Fitch Downgrades Long Island Power Authority's $5.9B Bonds to 'A-'; Outlook
NEW YORK -- September 5, 2013
Fitch Ratings has downgraded the ratings on $5.9 billion of outstanding Long
Island Power Authority (LIPA) electric system general revenue bonds to 'A-'
The downgrade broadly reflects Fitch's view that the authority's operating and
financial flexibility have been reduced to levels no longer consistent with
the 'A' rating category.
The Rating Outlook remains Negative.
The electric system general revenue bonds are senior lien obligations of LIPA
secured by the net revenues of the electric system, prior to the subordinate
lien debt (not rated by Fitch).
KEY RATING DRIVERS
FLEXIBILITY REDUCED FOLLOWING STORM: Fitch believes that the intense political
and public criticism of LIPA following Hurricane Sandy have reduced the
authority's rate and financial flexibility to levels more consistent with
those of 'A-' rated retail systems. Reaction to LIPA's storm response and
restoration efforts has resulted in management and board turnover, decreased
confidence in the utility's business model, widespread customer
dissatisfaction, and a material expansion in governmental oversight.
TRANSFORMATIVE LEGISLATION ENACTED: Legislation recently enacted will broaden
the operating responsibilities of the new system-operator (PSEG Long Island)
and expand the regulatory oversight of LIPA. The continued Negative Outlook
reflects rate pressures that are likely to remain high over the near-term, and
uncertainty regarding future financial goals and policies.
STORM COST RECOVERY PROGRESSING: The recovery of Hurricane Sandy damage costs
is progressing as expected and outlays have not materially compromised LIPA's
liquidity. LIPA has paid approximately $468 million of costs to date and has
received $308 million in reimbursements from FEMA. LIPA has qualified for
federal cost reimbursement of 90%, with additional state reimbursements
anticipated. Total storm cost estimates have been lowered to $700-$750
million, and available liquidity sources remain strong at $858 million.
STRONG UTILITY FUNDAMENTALS: LIPA's rating continues to reflect strong utility
fundamentals including an improved power supply mix, an affluent
well-diversified customer base, and approved rate mechanisms to stabilize cash
flow. These strengths will be unaffected by the recent legislation and
WEAK DEBT METRICS: The authority remains heavily leveraged and financial
metrics remain relatively weak for the rating. Potential reductions in total
debt and annual debt service by virtue of a proposed sale of securitization
bonds to refund existing debt is viewed positively by Fitch, but longer-term
deleveraging will be gradual.
WHAT COULD TRIGGER A RATING ACTION
ADOPTION OF ROBUST FINANCIAL POLICIES: The adoption and implementation of
rate-setting and financial policies that are supportive of credit quality
consistent with the rating, and not subject to undue political influence,
would be viewed positively and could stabilize the Outlook.
RESTRICTIVE REGULATORY AND/OR POLITICAL OVERSIGHT: Evidence that the proposed
changes to LIPA's business model and/or expanded regulatory oversight limiting
the adequacy and timeliness of necessary rate increases would likely result in
LIPA is one of the largest municipal electric distribution systems in the
U.S., serving a population base of more than 3 million people located
throughout Nassau and Suffolk counties and the Rockaways section of Queens in
New York City. The service area continues to exhibit above average wealth and
income levels. LIPA's customer base is well diversified and desirable as
residential users account for 54% of revenues; the single largest user
accounts for less than 2% of revenues.
Operations and management services related to the LIPA transmission and
distribution system are currently provided by a subsidiary of National Grid
plc pursuant to a management service agreement that expires on Dec. 31, 2013.
Following a request for proposals, Public Service Enterprise Group (PSEG) was
selected as the new system service provider for a 10-year period effective
Jan. 1, 2014.
UTILITY CHALLENGED BY STORM
On Oct. 29, 2012, Hurricane Sandy, a category 1 hurricane, hit the
Mid-Atlantic East Coast. The impact of the hurricane, as well as a Nov. 7
winter storm, on LIPA's transmission and distribution system was severe,
resulting in widespread power outages to more than one million customers.
Storm crews from system-operator National Grid and around the country,
ultimately restored power to the service area, which was declared a federal
major disaster area.
LIPA's storm preparedness, outage management system, communication response
and timeliness in restoring power was harshly criticized as ineffective by
ratepayers, local politicians, and the Governor's Office. While LIPA has
always operated in a politically-charged atmosphere, the rebuke ultimately led
to (i) the resignation of the authority's Chief Operating Officer, Vice
President for Customer Service and Chairman, and (ii) numerous proposals to
significantly modify, or eliminate areas of LIPA's control over operations.
