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Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric Primary Credit Analyst: Paul Dyson, San Francisco [PHONE REDACTED]; [EMAIL REDACTED] Secondary Contact: Jeffrey Panger, New York [PHONE REDACTED]; [EMAIL REDACTED] Table Of Contents Rationale Outlook Competitive Position Finances, Debt, And Capital Needs Economy Base Is Solid, Anchored By Disneyland Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 1 984347 I 301908238 ---PAGE BREAK--- Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric Credit Profile US$88.2 mil elec rev rfdg bnds (Anaheim) ser 2012A due 10/01/2031 Long Term Rating AA-/Stable New Anaheim Pub Fincg Auth, California Anaheim, California Anaheim Pub Fincg Auth (Anaheim) Long Term Rating AA-/Stable Affirmed Rationale Standard & Poor's Ratings Services assigned its 'AA-' long-term rating to the Anaheim Public Financing Authority, Calif.'s $88.2 million series 2012A revenue refunding bonds, issued on behalf of the City of Anaheim for its electric distribution system. Standard & Poor's also affirmed its 'AA-' long-term rating and underlying rating (SPUR) on the City of Anaheim's first-lien qualified obligations, its 'AA-' rating on the authority's series 2009A and 2011A revenue bonds, and its SPUR on the authority's series 2004 second-lien qualified obligations. Standard & Poor's also affirmed its 'AA-' long-term rating on the Southern California Public Power Authority's (SCPPA) series 2010A and 2010B Canyon Power Project revenue bonds (taxable Build America Bonds, or BABs), issued for the electric system of the City of Anaheim. In addition, Standard & Poor's affirmed its 'AA-' issuer credit rating (ICR) on the Canyon Power Project. The outlook on all ratings is stable. The 'AA-' rating is based our opinion of Anaheim's: • Strong willingness and ability to adjust rates to cover higher operating costs and, more so, to absorb power supply cost increases, including those related to emissions and renewable energy regulations, with two 5% base rate increases during the past 19 months along with various power cost adjustment (PCA) charges; • Deep and diverse economic base ('AA' general obligation rating) with significant employment opportunities within the region, including those offered by high-load customer Disneyland, which performed well during the recent recession and continues to do so; • Strong direct debt service coverage (DSC) of 1.7x in 2011, up from 1.6x in 2010 and forecast at 1.6x to 2.2x during fiscal years 2012 through 2016; • Diverse and low-cost resource portfolio, averaging 9.2 cents per kilowatt-hour (kWh) in 2011 (in part because of the city's large stake in coal-fired generation); and • Strong system liquidity totaling $81 million, or 96 days' cash, which management forecasts will rise to approximately $133 million, or 122 days, by fiscal 2016. Partly offsetting the above in our view, are the utility's: • Very high debt burden, with total direct and off-balance-sheet debt service representing one-third of total revenue, or more than $16,000 per customer; • Exposure to coal-fired generation and uncertainty about related emission costs and regulations, given Anaheim's WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 2 984347 I 301908238 ---PAGE BREAK--- participation in two coal-fired projects that combined for 59% of the city's energy in 2011; and • Fixed-charge coverage of just 1.14x after transfers in fiscal 2011, a level that is, in our opinion, only marginally adequate at the current rating level. The 'AA-' rating on the bonds issued by SCPPA and the 'AA-' ICR on the project reflect our view of the utility's: • Take-or-pay power sales agreement with SCPPA that requires payment regardless of whether the project is completed or operational; and • Strong 'AA-' bond SPUR (the system is obligated for 100% of project costs). We understand that the 2012A bond proceeds will refund the authority's series 2002A bonds, that the bonds are secured by net revenue of the electric system of the City of Anaheim, and that the bonds are subordinate to any future senior bonds issued. However, no senior bonds are outstanding, and issuance of senior debt requires voter approval. As such, the subordinate lien is the working lien. The one-notch difference between the 'AA-' bonds and the rated series 2004 bonds is based on our view of the junior-lien status of the series 2004 funds' flow and the more permissive bond covenants of the series 2004 second lien. Series 2012A bond provisions include a debt service reserve fund funded at the least of 10% of par, 125% of average annual debt service, and maximum annual debt service. The rate covenant equals 1.25x, and the additional bonds test (ABT) is a projected test, requiring 1.25x on total qualified obligation debt service plus an adjustment for rates or charges equal to 95% of surplus revenue for the past two fiscal years. The bonds previously issued by SCPPA on behalf of the city's electric system are secured by payments to be made from the city's electric system to SCPPA, pursuant to a power sales agreement. Payments of Anaheim's share of the project costs and related debt service are made solely from electric system revenue, with such payments constituting operating expenses of Anaheim's electric system, made prior to debt service on all Anaheim direct electric system debt. Anaheim's obligation to make debt service payments does not depend on completion or successful