LOS ANGELES — Los Angeles Department of Water and Power General Manager Ron Nichols said he participated in almost 70 of the 80 public hearings the department held over an 18-month period to get last year’s two-step, 10.9% rate increases approved in September.
Both road shows for bond investors and public hearings on additional rate increases will be a regular part of Nichols’ life for the next several years as LADWP has an $8.9 billion infrastructure program planned. Those needs mean additional rate increases varying from five to seven percent between 2014 to 2017, Nichols said.
“Our capital needs on the power side are $1.1 billion a year for the next five years,” said Phil Lieber, LADWP’s chief financial officer.
LADWP, which has $7.2 billion in existing long-term debt on the power side, issued $500 million for power system projects in November and plans to issue another $480 million in May, said Mario Ignacio, LADWP’s assistant chief financial officer and treasurer. Approval from the board is still required and an underwriter has not been selected for that issuance, Ignacio said.
The utility also plans $700 million of capital projects annually for its water system over the next five years, which has $3.2 billion in outstanding debt, Ignacio said. It plans to use external financing for about two-thirds of that. It already issued about $308 million in June 2012 to fund water system projects for fiscal 2012-13.
The utility has not set a timeline for bond sales to fund capital projects in fiscal 2013-14, Ignacio said.
The city utility achieved $104.7 million in savings on a $527 million power refunding priced on Feb. 20. Bank of America Merrill Lynch was bookrunner.
“We had been working on a financial plan as a basis for setting rates in the future, so we had put $100 million as a place holder,” Lieber said. “We were pleased that it came in above expectations.”
The savings, however, are not what they would have been if LADWP had done the refunding a few months ago.
“The rates have crept up over the last couple of months,” Lieber said. “At one point, our savings was estimated to be as high as $130 million.”
The utility did save enough to postpone to July 2014 a 5% water increase planned for July 2013, he said.
Lower interest rates, savings on the refunding and a zero-interest loan from the state enabled them to push the rate increase out, he said.
LADWP like most bond issuers has a plan to refund regularly as opportunities arise while rates remain low, but that program is separate from plans to sell bonds for its capital needs, Lieber said.
Between refundings and the utility’s debt service needs, that would seemingly run the risk of investors tiring of the credit. But Craig Brothers, a portfolio manager at Bel Air Investment Advisors, said that won’t be the case, because the demand for well-known AA bonds is so strong now.
LADWP’s power revenue bonds carry double-A-minus ratings across the board, and its water debt is at double-A level.
Bel Air Investments, which has LADWP bonds in its $3 billion portfolio, isn’t in the market for them currently because it doesn’t like the spreads.
Ignacio confirmed that demand for its refunding was strong – so strong that it sold out 75% of the bonds offered during the retail order period.
Solid, essential-service recognizable names are very sought after, so their spreads are pushed down quite a bit, Brothers said.
“I think we would like to get more negative news in the market, because the way the market is trading right now is that buyers are lined up around the block, because they have no fear of credit,” he said.
Spreads on the weakest credits have tightened the most, he said.
“We would prefer for the market to be more disorderly so that there is news that is not fully factored in and would cause the owners of the credits to sell them because they think the landscape is changing,” he said.
OLD PIPES AND MANDATES
Among the undertakings the department has planned to address state and federal environmental mandates and its aging infrastructure is a $2.2 billion project that will eliminate once-through ocean cooling at three different power plants at coastal operations, Nichols said.
“That requires us to rebuild every gas-fired plant; nine different units at three different sites,” Nichols said. “Those plants are the backbone of the system, so we have to replace one before we can take the next one off line.”
Beginning in June, that process will occur sequentially so customers don’t experience any blips in service.
The LADWP also has to make changes necessary to meet state goals of having 33% of its power come from renewable energy sources by 2020. Currently, the system generates 39% of its power using coal, but it aims to eliminate all of that by 2025.
The average age of its water pipes is 100, which means it expends a lot of money and time repairing leaks.
“We are an old water system,” Nichols said. “We get three to four breaks a day. It adds up to 1,300 a year.”
He said the utility has done a good job of fixing the breaks, but it results in increased expenditures. The system has a 400-year rate of replacing the pipes, meaning it would take that long to replace them all at its current pace. Nichols admits that doesn’t work well.
Current plans will reduce that to a 320-year replacement rate for the massive pipes, which he acknowledges also isn’t great.
“We know pipes don’t last that long,” he said.
DEBT CAPACITY
With roughly $3.2 billion in debt on the water system for a combined total over $11 billion for both water and power, the massive city enterprise has capacity to issue more debt, according to Fitch Ratings.
Plans to issue additional debt won’t adversely impact the credit if it increases rates on par with the increased debt load, said Kathy Masterson, a Fitch senior director.
Fitch rates the outstanding power debt at AA-minus and the water debt AA.
“They have a lot of needs,” Masterson said. “They have the capacity to support the debt, but it comes down to the timeliness of the rate increases.”
Fitch has maintained its AA-minus rating on the utility’s power debt since Aug. 29, 2001. It downgraded the system’s water debt from AA-plus to AA in Dec. 2011.
In the report on the downgrade, Fitch cited financial margins that were trending lower over the previous few years, primarily driven by water conditions in the region, lack of revenue adjustments, and escalating debt costs. It also cited the utility’s inability to get rate increases from the city council, which appears to have turned a corner.
Still, Nichols doesn’t anticipate it taking less than 18 months to get the next of rate increases approved, which is why they will start the process of selling increases to customers and city leaders again in a few months.
Nichols frank approach in explaining the system’s needs has been lauded by rating agencies, council members and even environmental advocates.
Masterson said the utility has strong managers under Nichols, but having him heading the agency after several years of general managers who rarely lasted more than a year has made a difference.
Plus, he has earned the trust of the council, she said, by being transparent.
Nichols said he has spent a lot of time sitting down with council members to explain the utility’s needs.
