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Fitch Rates Northern California Energy Auth, CA's 2018 Commodity Supply Revs 'A'; Outlook Stable.

New York: Fitch Ratings has assigned an 'A' rating to the following bonds issued by Northern California Energy Authority, CA (NCEA):

--$554.4 million commodity supply revenue bonds, series 2018A, 2018B, and 2018C.

The Rating Outlook is Stable.

The series 2018A bonds will be issued with a long-term fixed rate, and the 2018B and 2018C bonds will be issued with a variable rate. The allocation of the par amount of the bonds remains to be determined. While the bonds will be issued with a final maturity date of July 1, 2049, all bonds will be subject to a mandatory tender on July 1, 2024 (the mandatory purchase date). Fitch's rating on the bonds only addresses the credit risk of the bonds up to and including the mandatory purchase date.

SECURITY

The series 2018A, 2018B, and 2018C commodity supply revenue bonds (collectively, the 2018 bonds) are secured by the trust estate pledged under the indenture, including revenues derived from the sale of natural gas or electricity, payments received from the commodity swap provider and interest rate swap provider, and any payments received pursuant to the Receivables Purchase Agreement (RPA).

The mandatory purchase is secured only by remarketing proceeds and relies on principal balances within the debt service fund, debt service reserve fund and working capital account. However, in the event of a failed remarketing, The Goldman Sachs Group (GSG) is required to make a termination payment designed to be sufficient to pay the redemption price on the bonds on the mandatory purchase date.

KEY RATING DRIVERS

COUNTERPARTY PAYMENT OBLIGATIONS: The rating on the NCEA 2018 bonds reflects the structured nature of the prepaid commodity transaction and Fitch's analysis of the principal transactional counterparties, including J. Aron & Company (J. Aron, the gas/electricity supplier, receivables purchaser, and interest rate swap provider), and the Sacramento Municipal Utility District (SMUD; AA/Outlook Stable). Other counterparties will include investment agreement provider(s) for the debt service account, (DSA), debt service reserve account (DSRA), and working capital account (WCA), which will be determined at bond closing. The obligations of J. Aron will be guaranteed by GSG (A/Outlook Stable).

WEAK LINK COUNTERPARTY: The rating on the bonds is driven by the credit quality of the weakest counterparty whose default risk is not otherwise mitigated. Although the investment agreements related to the DSA, DSRA, and WCA are undetermined, the providers are required to be a financial institution(s) with a minimum IDR of 'A'/Outlook Stable. The rating of the bonds reflects the credit quality of GSG, which is also the current constraint on the transaction's rating.

SINGLE PROJECT PARTICIPANT: SMUD is the sole project participant and reflects credit quality that supports the rating on the Series 2018 bonds. SMUD is a vertically integrated electric utility serving an economically sound service area.

COMMODITY SWAP PROVIDER: The commodity swap provider will be Royal Bank of Canada Europe Limited (RBCEL; not rated), a subsidiary of Royal Bank of Canada (RBC; AA/Outlook Stable). A custodial agreement between J. Aron, RBCEL, and Wells Fargo and Company (A+/ Outlook Stable) will, in Fitch's view, insulate bondholders from the credit risk of the commodity swap provider.

RATING SENSITIVITIES

CHANGE IN COUNTERPARTY CREDIT QUALITY: The long-term rating of Northern California Energy Authority is determined by Fitch's assessment of the structure, including the role and credit quality of each counterparty in the structure. Therefore, unless otherwise mitigated, shifts in the rating or credit quality of Goldman Sachs Group, Inc., the rating or credit quality of any of the debt service accounts, debt service reserve account, or working capital account providers, or the rating or credit quality of the Sacramento Municipal Utility District below the current rating on the bonds, would result in a downgrade. Conversely, shifts in the rating or credit quality of all of the counterparties above the current rating on the bonds would result in an upgrade.

CREDIT PROFILE

NCEA is new joint power authority created by SMUD and the SMUD Finance Authority to assist SMUD in the acquisition and financing of supplies of natural gas and electricity. The board of directors of SMUD is the governing body of NCEA. NCEA has the power to acquire natural gas, sell, exchange, and store or manage gas supplies, and acquire or sell electricity.

SMUD is the sole project participant in the NCEA 2018 prepaid commodity transaction, and is obligated to purchase delivered gas as an operating expense of its system. SMUD has also covenanted and agreed that it will establish, maintain, and collect rates and charges for the services furnished by its electric system to provide revenues sufficient (together with other available system revenues) to enable SMUD to pay NCEA all amounts payable under the Commodity Supply Contract, and to maintain any required reserves.

SMUD is an integrated electric utility providing generation, transmission, and distribution electric services to Sacramento, the state capital, and a small portion of adjoining Placer County. The district's 628,952 retail customers are largely residential, commercial, and governmental users with limited industrial exposure. SMUD is the sixth largest public power retail system in the U.S. in terms of total customers served.

PREPAY STRUCTURE TO PROVIDE FLEXIBILITY FOR SMUD

California has ratcheted up its statewide environmental goals with the passage of the California 100% Clean Energy Act. The legislation, signed by the Governor in September 2018, is the latest step in the state's ambitious transformation of its energy supply through the implementation of additional constraints on utility power supplies.

California's 100% Clean Energy Act requires utilities to achieve 60% of their energy supply from renewable sources by 2030, which is an increase from the 50% renewable by 2030 mandate set by legislation passed as recently as 2015. Significantly, the legislation also requires 100% of a retail utility's energy supply to be provided by renewable or carbon-free energy by 2045. Additionally, SMUD passed its Integrated Resource Plan in October 2018 with even higher goals than those contained in the Clean Energy Act, according to management. To support these endeavors, SMUD will be the sole project participant in the NCEA transaction whereby it has the flexibility to switch from gas to electricity to accommodate uncertainty regarding future gas needs.

