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Summary: California Municipal Finance Authority Anaheim; Retail Electric; Wholesale Electric Primary Credit Analyst: Jeffrey M Panger, New York [PHONE REDACTED]; [EMAIL REDACTED] Secondary Contact: Paul J Dyson, San Francisco [PHONE REDACTED]; [EMAIL REDACTED] Table Of Contents Rationale Outlook Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 22, 2014 1 1360446 I 302068838 ---PAGE BREAK--- Summary: California Municipal Finance Authority Anaheim; Retail Electric; Wholesale Electric Credit Profile US$110.11 mil rev rfdg bnds (Anaheim) ser 2014-A due 10/01/2034 Long Term Rating AA-/Stable New Anaheim Pub Fincg Auth, California Anaheim, California Anaheim Pub Fincg Auth (Anaheim) Long Term Rating AA-/Stable Affirmed Southern California Pub Pwr Auth, California Anaheim, California Southern California Pub Pwr Auth (Anaheim) (Natural Gas Proj A) Unenhanced Rating AA-(SPUR)/Stable Affirmed Rationale Standard & Poor's Ratings Services has assigned its 'AA-' rating to California Municipal Finance Authority's revenue refunding bonds series 2014-A, issued on behalf of the City of Anaheim's electric utility, Anaheim Public Utilities (APU). At the same time, Standard & Poor's has also affirmed its 'AA-' rating on the Anaheim Public Financing Authority (APFA), Calif.'s revenue bonds (also issued on behalf of the APU). As well, Standard & Poor's affirmed its rating on the APFA's series 2004 second-lien qualified obligations. Standard & Poor's also affirmed its 'AA-' rating on the Southern California Public Power Authority's (SCPPA) Canyon Power project revenue bonds, issued for Anaheim, and its 'AA-' issuer credit rating (ICR) on the project. The outlook is stable The ratings reflect what we view to be the APU's credit • A deep and diverse customer profile that serves a population of 350,000 and 15,000 businesses, including high-load customer Disneyland, which has performed well both during and after the recession; • A service-area economy with significant employment opportunities within the city and throughout the greater Los Angeles and Orange County areas. High median household effective buying incomes (113% of the national average) enhances the APU's rate raising flexibility; • The demonstrated use of a responsive mechanism to recover cost increases related purchased power, fuel and compliance with emissions regulation, helping to preserve financial metrics; and • Solid system liquidity at fiscal year-end 2013 (June 30), with unrestricted cash and investments ($54 million) plus available credit lines ($49 million) in total covering 99 days of operating expenses. Providing additional cushion is $67 million of prepaid power expenses, which the APU can direct the SCPPA to apply to future power bills, though we note that the utility cannot claw back this money for other purposes. As such, we do not include it in our calculation of liquidity, although we acknowledge that it provides additional financial flexibility. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 22, 2014 2 1360446 I 302068838 ---PAGE BREAK--- The ratings also reflect what we view to be the following credit weaknesses: • As is the case with all utilities in California, the APU is exposed to significant mandates governing coal-fired generation and renewable energy. These mandates constrain operational flexibility and impose financial burdens. The APU meets about 50% of its energy needs with coal-based resources Intermountain Power Project (IPP; 41%) and San Juan Unit 4 (SJ4; As such, the APU is among the state's most carbon-intensive utilities, and exposed to uncertainty with regard to future emission costs and regulations. We note that the utility is on pace to comply with renewable mandates and that management is pursuing plans to divest from carbon based resources, which we believe carries additional challenges. • At the current rating level, fixed-charge coverage which treats payments in lieu of taxes as an operating expense and off-balance sheet take-or-pay obligations as debt was weak at 1.26x in fiscal 2013. However, we note an improvement over the previous year (1.17x) and projections of further strengthening over the next five. • In consideration of on- and off-balance-sheet obligations, debt levels are very high, measuring $13,783 per customer. We expect that debt outstanding will amortize more rapidly than will be added, which mitigates (but not eliminates) this concern. Bond proceeds will refund existing APFA debt. Electric system net revenues secure the bonds, which are subordinate to any future senior bonds. However, there are no senior bonds outstanding, and issuance of senior debt requires voter approval. As such, the subordinate lien is the working lien. We base the one-notch difference between the 'AA-' bonds and the rated series 2004 bonds on our view of the junior-lien status of the 2004 funds' flow and the more permissive bond covenants of the 2004 second lien. The 'AA-' rating on the bonds the SCPPA issued and the 'AA-' ICRs on the projects reflect our view of the utility's take-or-pay power sales agreements with the SCPPA that require payment regardless of whether the project is operational. Anaheim's business profile score is given the utility's carbon intensity and exposure to environmental regulations. The score is on Standard & Poor's scale from to '10', being the highest score, and also reflects our view of the utility's solid management and the deep and diverse market that the APU serves. We view the utility's service area as a considerable credit strength. Anaheim's electric utility serves a mature and diverse base of 115,418 retail customers, and a population of more than 346,000. In our opinion, the customer base is balanced in terms of revenues among residential commercial and industrial (40%) users. The top 10 customers account for just 19% of revenue, and as such, the APU is not unduly exposed to demand volatility. Indeed, retail demand has been resilient despite the recession and conservation efforts. The sale of surplus energy measured 21% of 2013 sales, but only 6% of total revenue, because lower market prices produced slim margins. The utility typically makes surplus sales during off-peak hours from among Anaheim's baseload resources. Anaheim is one of California's most carbon-intensive utilities, which we believe exposes it to regulatory mandates. SB 1368 prohibits renewal of the Intermountain PPA as a coal based resource, and investment in SJ4 that extends its useful life. AB32 requires significant reduction in greenhouse gases by 2020, and the EPA's Federal Implementation Plan requires installation of costly emission controls at SJ4 (by 2016), and possibly at IPP as well. Anaheim must also comply with SB2X, California's renewable portfolio standard. The utility expects compliance with these and other state mandates to have a 13% rate impact by through 2024, which it expects to recover through its environmental