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18 Mar 2019
New York, March 18, 2019 -- Moody's Investors Service has affirmed the A3 rating on the City of Colton, California's Electric Enterprise revenue bonds. The outlook remains negative. The rating and outlook affect $30.7 million in debt.
Today's rating action reflects Moody's view that the utility's operating environment in California has become more challenging as legislators and other policy makers look for viable alternatives around laws and proceedings involving the application of inverse condemnation while simultaneously balancing the potential impact on municipal utilities and ratepayers. The potential risk of wildfires related to inverse condemnation could materially impact the utility long-term as the frequency and intensity of these fires increase, coupled with subsequent mudslides that often follow when heavy rains occur after a fire.
While the municipal ratemaking structure does provide greater certainty for cost recovery of inverse condemnation costs, it does effectively transfer risks typically borne by insurance to the utility and their ratepayers. Moreover, given the size of the potential claims following a wildfire and the degree of frequency that they have occurred, the ability to seamlessly change customers rates for inverse condemnation claims may become in question particularly given the severity and size of the wildfire and its potential impact to customer rates. For Colton, in particular, the city's financial dependence on substantial transfers from the electric enterprise and a voter-approved rate freeze further complicates this issue. California Senate Bill 901 requires all electric utilities to prepare a wildfire mitigation plan before January 1, 2020.
Moody's acknowledges recent pronouncements from the governor's office to address these issues are credit positive. This is consistent with Moody's expectation that state policymakers will look to ensure Colton electric and other utilities remain financially healthy to help the state meet its ambitious renewable targets and other public policy goals. That said, the problem is complicated and multi-faceted, and the solutions, when identified, will take several years to fully implement.
Just a small portion of the enterprise's service area (principally around Reche Canyon Road and La Loma Hills) is identified as either a Tier 3 Extreme Fire Threat or Tier 2 Elevated Fire Threat by the California Department of Forestry and Fire Protection (CAL FIRE). The city has a local hazard mitigation plan that includes the risk from wildfires, and has engaged relevant stakeholders including Southern California Edison in its overall mitigation strategy.
The rating reflects the electric enterprise's continued satisfactory financial position, despite sizeable transfers to the city's General Fund. Senior lien debt service is quite strong, though fixed obligation charge coverage, including the transfers, is quite thin. Healthy liquidity, robust reserves, and the scheduled expiration of the rate freeze in two years provides an opportunity to mitigate the risk posed by the thin fixed obligation coverage. The enterprise is well managed, with generation risk mitigated through fixed-price forward contracts and a diverse power supply mix, though rate management is severely constrained through 2021. Other credit factors include a service area still in recovery from the recession with somewhat concentrated ratepayer composition and manageable capital requirements.
The rating outlook is negative. Although the enterprise has healthy cash reserves, the large transfers to the city's General Fund have substantially reduced fixed obligation charge coverage levels, making the enterprise more sensitive to revenue declines or expenditure increases. The city's demonstrated willingness to tap the enterprise for additional funds also contributes an element of uncertainty and downside risk going forward, as the city adjusts to substantially higher projected pension costs.
The negative outlook also incorporates the potential risks associated with inverse condemnation. The enterprise has explored various avenues to mitigate its exposure to wildfires caused by their equipment, including the use of insulated power lines and undergrounding distribution lines, but is awaiting further legislative developments from the State of California.
FACTORS THAT COULD LEAD TO AN UPGRADE (REMOVE NEGATIVE OUTLOOK)
- Substantial improvement in the service area economy
- Improvement in the city's fiscal health mitigating the need for transfers from the electric enterprise
- Sustained coverage, reserve, and liquidity levels despite transfers to the city's general fund
- Implementation of capital improvements that substantially mitigate the enterprise's equipment from causing wildfires
- Regulatory, legislative, or judicial action that effectively mitigates the financial impact of the enterprise's exposure to wildfire risk
FACTORS THAT COULD LEAD TO A DOWNGRADE
- Decline in the service area economy
- Material weakening of the electric enterprise's financial profile, including drops in fixed obligation charge coverage or liquidity
- Exposure to legal liability stemming from wildfires caused by equipment owned by the enterprise
- Failure to pass legislation or enact regulatory measures to largely mitigate the impact of inverse condemnation risk exposure from wildfires on utilities
The electric enterprise revenue bonds are secured by a net revenue pledge of the city's electric enterprise.
USE OF PROCEEDS
Located 59 miles east of downtown Los Angeles in San Bernardino County, the electric enterprise is owned and operated by the City of Colton and serves the entire area within the city's limits. The electric enterprise has a diversified power supply via participation in several jointly-owned generation and transmission projects, as well as several power purchase contracts.
The principal methodology used in these ratings was US Public Power Electric Utilities With Generation Ownership Exposure published in November 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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