Fitch Downgrades Virgin Islands WAPA Sr Lien Bds to 'BB', Sub Bds to 'BB-'; Maintains Watch Negative

Fitch Ratings assigns Virgin Islands Water and Power Authority's (WAPA or the authority) $17 million electric system revenue refunding bonds series 2012A a rating of 'BB' and the $41 million electric system subordinated revenue bonds series 2012B and 2012C a rating of 'BB-.'

In addition, Fitch downgrades and maintains the Rating Watch Negative on the following WAPA outstanding debt:

--$156.05 million senior lien bonds to 'BB' from 'BBB';

--$57.50 million subordinate lien bonds to 'BB-' from 'BBB-'.

The Rating Watch Negative reflects uncertainly regarding WAPA's ability to extend a line of credit with Banco Popular that expired Dec. 31, 2011 and the status of discussions with HOVENSA regarding payments for future oil supplies. Also, the successful refinancing of existing short-term debt with the new series 2012B and 2012C bonds is important. The resolution of these issues would likely result in the removal of the Rating Watch Negative and assignment of a more appropriate Rating Outlook.

The bonds are expected to price in January, with proceeds of the 2012A bonds being used to refund all of the outstanding series 1998 bonds and the series 2012B and 2012C bonds being used to refinance existing working capital lines of credit and a portion of a term loan used to finance the purchase of fuel.

SECURITY

Senior bonds are secured by net electric revenues and certain other available funds; while the subordinated bonds are secured by net electric revenues on a subordinate lien basis. Lines of credit and term loans are junior to the payment of all obligations under the senior and subordinated resolutions. Debt service reserve funds are available for both series of bonds. The senior and subordinated bonds are not subject to cross-default provisions.

KEY RATING DRIVERS

Heightened Number of Risk Factors: WAPA's financial metrics have deteriorated considerably in recent periods to subpar levels for the current rating category, reflecting escalating fuel costs, increasing accounts receivables, growing amounts due from the Water System and an increased reliance on short-term debt. The ability of WAPA to meet its financial obligations and stabilize its fiscal position is uncertain.

Heavy Exposure to Oil: WAPA's power plants are exclusively oil-fired, limiting the system's operating and financial flexibility. High oil prices continue to adversely affect WAPA. Other fuel and transmission options are under consideration, but they will take time to develop.

Increased Short-Term Borrowings: To meet working capital needs and to pay for fuel, the utility has significantly expanded its use of short-term bank lines of credit ($39 million available, with $23 million currently outstanding); in addition to borrowing around $35 million under a $40 million term facility, to purchase fuel oil. A portion of the short-term borrowings came due Dec. 31, 2011 and the remainder is due during 2013. WAPA's ability to either extend these loans or refinance them with bonds, which is currently the plan, is important to the stability of the credit.

Virgin Island Government Under Stress: The VI Government, together with its departments, is WAPA's largest electric customer accounting for about 14% of total electric revenues. The Government remains delinquent in its payments to the authority. As of Oct. 31, 2011, approximately 64% of the electric system's accounts receivable from the Government were more than 60 days in arrears. Fitch rates the VI Government's outstanding general obligations bonds 'BB+' with a Stable Outlook.

Subject to Rate Regulation: The VI Public Service Commission (PSC) establishes and sets rates for WAPA, which limits the authority's financial flexibility. The current rating reflects the PSC's historical support for WAPA's goal of maintaining solid debt service coverage (DSC), but also recognizes the further limits imposed by current electric rates, which approximate 45 cents/kWh. WAPA expects to petition the PSC in the spring of 2012 for a rate increase sufficient to maintain coverage at targeted levels.

WHAT COULD TRIGGER A RATING ACTION

Liquidity Position: WAPA's ability to arrange and maintain access to sufficient liquidity and achieve greater financial stability will be critical factors in any decision to consider any rating action, upward or downward.

CREDIT PROFILE

Electric System

WAPA is the primary provider of electric and water service to the U.S. Virgin Islands (St. Thomas, St. Croix, St. John and Water Island). The electric system generates, transmits and sells electric power and energy, serving residential, commercial and large power customers, including the VI Government, as well as public street lighting and private outdoor lighting customers. The Electric System serves more than 54,000 customers. The utility owns and operates two principal generating facilities, one of which is located on St. Thomas and the other on St. Croix. In addition, it has a smaller generating facility on St. John. These facilities consist of steam, diesel and gas turbine generators, with an installed capacity of 307.7 megawatts (Mw). Oil is the dominant fuel. WAPA continues to explore various options to reduce its oil dependency.

WAPA also owns and operates a water utility system. WAPA maintains separate financial statements for the two systems and the debt of each system is separately secured. The two systems, however, share common administrative and operating personnel and a portion of each system's operating expenses is paid initially by the Electric System, which bills the Water System for its share of such expenses. The Electric System and Water System also share dual-purpose plants for the production of electricity and water.

Water System

To provide additional financial security for the Water System revenue bonds, series 1998, the authority granted to the Trustee for the benefit of the holders of the Water System bonds, a subordinate lien and security interest in the Electric System General Fund. As of Oct. 31, 2011, $19,335,000 of the Water System bonds were outstanding. To date, no transfers have been made from the Electric System General Fund to pay debt service on the Water System bonds.

To help with cash management, however, WAPA has entered into short-term, temporary interfund transfers between the Electric System and the Water System. Such transfers have become more frequent over the past several years and repayment by the Water System has been significantly delayed. As of Oct. 31, 2011, receivables due to Electric System from the Water System totaled $16,857,838. This compares with $877,000 in 2006. The authority expects to repay the remaining amount through an anticipated emergency base rate increase case to be filed in February 2012.

The authority is updating its five-year capital improvement plan for the Water System and may issue additional Water System bonds to finance certain capital projects. Under the Line of Credit, $5,000,000 is allocable to the Water System. The authority has drawn $2,500,000 on the Line of Credit.

Weakened Financial Performance

WAPA's overall financial position has declined in recent years, reflecting much higher fuel costs, a weakened economy, poor results of the Water system and a sharp increase in receivables due WAPA from the VI Government. Debt service coverage, pursuant to WAPA calculations, seems satisfactory at around 1.90 times (x) on senior bonds, 1.58x on senior and subordinated bonds and 1.0x on all debt for fiscal year 2010. However, this does not accurately provide a full representation of the sharp rise in short-term debt obligations, higher receivables, increased deferrals and money owed the Electric System by the Water system. This deteriorating situation will necessitate timely rate relief by the PSC, the need to rollover short-term debt obligations and managing exposure to volatile fuel oil prices.

While WAPA's business model offers some elements of predictability, there remains a high degree of overall uncertainty. WAPA's success in extending credit lines and term loans, refinancing short-term debt, maintaining workable fuel agreements and improving accounts receivable collections are central to the overall success of the utility.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria/Criteria for Rating Prepaid Energy Transactions, this action was informed by information from CreditScope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 20, 2011;

--'U.S. Public Power Rating Criteria', March 28, 2011;

--'Criteria for Rating Prepaid Energy Transactions', dated Aug. 15, 2011;

--'Prepay Gas Transactions: Focus on Counterparty Risk', dated Feb. 23, 2009.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=613065

Criteria for Rating Prepaid Energy Transactions

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648406

Prepay Gas Transactions: Focus on Counterparty Risk

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=427254

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