mitigation WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 22, 2014 3 1360446 I 302068838 Summary: California Municipal Finance Authority Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- adjustment (EMA) mechanism. We understand that although the IPP expects to repower with natural gas in 2025, the APU nevertheless does not plan to renew its contract. Instead, it plans to construct local generation, avoiding costly transmission charges but incurring capital costs. We also understand that APU plans to divest its 50 megawatt (MW) ownership interest in SJ4 by 2018, in advance of the 2022 expiration of its participation agreement. SJ4 is not serving retail load and management expects to apply operating cost savings to offset the costs associated with additional contracts for renewable energy. Qualifying renewable resources measured 21% of energy in 2013, and the utility expects that it will serve 34% of retail load by 2020, giving the APU a near-equal split between coal, natural gas, and renewables, and enabling the utility to comply with these mandates. APU is not required to purchase credits for out-of-state generating resources under California's cap and trade program to reduce greenhouse gas emissions. In 2013, the purchase and sale of credits was a financial net wash. According to the U.S. Department of Energy's Energy Information Administration, average revenue per kilowatt-hour (kWh) was above the state average in 2012, the most recent year of available comparative information. Above-average median household effective buying incomes contribute to our view that rates are affordable within the context of the California market, and that the APU's competitive position is modestly favorable. Management does not expect base-rate increases through 2018, but expects using its full authority to raise its EMA by 0.5 cents per kWh in both 2015 and 2016, and its power cost adjustment (PCA) similarly in 2015, 2016, and 2017. This will raise about $24 million in both 2015 and 2016, and $12 million in 2017; in total, it will result in a 15%-16% increase in rates. We note that the utility also has the authority to increase both the PCA and EMA without council approval under certain conditions of budget variance (for the PCA) and major outages or natural disasters (for the EMA) In our opinion, coverage of senior lien debt service was robust in 2013, at more than 2x, but the APU has significant off-balance sheet obligations and makes transfers to the city that we view as fixed. In consideration of these, we view fixed cost coverage as a more accurate measure of the utility's financial operations, which we believe to be weak for the rating. However, we take some comfort in the improvement in audited results for 2012 and 2013, and in management's projections covering 2014-2018. Fixed charge coverage, which treats transfer payments as an operating expense and a component of purchased power expense as debt, was 1.26x in 2013, up from 1.17x in 2012 and 1.14x in 2011. Management's projections suggest that similarly based fixed costs coverage will be about 1.22x in 2014 and improve to the 1.3x-1.4x range in fiscal years 2015-2018. We view liquidity as solid, with $54 million unrestricted cash and investments and $39 million in remaining line of credit capacity; combined, they measure 99 days of operating expenses. In addition, the APU has prepaid $67 million in expenses to the SCPPA, representing about six months of costs for the related projects. The utility can direct the SCPPA to uses these funds to pay future bills, but insofar as it cannot tap this money immediately and in full, we do not include it in our liquidity calculation. Nevertheless, we acknowledge that they provide additional cushion and flexibility, and represent a credit strength. We expect liquidity to be relatively stable through 2018. Including off-balance-sheet obligations, debt levels are what we consider very high. The APU has $732 million of direct electric debt, and $859 million of obligations related to the SCPPA and IPP. Amortization of on- an off-balance-sheet WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 22, 2014 4 1360446 I 302068838 Summary: California Municipal Finance Authority Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- obligations measure a substantial 31% of revenue, while debt per customer is also what we consider very high, at $13,783. The utility's capital plan for 2014-2018 totals $233 million, and it expects to finance $140 million with debt. However, as existing debt amortizes fairly rapidly, we expect a net $350 million reduction in debt outstanding by 2018. Bond provisions include a debt service reserve fund financed 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 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 revenues for the past two fiscal years. Securing the bonds the SCPPA previously issued on behalf of the city's electric system are payments from the city's electric system to the SCPPA, pursuant to a power sales agreement. Payments of Anaheim's share of the project costs and related debt service come solely from electric system revenues, and these constitute operating expenses of Anaheim's electric system, made before debt service on all city 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. Outlook We are concerned that fixed cost coverage is weak for the rating, but the stable outlook reflects our assessment of recent improvement and management's projections, as well as the service area's strength. Should coverage levels fail to match our expectation of further improvement, we could lower the rating or revise the outlook to negative. Given the APU's operating profile and exposure to regulatory mandates, we do not expect to raise the rating over the next two years, even if coverage exceeds expectations. Related Criteria And Research Related Criteria • USPF Criteria: Electric Utility Ratings, June 15, 2007 • USPF Criteria: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations, Nov. 29, 2011 Related Research • U.S. State And Local Government Credit Conditions Forecast, July 8, 2014 Ratings Detail (As Of September 22, 2014) Anaheim ICR (Canyon Pwr Proj) Long Term Rating AA-/Stable Affirmed Anaheim ICR (Tieton Hydro Proj) Long Term Rating AA-/Stable Affirmed Anaheim Elec Sys, California Anaheim, California Anaheim Pub Fincg Auth (Anaheim) elec rev rfdg bnds Long Term Rating AA-/Stable Affirmed WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 22, 2014 5 1360446 I 302068838 Summary: California Municipal Finance Authority Anaheim; Retail Electric; Wholesale Electric ---PAGE BREAK--- Ratings Detail (As Of September 22, 2014) (cont.) 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 Southern California Pub Pwr Auth (Anaheim) (Canyon Pwr Proj) Long Term Rating AA-/Stable Affirmed Many issues are enhanced by bond insurance. Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. 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