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Rating Action:

Moody's changes the outlook for Vernon, CA's Electric Revenue Bonds to stable from negative; affirms Baa3

31 Jul 2018

New York, July 31, 2018 -- Moody's Investors Service ("Moody's") affirmed the ratings for Vernon, CA's Electric Revenue Bonds (Vernon Electric) at Baa3. The outlook has been changed to stable from negative.

RATINGS RATIONALE

The outlook revision and rating affirmation reflects Moody's view that Vernon Electric's credit quality is stabilizing, acknowledging the city of Vernon's progress on governance and credit-enhancing reforms. In April 2018 the city voted to increase taxes for nonresidential utility users, creating a legally mandated revenue source for the city intended to eliminate future general fund transfers from the utility. The legislation is a material credit positive for the utility because it ends the City of Vernon's long-term practice of moving utility cash flow to the city's general account and adds an additional layer of separation between the entities. That said, the utility continues to bear most of the tax's financial burden its initial years. Under the terms of the legislation, the utility will smooth the tax impact to customers by providing an offsetting credit equal to the initial tax increase. This credit will then decline over time as proposed rate increases take effect. The stable outlook and rating affirmation assume the utility and the city are able to implement rate increases that reduce the credit to zero within the next three years.

The legislation is further evidence of the city's multi-year reform effort to strengthen its governance practices. In July 2017 Vernon was released from state ethics oversight after the reform monitor concluded it had completed reforms required to remedy past corruption issues, including overhauling its rulebook and replacing city council and electric utility leadership.

Vernon's legacy financial burdens are known and generally ring fenced with the 2021 maturity horizon in sight for the utility's natural gas prepay transaction and related debt. Business decisions from 2006-2009 burdened Vernon Electric with a physical supply of natural gas that it cannot use in its local gas plant. Instead, it is contracted to resell 75% of its prepay volumes to Sacramento Municipal Utility District (SMUD, Aa3 Stable) at a $0.25/mmbtu discount and sells remaining volumes to its retail gas customers. While there is a negative spread of $1-$2/mmbtu between the prepay gas and current gas prices, we note that Vernon Electric also purchases natural gas at current market prices for its local gas plant.

Vernon enjoys a strong competitive position as a key industrial center adjacent to downtown Los Angeles. Its pro-business policies and unique positioning as a rare industrial haven in a major urban area provide a sustaining tax base and competitive advantage relative to other municipal-owned utilities. Its small city council and tiny voter base makes enacting laws or changing policies much simpler and more achievable than a larger municipal area.

RATING OUTLOOK

The stable outlook reflects our expectation that management will continue efforts to improve governance practices and that financial results will strengthen particularly as planned rate increases are implemented to offset the utility tax revenue credit over the next few years. The outlook includes expectations for management to maintain or improve financial metrics, including a debt service coverage ratio (DSCR) above 1.0x.

FACTORS THAT COULD LEAD TO AN UPGRADE

- Steady improvement in financial metrics, including DSCR above 1.1x and debt ratios below 90% on a sustained basis

- Financial policy to maintain liquidity of at least 150 days cash on hand

- Demonstration that governance improvements are sustainable

FACTORS THAT COULD LEAD TO A DOWNGRADE

- Worsening debt service coverage that is chronically below 1.0x or liquidity declines such that days cash on hand falls below 75 days on a sustained basis

- Multi-notch downgrade of counterparty rating of Natural Gas Prepay supplier and guarantor or any weakening in the terms of the SMUD natural gas purchase contract

- Governance issues

LEGAL SECURITY

Security provisions are satisfactory with net revenues of the electric system being the main revenue pledge in the bond security. The rate covenant requires that rates are set to provide net revenues equal to 1.1x debt service. Additionally, there is a one year debt service reserve.

PROFILE

Vernon is a small city located just south of downtown Los Angeles. It is almost exclusively industrial, with a private sector labor force of 55,000 and a residential population of 211. Demand for public utilities comes almost entirely from the business sector. In fiscal 2017, 99% of Vernon Electric's retail energy sales revenue came from industrial and commercial customers. The electric utility, which had $368 million of debt outstanding as of fiscal 2017, serves 1,916 customers with a heavy concentration in the food processing, chemical processing and container packaging sectors.

METHODOLOGY

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.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gayle Podurgiel
Lead Analyst
Project Finance
Moody's Investors Service, Inc.
7 World Trade Center
250 Greenwich Street
New York 10007
US
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Kurt Krummenacker
Additional Contact
Project Finance
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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