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02 Dec 2019
New York, December 02, 2019 -- Moody's Investors Service ("Moody's") has assigned a Aa3 rating to Lansing Board of Water and Light's (MI) (LBWL) $252 million Utility System Revenue Refunding Bonds, Series 2019B ("Series 2019B bonds"). The outlook is stable. The bonds are expected to price around December 12, 2019, subject to market conditions.
The Aa3 rating reflects our expectation that the consistently strong financial performance will continue owing to management's willingness to adjust rates as needed, which is of particular importance as LBWL transitions to primarily natural gas and renewable generation from its current mostly coal-fired generation fleet. LBWL continues to methodically manage this transition and is expected to maintain strong liquidity and financial margins to provide a cushion against any unexpected occurrences related to the construction, execution and implementation risks associated with the transition. After the transition is complete, LBWL's exposure to carbon transition risks will be notably reduced. The rating also incorporates LBWL's captive customer base, with strong governmental and institutional customers, provides a steady base for future demand and balances the exposure to the more volatile auto manufacturing industry in the region.
The rating could be negatively pressured if the credit quality of the city owner declines below current levels. The relationship with the city remains sound and the current 6.1% ROE agreement between LBWL and the city expires at the end of FY 2020. The outcome of this negotiation will be key to our forward view of LBWL's level of autonomy from the city. LBWL has approved the required rate increases on its services through FY 2020 and we expect LBWL to follow through with any needed future rate increases to ensure strong financial metrics are maintained as they have historically.
LBWL issued $320 million of Utility System Revenue Bonds earlier this year and plans to issue approximately $77 million in Variable Rate Demand Bonds in 2020 to fund additional costs for the construction of the new gas plant, as well as other capital improvements. The new bonds doubled LBWL's total leverage with Moody's adjusted debt ratio increasing to 61.9% in FY 2019 from 32.2% in FY 2018. Construction risk of the new plant has been adequately mitigated to date and the project remains on schedule and modestly under budget. Phase I of the gas supply line construction is expected to be completed eminently with Phase II already having about 90% of the required easements. The gas turbines are set to be ready for first fire by March 2021 and the plant is still on schedule to be operational by June 2021. The utility constructed a new 100 MW natural gas plant from 2011 to 2013 on time and on budget at about $180 million. Similarly, debt increased at the time of construction but owing to LBWL's fully amortizing debt profile, leverage has gradually declined since. We expect a similar dynamic with the debt issued for the new gas plant.
The construction of the new plant reduces LBWL's currently elevated carbon transition risk owing to its coal fired generation profile. The new 250 MW natural gas fired combined cycle power plant offsets LBWLs planned shutdown of Erickson by 2025 and the planned closure of Belle River by 2030, reducing coal exposure to zero by 2030. The new plant is coupled with new and existing solar, wind, hydro and other renewable PPAs. Thus, the new plant positions LBWL for long-term environmental risks currently associated with its older coal fired units that are reaching the end of their useful life.
While the plant does increase natural gas procurement exposure, LBWL has years of managing gas supply and with a larger demand base could capitalize on larger purchases in the future to better manage this cost. Lower long-term staffing needs will help reduce long-term labor costs. About one third of employees are eligible for retirement and the reduction in workforce over the next few years will help improve operating margins.
Moody's calculated net revenues increased materially by 20% in FY 2019 owing both lower PPA expenses and a modest increase in revenues from the rate increase. This net revenue growth coupled with lower debt service materially improved Moody's total adjusted net revenue debt service coverage ratio (DSCR) to 3.66x in FY 2019 from 2.04x in FY 2018, but we expect DSCRs to remain generally above 2.5x after the new debt begins to fully amortize post construction. Days cash on hand declined modestly to a still strong 230 days in FY 2019 from 252 days in FY 2018.
The stable outlook reflects our view that LBWL will continue to adequately adjust rates in line with its projections to ensure financial metrics remain healthy to mitigate the construction and execution risks associated with transitioning its generation fleet to natural gas and renewables from primarily coal.
FACTORS THAT COULD LEAD TO AN UPGRADE
-LBWL successfully diversifies its generation fleet to mitigate its long-term exposure to carbon transition risks associated with its dominant coal-fired generation fleet while maintaining above-average financial metrics and competitive rates.
FACTORS THAT COULD LEAD TO A DOWNGRADE
-LBWL's financial performance weakens with Moody's debt service coverage ratio remaining below 2.0x and Moody's adjusted days cash on hand below 150 days.
-Incurrence of unexpected higher costs that results in higher leverage and pressures financial metrics.
-Deterioration of customer base that materially weakens demand and/or user affordability.
The senior lien bonds are secured by a first lien on the net utility revenues of the LBWL. The rate covenant is on a forward-looking basis with net revenues required to be at least 1.25 times all debt service due in the next 12 months. The additional bonds test (ABT) allows for the inclusion of new net revenues to be derived from approved rate increases and certain customer growth and requires net revenues to cover maximum annual debt service on all debt, including the additional bonds, by 1.25 times in the last fiscal year within 15 months of the new debt issuance. The flow of funds includes a junior lien, which remains open but with no bonds outstanding. Surplus cashflows can be used for such purposes that LBWL deems to be in the best interests of the city.
The debt service reserve fund (DSRF) requirement is weak given it is a springing lien requirement that depends on LBWL's rating by two rating agencies. If LBWL is rated at least A and A2, the DSRF requirement is $0. If LBWL's ratings decline below to A- and A3 by two rating agencies, the DSRF requirement equals the lesser of (1) 50% of maximum annual total debt service, (2) 62.5% of average annual total debt service, or (3) 5% of the original aggregate face amount of each outstanding series of bonds. LBWL can satisfy the DSRF requirement with a letter of credit or a surety bond within 180 days or with excess cash flow in six semi-annual installments. Owing to LBWL's current ratings, the DSRF requirement is $0 for the Series 2019B Bonds.
USE OF PROCEEDS
The Series 2019B bond proceeds will be used to pay issuance costs and refund about $250 million of outstanding Utility System Revenue Bonds, Series 2011A for an estimated net present value savings of at least 15% of the refunded principal amount with no extension of maturity.
Lansing Board of Water and Light (LBWL) is a municipally-owned combined utility system with electric generation and transmission, water filtration, steam and chilled water services. The electric system is the largest and averages about 85% of total annual revenues while serving over 97,000 residential, commercial, and industrial customers in the greater Lansing area. LBWL generates the majority of its retail and wholesale power sales from owned and operated generation assets or through energy received through its partial ownership of Detroit Edison's Belle River Plant through the Michigan Public Power Agency. LBWL owns and operates water wells, a raw water transmission system, water conditioning facilities, and extensive water distribution system serving potable water to over 56,000 residential, commercial and industrial customers, steam generation boilers, a steam transmission and distribution system serving 170 customers, and a chilled water facility and distribution piping system serving 19 customers in the City of Lansing.
The principal methodology used in this rating was US Public Power Electric Utilities with Generation Ownership Exposure Methodology published in August 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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