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Rating Action:

Moody's downgrades Pend Oreille P.U.D. 1, WA's to Baa2 from Baa1. Outlook remains negative

25 May 2017

New York, May 25, 2017 -- Summary Rating Rationale

Moody's Investors Service downgraded Pend Oreille County Public Utility District 1, WA's (PoPud or Pend Oreille PUD) to Baa2 from Baa1 on its electric system and Box Canyon revenue bonds. The rating outlook remains negative.

The downgrade to Baa2 considers the continuing contract dispute with Ponderay Newsprint Company (PNC, unrated), the district's largest customer at 60-70% of demand, high likelihood of an eventual shutdown of PNC given the continued significant decline in newsprint demand, and further deterioration in the outlook for wholesale power prices. The district claimed in 2016 that a contract termination event occurred, which PNC has disputed and litigation on this matter is continuing. More broadly, the newsprint industry sector continues to shrink and we see more newsprint plant closures occurring as the industry seeks to balance supply with decreasing demand. If PNC were to shut down, we see the district likely having DSCR materially below 1.0x given Box Canyon's average production costs are above recent wholesale power prices, whose outlook continues to face downward pressure. In addition the direct loss of a major customer, the closure of PNC also would materially weaken the service area's economic strength, which has below average socio economic indicators. The rating action further considers the district's capital funding needs including $36 million for upstream fish passage that further pressures the utility's financial flexibility and long term cost since it's currently funded with a short term bank line that will have to be refinanced.

That said, we recognize that power demand at PNC increased in 2016 that contributed to higher liquidity and improved financial metrics achieved at the district in 2016. While transparency into PNC's operations is limited, a possible cause of PNC's increased demand is the shutdown of competing newsprint facilities although we do not see the improvement as being sustainable over the long-run. However, the combination of increased revenues and some lower costs in 2016 allowed the district to improve its debt service coverage ratios (DSCR) to 1.6x in 2016 and increase its total liquidity to 312 days cash on hand at year-end 2016. While we see the improved liquidity as a credit positive action by the district's management, it falls short of a much stronger risk mitigation action like signing new long-term contracts for Box Canyon's output.

Other key factors that support the district's credit quality include ownership of or access to competitive hydro generation, low retail rates, conservative risk management philosophy, and the district's demonstrated willingness to raise rates. We view the district's willingness to raise rates as an important credit anchor and any weakening of that assessment could have a multi-notch impact on the utility's rating.

Rating Outlook

The negative outlook reflects Moody's view that an eventual shutdown of PNC is likely to occur leading to substantial deterioration of the utility's financial performance if significant risk mitigation measures are not implemented. The negative outlook also considers ongoing contractual dispute with PNC, refinancing risk associated with environmental capital fund, and the potential for economic weakening of the utility's service area if PNC terminates operations.

Factors that Could Lead to an Upgrade

An upgrade is unlikely given the negative outlook. Pend Oreille PUDs outlook could stabilize if PNC's demand stabilizes at around historical demand levels on a sustained basis and the district is successful in its contractual dispute with PNC.

Pend Oreille PUDs outlook could also stabilize if the district is able to implement additional strong risk mitigation such as substantial increase in liquidity or sourcing a creditworthy, replacement power purchaser on a long term basis for Box Canyon's output.

Factors that Could Lead to a Downgrade

PNC shuts down and the district does not take timely action to mitigate the impact.

The district loses its contractual dispute with PNC.

The districts internal liquidity drops below 150 days cash on hand or if consolidated DSCR drops below 1.1 times on a sustained basis.

Inability to refinance or extend its short term bank line

The utility's willingness to raise rates as necessary weakens.

Legal Security

Box Canyon bondholders benefit from a pledge of net revenues of the Box Canyon project and the Box Canyon project is considered a resource obligation of the Electric System. As a resource obligation, the Electric System agrees to pay for Box Canyon's operating costs, non-debt financed capital expenditures and debt service payments irrespective of generation levels. Box Canyon revenue bonds have a debt service reserve requirement equal to the lesser of maximum annual debt service, 10% of bond proceeds or 125% of average annual debt service net of the federal subsidy on interest. The reserve is cash funded and is equal to around the annual debt service in most years. While there is no explicit minimum debt service coverage ratio, Box Canyon's additional bonds test effectively requires a 1.0x debt service coverage.

The Electric System revenue bonds are secured by a first lien on the revenues of the districts Electric System. The rate covenant and additional bonds test for the Electric Revenue bonds are 1.25 times. The debt service reserve requirement is equal to the lesser of maximum annual debt service, 10% of bond proceeds or 125% of average annual debt service. The debt service reserve is backed by cash and is equal to around the annual debt service in most years.

Use of Proceeds

N/A

Obligor Profile

Pend Oreille PUD operates a utility system that generates and delivers electricity to approximately 9,056 retail customers in Pend Oreille County, which is located in the northeastern part of Washington State. The district also provides other services such as water and wholesale fiber-optic albeit they are a small portion of revenues and assets.

Methodology

The principal methodology used in this rating was US Public Power Electric Utilities With Generation Ownership Exposure published in March 2016. 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.

Clifford Kim
Lead Analyst
Project Finance
Moody's Investors Service, Inc.
7 World Trade Center
250 Greenwich Street
New York 10007
US
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Kurt Krummenacker
Additional Contact
Project Finance
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
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