Standard & Poor's Ratings Services said it has lowered its rating on Puerto Rico Electric Power Authority's (PREPA) power revenue bonds to BBB from BBB-plus.

The outlook is stable.

"The lower rating better reflects our opinion of both the continuing weakness of the island's economy and the utility's own challenges," said Standard & Poor's credit analyst Judith Waite.

These challenges include: an isolated electric system, which requires the utility to maintain a capacity margin of at least 50%; high rates due to dependence on fuel oil for 61% of energy production; large capital requirements to convert generating plants to gas, bury distribution wires, and upgrade and extend the transmission system; weakened debt service coverage in 2012 and 2013; and limited liquidity, exacerbated by delinquency of public corporation receivables.

The rating also takes into account steps PREPA's management is taking to lower the cost of electricity by converting generating plants to gas, reducing operating costs and energy theft, increasing collection of government receivables, and strengthening transmission efficiency. Management also intends to increase the percentage of power provided by renewable sources.

PREPA's credit profile is strongly linked to the economy it serves, although the utility has maintained fairly stable financial metrics through past economic cycles. The authority has also maintained a stable base rate of less than 6.0 cents per kilowatt-hour. In the next five years, management expects the base rate to be about that amount despite significant investment in the system because of other cost reductions.

The stable outlook reflects PREPA's ability to maintain adequate credit metrics while continuing to fund its capital investment program with substantial amounts of debt. The authority's commitment to reduce its own operating costs and the Puerto Rico government's commitment to honor its financial obligations to PREPA support this.

Progress in both of these endeavors will be important factors in maintaining the rating during the two-year outlook horizon. Moreover, the authority's goal of reducing its dependence on oil and improving the electricity system's overall reliability and efficiency will be an important component of Puerto Rico's economic growth, and successful execution of the planned conversion and upgrade will also be important factors in maintaining the rating. The agency does not expect to raise the rating during the outlook period.

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