issuing new debt, it is unclear whether the political support exists for additional debt to fund further capital needs of the system. If the bond issue does not occur, management indicates that capital spending will be curtailed to only the regulatory required projects until rates can support the typical annual reinvestment in the system expected at healthy utilities. Rates Adopted But Levels Reflect Limited Rate Flexibility City Council adopted a package of rate increases in March 2012 that implement 2% rate increases in the first two fiscal years (2012 and 2013) and 4% and 5% in the following two years. The structure offered lower increases in the initial years than the original staff proposal of 3% annually. Given the water fund's lack of reserves and increasing debt costs, the rate increases appear very modest, which Fitch views as an indication of limited rate flexibility. The latest rate package does follow a series of large base rate increases of over 12% in each of the previous three years, possibly explaining some hesitation towards the current more modest adjustments. But the revenue increases were outpaced by the unanticipated declines experienced in water sales during that same time. WATER SUPPLY CONTRACT HAS HELPED GWP MANAGE WATER SALES DECLINES GWP, an enterprise of the city, provides retail services to approximately 33,000 water system customers within the city limits. The city is a mature community, northeast of downtown Los Angeles. Water sales declined the past four fiscal years, consistent with other regional utilities, initially as a result of the economic recession and water shortages but more recently because of very cool, wet weather conditions over the past year. Water sales appear to have improved in fiscal 2012, which have provided revenues consistent with budget expectations. The majority of the city's water supply is provided by the Metropolitan Water District of Southern California (MWD), the regional wholesale provider of imported water to communities that do not have sufficient local water resources, such as Glendale. In typical years, MWD provides around 70% of GWP's water supply, but this fell to around 60% with the lower customer demand. The purchase contract with MWD does not require a minimum amount or a fixed payment, so GWP is able to reduce its purchases in response to lower customer water demand. The cost of MWD supplies has been increasing. Overall, MWD has raised its rates 75% on a cumulative basis over the last six years. The adjustable component in Glendale's rates recovers the imported water and pumping costs from MWD. Concerns with Governance Fitch has concerns regarding management turnover at GWP, uncertain political support for debt-funded capital spending, delays in planned rate requests and bond issues over the past year, and the lack of restraint in capital spending when the bond issue did not occur and reserves were depleted. A new management team is in place and restructuring of GWP management reporting lines have been implemented in order to achieve a more direct relationship between GWP and the City going forward. Fitch is looking for management stability to occur and a consistency between planning and execution.
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