Fitch Revises Silicon Valley Power's Outlook to Stable; Affirms Rating.

NEW YORK -- Fitch Ratings affirms the 'A' rating on Silicon Valley Power's (SVP) outstanding $235 million subordinate electric revenue bonds. The Rating Outlook for SVP is revised to Stable from Positive. The revision in Outlook reflects uncertainty regarding the utility's future financial projections, thus limiting SVP's rating to 'A' at this time.

Many of SVP's credit factors compare favorably with those of strong 'A' rated municipal utilities, with solid support for the rating provided by SVP's very competitive retail rates and diverse power supply, which is sufficient to meet the utility's load requirements for several years. The primary factors for maintaining the existing rating, and the revision in Outlook, include concerns about natural gas price volatility, the impact of increased fixed costs associated with the utility's new Donald Von Raesfeld (DVR) generating station, and management's willingness to time future retail rate increases to sufficiently maintain margins and liquidity at levels that Fitch believe would support a higher rating. DVR, a 147-mw natural gas-fired facility, was constructed to compensate for a reduction in low-cost WAPA and BPA purchase power deliveries. Since the unit began commercial operation in March 2005, SVP is now meeting over 38% of its power supply needs with natural gas-fired generation, up from about 8% historically. The utility estimates that this has resulted in a $50 million per year increase in operating expenditures (at natural gas prices in the $7.00 +/mmbtu range.)

Although cost pressures attributed to currently elevated natural gas prices will be partially offset by strong hydro flows this year, management projects additional budget shortfalls in the near term, even when considering the $18 million in supplemental revenue generated from two 5% rate increases effective this year. It is unclear at this time whether the utility will phase in subsequent rate increases, or continue to run at an operating deficit, which would require an accelerated drawdown of the utility's substantial cash reserves.

SVP presently maintains over $400 million of unrestricted cash, equivalent to 865 days cash on hand. This unusually strong liquidity position has enhanced the utility's ability to manage market risks and its capital planning process; and was an important factor when Fitch assigned SVP a Positive Outlook in 2003. For fiscal year 2005, the utility posted adequate direct debt service coverage of 1.79 times (x), and coverage of full obligations of 1.14x, adjusted for off-balance-sheet obligations to the Northern California Power Agency (rated 'A' by Fitch) and M-S-R Public Power Agency (rated 'A' by Fitch.) With the expectation that cash reserves will be drawn on to partially fund the current operating deficit, management has proposed a new liquidity target of $185 million - $245 million (equivalent to 450 days cash), which is a reasonable level for the system's risk profile. It should be noted that in Fitch's view, the use of cash balances to fund capital projects or debt reduction opportunities is a preferred cash policy, as compared to the use of reserves to continually fund operating deficits. Accordingly, to the extent SVP is able to manage its elevated operating expenditures over the next few years and maintain solid financial metrics, its relative credit position may improve.

Fitch has historically noted the very high percentage of revenue (85%) contributed by the industrial customer class and the potential for instability in the California energy market as added concerns for SVP. Constructively, within the last year, the high-tech business base appears to have stabilized, following a protracted period of economic slowdown in Santa Clara. Although total system energy sales are still below 2001 levels, SVP forecasts 4% annual system load growth in the near term, which imparts greater certainty about SVP customer retention and growth in the future. In addition, Fitch believes that the DVR unit, which is located in the utility's load center, will help mitigate concerns about potential transmission congestion, and allows SVP more control over its own electric and fuel resources.

Silicon Valley Power (SVP) is an enterprise fund of the City of Santa Clara, CA and provides retail electric service to over 50,000 customers located within the city limits. In 2005, SVP's energy was derived from coal (23%), nuclear (1%), natural gas (30%), large hydro (24%) and other renewable sources (22%).

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