SWITCH DATE MECHANICS

On the Switch Date (defined as either: (i) 15 years after commencement of gas deliveries, and (ii) such earlier or later date as determined by the Prepaid Commodity Sales Agreement), deliveries of gas will cease and deliveries of electricity will commence. NCEA may modify the Switch Date to an earlier or later date (if an earlier date, this can only occur once), provided NCEA gives the required notice. However, the Switch Date cannot occur prior to the mandatory purchase date of July 1, 2024.

The commodity swap incorporates the ability to switch between gas and electricity, with the exception that NCEA will pay a monthly index price and receive a fixed gas price under the commodity swap during the gas delivery period, and NCEA will pay a day-ahead market price and receive a fixed electricity price during the electricity delivery period.

As the Switch Date cannot occur prior to the mandatory purchase date, the rating on the bonds will only address the risk of the bonds up to and including the mandatory purchase date.

STRUCTURE DESIGNED FOR TIMELY PAYMENT

NCEA will use the bond proceeds to prepay J. Aron for a specified 30-year supply of natural gas and electricity. By virtue of the sales, hedging, and investment agreements outlined below, the project is structured to ensure that monthly net payments to NCEA are sufficient to pay scheduled debt service, regardless of changes in natural gas and electricity prices, the physical delivery of gas or electricity, or the acceptance of delivered gas or electricity.

Since the 2018B and 2018C bonds will be issued with variable interest rates, NCEA will enter into an interest rate swap with J. Aron in order to hedge its exposure to interest rate fluctuations. The interest rate swap terminates on the mandatory purchase date.

STRUCTURE PROVIDES FOR MANDATORY TENDER

The bonds are being issued as 30-year amortizing debt, with a mandatory tender on July 1, 2024. Proceeds to fund the mandatory purchase are expected to come from remarketing proceeds. If on the fixed rate tender date or on the index rate tender date (defined as the mandatory purchase date with respect to the initial fixed rate period and the initial index rate period), the trustee has insufficient funds in the bond purchase account or insufficient funds in other funds and accounts held under the indenture available to purchase or redeem the bonds five days prior to the mandatory purchase date, a failed remarketing of the bonds will occur.

A failed remarketing will cause an early termination of the Prepaid Commodity Sales Agreement and the extraordinary redemption of the bonds. In this case, J. Aron (supported by the GSG guaranty) will be required to make a termination payment to NCEA on the mandatory purchase date. The termination payment, together with other available funds in the WCA, DSA, DSRA, and SMUD payments, will be sufficient to pay off the bonds plus accrued interest, ultimately covering all principal, unamortized premiums, and accrued interest through the redemption date (redemption price). Bondholders are subject to an early repayment but are still expected to receive full payment.

Fitch's rating on the bonds only addresses the credit risk to bondholders up to and including the mandatory purchase date.

NCEA SELLS DELIVERED GAS TO SMUD AT MONTHLY INDEX RATE

NCEA will sell all of the natural gas delivered by J. Aron to SMUD pursuant to the Commodity Supply Contract. Gas volumes will be purchased by SMUD at a price equal to a monthly index less a discount, and used for electric generation provided to retail customers located in its service area.

COMMODITY SWAP HEDGES PRICE RISK

To hedge the risk of changes in gas prices, NCEA will enter into a commodity swap agreement (front-end swap) with RBCEL, exchanging a monthly index price for a fixed price less a discount that is sufficient, together with the payments for gas, to cover NCEA's debt service requirements. RBCEL will also enter into a matching swap agreement with J. Aron (back end swap), exchanging a fixed price for a monthly index price to further hedge its position.

A custodial agreement amongst RBCEL, J. Aron, and Wells Fargo and Company insulates bondholders from the credit risk of RBCEL, which is unrated. Wells Fargo will hold the payment from J. Aron and will pay the swap provider only after RBCEL has paid NCEA under the front-end swap. In the event of nonpayment by the swap provider to NCEA under the front-end swap, the custodian shall be authorized to remit payment received from J. Aron directly to NCEA.

FAILURE TO ACCEPT OR DELIVER GAS

The failure by J. Aron to deliver gas, or NCEA to accept gas deliveries, is not expected to jeopardize the transaction's performance. If J. Aron fails to deliver gas for any reason, it is required to pay NCEA for the undelivered volumes at prices sufficient to allow NCEA to meet its obligations, including debt service payments. Alternatively, if NCEA provides notice to J. Aron to remarket gas to other purchasers that it does not need, or does not accept delivered gas, J. Aron is required to remarket such gas. If the gas cannot be remarketed, J. Aron is required to purchase the gas for its own account. In either case, J. Aron's payments from the remarketing or purchasing of the gas will be based on index prices sufficient to preserve transactional cash flows.

BONDS SUBJECT TO EXTRAORDINARY REDEMPTION

The bonds are subject to extraordinary redemption prior to maturity. Under certain circumstances (a designated seller default and buyer default) or events such as changes in tax laws resulting in nonperformance of the seller or buyer (designated non-default termination events), the bonds may be called prior to the stated maturity through the extraordinary redemption mechanism. In the case of an extraordinary redemption, J. Aron will be required to make an early termination payment, which together with available funds in the WCA, DSA, DSRA, and SMUD payments, is calculated to be sufficient to pay the redemption price of the bonds. Bondholders take the risk of early redemption in these events but should receive full payment.

GSG, the parent company of J. Aron, has provided a financial guaranty to secure the supplier's performance under the purchase agreement, including its obligation to make a termination payment.
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Publication:Daily the Pak Banker (Lahore, Pakistan)
Geographic Code:1U9CA
Date:Jan 25, 2019
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