operation of the Canyon Power Project. Anaheim's business profile score of based on Standard & Poor's 10-point scale on which is the highest score, reflects our view of the utility's strong management, favorable competitive position, rate-setting authority, and stable markets. Anaheim's (population 343,793) electric utility serves a mature and diverse base of 114,662 retail customers. In fiscal year 2011 the city generated, and purchased for sale, 3,168 gigawatt-hours (GWh), which is still down 10% from its peak of 3,536 GWh in 2006 because of lingering effects of the recent recession. In our opinion, the large and diverse customer base is balanced in terms of revenue among residential commercial and industrial (39%) users. Cooler weather in 2011 contributed to lower overall retail energy demand. In fiscal year 2011, wholesale sales accounted for 5% of total revenue, down from 9% in 2010. Off-system sales are typically made during off-peak hours from among Anaheim's baseload resources. Anaheim has a diverse power portfolio with a growing renewable energy component, but it remains exposed to and is dominated by coal-based power, specifically Intermountain Power Project's (IPP) Units 1 and 2, and San Juan Unit 4. Coal-fueled power plants accounted for approximately 59% of Anaheim's energy in 2011, down from 64% in 2010 and WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 3 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- 69% in 2009. The decline in 2011 was mostly outage-related and required Anaheim to implement an emergency PCA increase in March 2012. Other resources include hydroelectric, natural gas, and various renewable resources. Assorted contract and spot purchases make up the balance of energy requirements, as needed, but in fiscal year 2012 and future years the 200-megawatt (MW) Canyon Power Project peaking plant will provide a large share of these peaking resources. The plant went operational in two phases, in July and September, 2011, and was completed six months ahead of schedule. Canyon provides many benefits, according to management, including reducing market dependence, reducing California Independent System Operator (CAISO) local capacity requirement fees, providing quick response to changes in customer demand, providing reliable firming of wind and hydro resources, and meeting certain other service requirements. In fiscal 2011, the utility experienced increased operating expenses caused by several unplanned outages, but the Canyon Power Plant partially mitigated these. The SCPPA-owned gas-fired Magnolia Project, of which Anaheim owns a 118 MW share (92 MW base, 26 MW peaking), has been fully operational since 2006 and accounted for roughly 14% of Anaheim's energy supply in 2011, making it the second-largest source of power after IPP. Anaheim, also through SCPPA, participates in a 40 MW share in Hoover Dam output. Anaheim has take-or-pay contracts with both SCPPA and Intermountain Power Authority. Anaheim's contract with coal-fired IPP runs through 2027 and represented 47% of total energy in 2011, while the San Juan Unit 4 contract runs through July 1, 2022 and accounted for 12% of total energy in 2011. Cost uncertainty results from proposed carbon legislation, and also from cap-and-trade regulations with the state, which requires Anaheim to purchase credits for about 10% of its carbon emissions. Given Anaheim's reliance on IPP, these factors introduce moderate financial exposure, but we believe the exposure is manageable. Management projects that Anaheim will be in compliance with the requirements of California legislation known as SBX1-2 (Senate Bill 2 in the First Extraordinary Session). Signed into law on April 12, 2011, SBX1-2 requires both investor-owned utilities and public utilities in the state to achieve a 33% renewable portfolio percentage by 2020. All load-serving utilities must also serve an average of 20% of all retail sales from renewable resources for 2011 to 2013, and reach 25% by 2016. We believe that Anaheim has demonstrated a commitment to increasing the percentage of renewable energy in its portfolio. Renewable energy was approximately 7% of the utility's overall energy resources in 2010, rising to 8% in 2011 and an estimated 13% for 2012. As of June 1, 2012, this included 66.4 MW of renewable-energy capacity (32 MW of wind, 5 MW of landfill gas, 19.4 MW of geothermal, and 10 MW of eligible renewable hydro). We understand that management's strategy is to carefully consider all options before acquiring generally more costly renewable-energy resources. As such, we expect that Anaheim will be purchasing incremental renewable energy on a linear track, especially when beneficial opportunities present themselves. We believe that the rate impact of SBX1-2 and Anaheim's pending renewable contracts will result in higher-cost power, but we also believe that management can capture costs through Anaheim's adjustment mechanisms in place. We believe this would also assist Anaheim in its compliance with legislation Assembly Bill 32 (known as the Global Warming Solutions Act), which establishes a goal of reducing greenhouse gas emissions to 1990 levels by 2020. Anaheim is exploring several options for managing its significant carbon exposure, including the use of environmental adders for carbon dispatch operations, divestiture of San Juan Unit 4 and potential conversion of IPP to gas. DSC levels have fluctuated, but have met or exceeded management's target