RESTRUCTURING LEGISLATION ENACTED
The New York State Assembly and Senate passed a series of amendments to the
Public Service Law and the Public Authorities Law (the 2013 Legislation) on
July 29, 2013 that were broadly intended to (i) restructure the relationship
between LIPA and the system service provider, such that PSEG would assume
broader control of all utility operations, (ii) establish a new office of the
Department of Public Service (DPS) with broad responsibility to oversee and
make recommendations with regard to LIPA's rates, operations and programs,
(iii) and authorize the sale of securitized bonds that would be used to
refinance a portion of LIPA's outstanding debt and lower debt service costs
Fitch views a number of the restructuring initiatives positively, particularly
those designed to lower or moderate LIPA's operating costs. These include the
elimination of the applicable state franchise tax, anticipated operating cost
efficiencies, and a 2% limit on increases in payments in lieu of taxes
(PILOTs) in relation to LIPA's transmission and distribution assets.
The broader oversight role of the DPS, however, is a concern. Although the
role is intended to be advisory, the nature of the department's advice, and
how obligated the LIPA board will feel to implement DPS recommendations, is
uncertain at this time.
The DPS will be required to review LIPA's rates for 2016-2018, and to review
revenue increases that exceed 2.5% after 2018. Concerns about the timeliness
of the review process are somewhat mitigated by LIPA's authority to increase
revenues prior to the DPS recommendation, but the board's willingness to do so
is also undetermined.
REIMBURSEMENT OF STORM COSTS PROGRESSING
The recovery of storm related costs have progressed reasonably well to date.
LIPA's latest estimate of storm-related costs is $700-$750 million, down from
initial estimates of $806 million. The Authority has paid for $468 million of
storm costs as of August 2013 and has already received reimbursements of $308
million from FEMA. Payments from FEMA have been timely, allaying concerns that
the storm costs would strain the Authority's liquidity. LIPA expects all
remaining billing and FEMA reimbursement to be complete by year end 2013.
Given the significant damage caused by Hurricane Sandy, LIPA has qualified for
90% reimbursement of costs, versus the traditional level of 75%. Total FEMA
reimbursements, at the 90% level, should approximate $630-$675 million.
LIPA's available liquid resources have been comfortably sufficient. The
authority arranged a new $500 million three-year working capital line of
credit from a syndicate of banks earlier this year to further bolster
borrowing capacity and liquidity. At Aug. 22, 2013 the facility was undrawn.
Together with cash and investments on hand ($258 million) and available
commercial paper capacity ($100 million), available liquid resources totaled
A Fitch concern has been the recovery of unreimbursed storm costs (remaining
10%). Storm costs that are not reimbursed by FEMA or other source are
recoverable via LIPA's base rates.
HIGH LEVERAGE AND WEAK FINANCIAL METRICS
Accounting for storm recovery costs and related reimbursements in each of the
last three years has complicated the comparability of LIPA's financial
metrics. Fitch calculated debt service coverage (DSC) was 0.31 times (x) in
2012, down from 1.30x in 2011, while total debt to funds available for debt
service rose to 365x from 17.2x. Excluding non-cash storm related costs
reported in 2012, however, DSC and debt to FADS improve to 1.50x and 13.2x,
Revenue for the full year 2012 fell slightly, reflecting lower kwh sales and
lower fuel and purchased power costs, which were partially offset by a 1.8%
base rate increase in April 2012. However, net cash from operations as
reported by LIPA and adjusted by Fitch for PILOT payments was virtually
unchanged at $686 million. FADS adjusted for non-cash storm costs totaled $734
Debt metrics for LIPA remain relatively high. Total debt at year end 2012 was
$9.7 billion, down slightly from year end 2011 ($9.9 billion) but consistent
with levels reported in 2011 and 2010. Borrowings at June 30, 2013 were
slightly higher at $10 billion reflecting storm cost borrowings. Year end 2012
ratios for debt per customer ($8,847) and debt to capitalization (96.7%) were
well above the medians for 'A' rated retail systems ($4,342 and 43.5%,
Total debt and annual debt service were anticipated to begin declining in
fiscal 2013. DSC was also expected to improve given LIPA's policy of budgeting
net income of $75 million each year. Although the authority has not prepared
updated financial projections reflecting the effects of the 2013 Legislation
and proposed securitization, Fitch expects that the deleveraging will occur.
However, LIPA's post-restructuring rate-setting policy and the effect of
projected costs savings on financial margins remains unclear.
Fitch expects greater clarity on these issues to emerge through 2013-2015.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's U.S. Public
Power Rating Criteria this action was informed by information from
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013);
--'U.S. Public Power Peer Study Addendum -- June 2013' (June 13, 2013);
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
U.S. Public Power Peer Study -- June 2013
U.S. Public Power Peer Study Addendum -- June 2013
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