Fitch Affirms Imperial Irrigation District, CA’s Electric System Revs at ‘A+’; Outlook Stable

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Imperial Irrigation bond

NEW YORK–()–Fitch Ratings has affirmed the following ratings for Imperial Irrigation District, CA (IID or the district) at ‘A+’:

–$303.4 million electric system refunding revenue bonds, series 2008A and 2011B;

–$32 million pension obligation bonds (taxable), series 2001.

The Rating Outlook is Stable.

Fitch has withdrawn its ratings on certain maturities of the following bond due to prerefunding activity:

–Imperial Irrigation District (CA) (Electric System Project) revenue certificates of participation series 2003 (all maturities).

The updated rating history for the above maturities is now reflected on Fitch’s web site at ‘www.fitchratings.com‘.

SECURITY

The electric system bonds are secured by net revenues of the electric system. The pension obligation bonds (POBs) are secured by electric (51.5% of debt service) and water system revenues (48.5% of debt service, rated ‘AA-‘ by Fitch), paid as an operating expense of both systems.

KEY RATING DRIVERS

STABLE CUSTOMER BASE: IID provides retail electric service to both the Imperial and Coachella Valley. While area demographics are weak, a healthy 49% of energy sales are residential and delinquency rates have been below 1% for the past 10 years.

AUTOMATIC COST ADJUSTOR IMPLEMENTED: Management has stated that the Energy Cost Adjustment Factor (ECAF), a component of IID’s electric rates, will unfreeze beginning in January 2014 and float monthly. Fitch views the automatic adjustor as a valuable tool that will allow IID to promptly capture fluctuations in purchased power costs.

IMPROVED LIQUIDITY: Strong cash flows have bolstered IID’s liquidity levels, including a rate stabilization fund (RSF), to a high 197 days cash on hand (DCOH). While management anticipates drawing down its RSF in the near term, unrestricted funds should remain at a sound level given management’s stated target of 90 DCOH.

CHALLENGING SUMMER PEAK: A substantial summer peak load requires active management of the power supply. IID has repowered Unit 3 at its El Centro Generating Station, which has added 100 MW of peaking capacity that should alleviate some peak pressure, as the plant can be operated during times when market purchases are uneconomical.

STRONG WATER SYSTEM FUNDAMENTALS: The POBs are supported by water system credit fundamentals that include exceptionally strong water rights, diversification of water sales revenues beyond the traditional service area, significant capital needs, and healthy financial margins.

RATING SENSITIVITIES

MANAGEMENT OF RATE STRUCTURE: Implementation of the ECAF and allowing it to truly fluctuate with costs would be viewed favorably, as it should ensure greater stability. It is important for the district to manage rates and maintain stable financial performance, given IID’s increased leverage position and an anticipated increase in purchased power costs.

GROWING DEBT LEVELS: IID’s outstanding debt has almost doubled in recent years, with leverage increasing from Fitch-calculated 5.3x debt to funds available for debt service (FADs) to 9.7x in 2012. Debt issuance in excess of what is currently forecast without timely rate increases to meet the district’s healthy debt service coverage target of 2.0x would be viewed negatively.

CREDIT PROFILE

IID operates a water and electric system in southeastern California, near the borders of Mexico and Arizona. The systems are accounted for separately and water revenues are not pledged to electric system bonds and vice versa. The district has a unique service territory that spans approximately 6,471 square miles and encompasses the Imperial Valley, Coachella Valley and a portion of San Diego County. The Imperial Valley includes large areas of agricultural production and an economy that is linked to that of Mexicali, Mexico. The Coachella Valley includes development in and around La Quinta, CA, which includes vacation and retirement properties.

Fitch views IID’s service territory as stable, even though area demographics are weak. Stability is derived from a largely residential customer base with steady customer growth, low delinquency rates and minimal concentration. Demographics have historically been significantly weaker than the state and the nation, which is common for an agricultural-based economy. Positively, the district has not seen large delinquency rates or a slowing of collections. The district’s well-diversified customer base provides additional credit strength in regards to its service area. Residential sales make up a healthy 48.6% of energy sales and the 10 largest customers account for a minimal 6% of revenues in 2012.

Senior management has remained consistent over the past two years, after a period of unusually high turnover. Fitch views this development favorably and will look for continued longevity at the senior management level.

POSITIVE CHANGES TO RATE STRUCTURE

Electric rates are comprised of a base rate and the ECAF. The ECAF, through a board approved change, will revert to a floating adjustor starting January 2014. The ECAF will be reviewed monthly based on a set formula to determine any needed change, and should move in tandem with purchased power costs. ECAF changes will not need board approval for implementation.

Fitch will look for consistency in IID’s application of the ECAF, which would be needed in order for it to be considered a true and full cost recovery component. The ECAF has the potential to ensure greater stability in IID’s financial performance during times of increased purchased power costs due to potential increased gas prices and renewable purchases.

POWER SUPPLY MANAGEMENT

IID’s resource mix is made up of district-owned and jointly owned resources, along with short-term contracts and some market purchases. The resource mix is very reliant on natural gas, which creates expense variability. The service area experiences a summer peak of approximately 1,000 MW, which is significantly higher than its winter peak of approximately 380 MW.

IID’s resources are more than sufficient for its energy requirements in three-quarters of the year, while the increased summer demand has historically been managed through call options and short-term market contracts. IID has repowered Unit 3 at its El Centro Generating Station, which should help the district meet its summer peak and reduce its reliance on market purchases.

FINANCIAL PERFORMANCE

IID saw a weakening of financial metrics in 2011 and 2012, due to decreased retail rates coupled with an increase in purchased power costs. Metrics were expected to decrease, given above-average cash flows in 2009 and 2010, but are lower than previously anticipated. The floating ECAF, in addition to a 1 cent/kWh ECAF increase that was implemented April 1, 2013 but will be fully passed through to customers on Jan. 1, 2014, should result in more stable operating results thereafter.

Liquidity has grown substantially in recent years, due to strong cash flows in 2009 and 2010. IID transferred a total of $100 million into a RSF, while the remaining free cash flow was held in unrestricted reserves or used to fund the capital plan. IID anticipates drawing on the RSF over the next three years, until the account is depleted. It will not be replenished. While unrestricted funds are projected to decrease, they should remain sufficient at approximately 100 DCOH.

Outstanding debt has almost doubled in recent years, due to capital plan funding, primarily the El Centro repowering. Projections show debt service will increase substantially by 2015, after additional debt issuances. The maintenance of sound financial metrics, despite the increased leverage position, supported by timely implementation of rate increases, will be an important measure of the district’s credit strength over the long term.