of 1.6x, with actual coverage of 1.7x in WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 4 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- audited fiscal 2011, up from 1.6x in 2010. However, coverage of all debt obligations including off-balance-sheet debt associated with generation and transmission assets when taking into account transfers to the city's general fund, has been relatively weak, with fixed-charge coverage ranging from 1.00x to 1.14x during the past five years, including 1.01x in fiscal 2009 (but 1.15x after adjustment for a one-time higher general fund transfer) and a better 1.12x in 2010, and improving again in 2011 to 1.14x. Fixed-charge coverage at these levels, in our view, is only marginally adequate at the current rating level. Outlook The stable outlook reflects our anticipation that Anaheim's financial margins, fixed-charge coverage, and reserve levels will not suffer material declines during the next two years, especially given the anticipated positive impact from a 5% base rate increase made in December 2011 and ongoing PCAs and environmental mitigation adjustments (EMAs). We view current fixed-charge coverage ratios and liquidity as only marginally adequate for a 'AA-' rated electric utility, but we view other, offsetting factors as If actual financial results for fiscal year 2012 and beyond are, in our view, materially worse than those forecast, we would likely revise the outlook to negative or even lower the rating, other factors being equal. We do not anticipate raising the rating in the foreseeable future, given factors such as limited fixed-charge coverage, lower-than-historical liquidity, and exposure to potential regulatory actions with regard to coal-fired emissions. The strength and diversity of the local economic base, a strong management team, and the city's substantial rate flexibility continue to provide stability to the rating. Competitive Position According to Energy Information Administration data, residential rates were 19% below the state average in 2010, with commercial 2% below and industrial rates 7% above. Residential customers, depending on usage, pay a rate as much as 19% below that charged by Southern California Edison (the area's investor-owned utility) at the 1,000 kWh-per-month level, but rates are comparable at the 200 and 500 kWh-per-month levels (as of June 2012). However, although Anaheim's rates are competitive with Edison's in other customer classes, Anaheim's commercial rates, at 5,000 kWh per month, are higher than those of Los Angeles Department of Water and Power, the nearest other municipal utility. However, ratepayers in Anaheim do not pay a utility users tax, which is a common charge in other cities and ordinarily an important source of general fund revenue for California municipalities; this is not reflected in traditional rate comparisons. Also contributing to Anaheim's competitive advantage, in our view, are the absence of a public benefits charge (typically 2.85%), which the city embeds in its base rates, and a relatively low rate of transfers to the city government of which is restricted by the city charter. A vote of the people would be required to modify the 4% transfer. According to the city, a electric bill is about 1.5% of median household income. Anaheim recently increased base rates by 5% in December 2011, following a 5% base rate increase in December 2010. The city also has PCA tools in place consisting of two components: the PCA and the EMA. The PCA has a cap of 1.5 cents, which we believe provides the utility with substantial financial flexibility because every half-cent adjustment equates to approximately $11 million in revenue. According to management, the additional EMA mechanism of 1.5 cents is designed to account for increased costs related to emissions costs, renewable energy, and other regulatory WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 5 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- issues, so that a total combined $66 million in financial flexibility would result from the combined automatic rate adjustment mechanisms. For residential customers in fiscal 2011, the city set the EMA at 1 cent, and the overall combined PCA and EMA was 2 cents. The balance of the PCA account totaled $46.3 million as of fiscal year 2011 and, according to the city's projections, the PCA will be maintained at approximately $50 million through fiscal year 2016 (with recognition of revenue approximately equal to the amount generated). This is equivalent to approximately 50 to 60 days of operations. Anaheim's forecasts assume no base rate increases and ongoing usage of both the PCA and EMA. Through the PCA and EMA, the city council has effectively given management the ability to increase rates approximately 5% per year without city council review. Finances, Debt, And Capital Needs Anaheim's five-year financial projections indicate that DSC on all obligations after transfers (fixed-charge coverage) will improve to approximately 1.1x to 1.4x after consideration of PCAs, EMAs, and estimates on load growth and debt issuance. In our view, although performance versus budget has been uneven, particularly in 2008 through 2010, the city exceeded projections in 2011 because power costs were substantially less than budgeted and more than offset a decline in revenue. We view fixed-charge coverage ratios and liquidity as only marginally adequate for a 'AA-' rated electric utility, but we view other, offsetting factors as Fixed-charge coverage after transfers was just 1.14x in 2011, and is forecast to be just 1.12x in 2012 before increasing to 1.19x in 2013 and 1.35x in 2016. Although reduced since 2010, liquidity is, in our view, strong, with the city estimating unrestricted cash plus additional reserves available for management's discretionary use at about $82 million, or 96 days' cash, in fiscal year 2011. This total, however, is down from a much stronger $205 million, or 278 days, in fiscal 2007, given a one-time acceleration in capital spending on reliability-related projects, higher-than-anticipated operating costs, and the one-time higher general fund transfer in fiscal 2009. The utility projects that the power cost and rate stabilization reserves, totaling $46 million, will be maintained at no less than $50 million in 2012 through 2016. In our view, Anaheim's electric system management team is strong and experienced. We believe that the system benefits from a supportive city council as its governing body, and that it has exhibited a strong willingness to adjust rates as it deems necessary. Key elements of Anaheim's business strategy, in our view, include acquisition of power resources within Southern California; a shift toward owned resources, either directly or through SCPPA (as with the Canyon Power Project), which we believe reduces Anaheim's exposure to market forces; and debt service coverage of at least 1.6x. Anaheim's debt burden is, in our view, high at about $1.7 billion, or more than $16,000 per customer, 63% of which is off-balance-sheet debt of $1.0 billion. Direct and off-balance-sheet debt represented a moderately high 32% of total revenue in 2011. The city has identified approximately $190 million in capital needs during the next five years that relate mainly to substation projects, undergrounding, system automation, and replacement of poles, transformers and switches. Management anticipates financing $140 million of this amount with bond proceeds, including $70 million in both fiscal year 2014 and fiscal year 2016. Other planned improvements include the ongoing undergrounding of transmission and distribution lines, according to management. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 6 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- Economy Base Is Solid, Anchored By Disneyland Anaheim is the 10th-largest city by population in California, and its business-friendly city council also helps to attract major industry to the city. Its low electric rates are a big draw as well. The 10 leading customers accounted for 20% energy sales in fiscal 2011. Disney is the largest customer and the only one served under contract. In our view, the utility has a strong working relationship with Disney, fostered by favorable time-of-use rates, and Disneyland's visitor traffic has been extremely strong in recent years. The park's California Adventure $1.1 billion makeover and expansion is now complete, adding 12 MW of load. In total, the city attracts more than 20 million visitors annually, with the convention center also a large draw. Local hotel taxes are up 6% versus budget in fiscal 2012, and several new businesses have relocated their headquarters to the city, including Fisker Automotive, Extron Electronics, and Infosend. Management also anticipates that a newly designated enterprise zone will spur growth, given the state's tax credit for labor and equipment purchases within the zone. Continued development in the city's Platinum Triangle mixed-used area has been solid and, according to the city, is the fastest-growing area in the county. The city also anticipates economic activity from the Grand Plaza convention center expansion and the to-be-constructed Anaheim Regional Transportation Intermodal Center, which will create an estimated 5,000 jobs and connect several regional transportation systems. The local unemployment rate, at 10.4% as of March 2012, has declined from 11.1% in March 2011. Incomes are above average, with median household effective buying income at 111% of the national average as of 2011. Related Criteria And Research USPF Criteria: Electric Utility Ratings, June 15, 2007 Ratings Detail (As Of July 3, 2012) Anaheim ICR (Canyon Pwr Proj) Long Term Rating AA-/Stable Affirmed Anaheim ICR (Tieton Hydro Proj) Long Term Rating AA-/Stable Affirmed Anaheim Pub Fincg Auth, California Anaheim, California Anaheim Pub Fincg Auth (Anaheim) (MBIA) (National) Unenhanced Rating AA-(SPUR)/Stable Affirmed Anaheim Pub Fincg Auth (Anaheim) 2nd lien (MBIA) (National) Unenhanced Rating A+(SPUR)/Stable Affirmed Anaheim Pub Fincg Auth (Anaheim) distrib sys Unenhanced Rating A+(SPUR)/Stable Affirmed Anaheim Pub Fincg Auth (Anaheim) elec Unenhanced Rating AA-(SPUR)/Stable Affirmed Southern California Pub Pwr Auth, California Anaheim, California WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 7 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- Ratings Detail (As Of July 3, 2012) (cont.) Southern California Pub Pwr Auth (Anaheim) (Canyon Pwr Proj) Long Term Rating AA-/Stable Affirmed Southern California Pub Pwr Auth (Anaheim) (Natural Gas Proj A) Unenhanced Rating AA-(SPUR)/Stable Affirmed Many issues are enhanced by bond insurance. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JULY 3, 2012 8 984347 I 301908238 Anaheim Public Financing Authority, California Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. 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