Audit of Los Angeles Department of Water and Power

Report on the Los Angeles
Department of Water and Power’s

April 5, 2010 Letter Regarding the
Feasibility for Transfer of Surplus
Power Revenue Funds
June 10, 2010

Report on the Los Angeles Department of Water and Power’s April 5, 2010 Letter
Regarding the Feasibility for Transfer of Surplus Power Revenue Funds
Table of Contents
EXECUTIVE SUMMARY .................................................................................................................................................................. 2
BACKGROUND ............................................................................................................................................................................... 5
Surplus Funds Transfer ............................................................................................................................................................................... 5
Energy Cost Adjustment Factor (ECAF) ................................................................................................................................................... 6
STATEMENT ONE........................................................................................................................................................................... 8
Background ................................................................................................................................................................................................... 8
Resources....................................................................................................................................................................................................... 8
Analysis......................................................................................................................................................................................................... 9
Conclusion .................................................................................................................................................................................................. 18
STATEMENT TWO ........................................................................................................................................................................ 20

Background ................................................................................................................................................................................................. 20
Resources..................................................................................................................................................................................................... 20
Analysis....................................................................................................................................................................................................... 21
Conclusion .................................................................................................................................................................................................. 23
STATEMENT THREE ..................................................................................................................................................................... 25

Background ................................................................................................................................................................................................. 25
Resources..................................................................................................................................................................................................... 25
Analysis....................................................................................................................................................................................................... 26
Conclusion .................................................................................................................................................................................................. 28
STATEMENT FOUR ....................................................................................................................................................................... 29

Background ................................................................................................................................................................................................. 29
Resources..................................................................................................................................................................................................... 29
Analysis....................................................................................................................................................................................................... 29
Conclusion .................................................................................................................................................................................................. 30
STATEMENT FIVE......................................................................................................................................................................... 32
Background ................................................................................................................................................................................................. 32
Resources..................................................................................................................................................................................................... 32
Analysis....................................................................................................................................................................................................... 32
Conclusion .................................................................................................................................................................................................. 34
APPENDIX A ......................................................................................................................................................... A-1
1
Executive Summary
The City of Los Angeles’ Controller’s Office (“Controller”) has engaged Crowe Horwath LLP
(“Crowe”) to conduct an evaluation of the Los Angeles Department of Water and Power (LADWP)
Power System’s (“Power System”) April 5, 2010 letter to the Controller (“Letter”). The Letter is
attached as Appendix A of this Report. Specifically, Crowe has been asked to evaluate five statements
made by the LADWP in the Letter regarding the feasibility for transfer of surplus power revenue
funds to the City’s Reserve Fund. The results of our evaluation are contained in the attached Report
on the Los Angeles Department of Water and Power’s April 5, 2010 Letter Regarding the Feasibility
for Transfer of Surplus Power Revenue Funds (“Report”). This Executive Summary highlights key
findings of the Report and should be considered in association with the full Report.
In the Letter, LADWP provides its justifications for why it would not be able to make a transfer of
$73.5 million to the City’s Reserve Fund as originally anticipated. This transfer amount represents the
remainder of the calculated surplus funds transfer that LADWP makes to the City on an annual basis,
based on an agreed-upon calculation method.
Based on our findings for each of the five statements, when taken as a whole, we find that the
assertion made by LADWP in the Letter that it did not have the ability to transfer the remaining $73.5
million of calculated surplus funds to be unsubstantiated. While LADWP has made certain financial
commitments, based on the information provided, we do not agree that these commitments would
prevent LADWP from upholding its agreement with the City regarding the surplus funds transfer.
The documentation provided does not support a definitive conclusion regarding a lack of funds on
the part of LADWP as suggested in the Letter. For example:
LADWP has committed to maintain an operating cash balance of $300 million as a method for
maintaining LADWP’s current credit ratings. However, this amount was a self-imposed
target and not based on guidance from the rating agencies.
Also, the rating agencies utilize the $500 million balance of the Debt Reduction Trust Fund
(DRTF) in addition to the $300 million in operating cash balance in their calculations of days
cash on hand. This allows for greater flexibility in the overall operating cash balance.
Finally, based on an evaluation of spending by LADWP in 2010, LADWP has been spending
down its operating fund cash balance by paying for significant capital improvements that
would normally be funded through a bond issuance. In doing so, LADWP has placed their
targeted operating balance, and potentially their credit ratings, in jeopardy.
The following is a summary of our findings on each of the five statements.
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“LADWP stated at Committee that we expected to make the additional transfer of $73.5 million.
This statement was based on the assumption that the ECAF (Energy Cost Adjustment Factor)
increases needed…would be approved. This is documented in our financial plan.”
While LADWP has been discussing an increase to the ECAF cap through Fiscal Year 2010,
they have run various projections both with and without ECAF cap increases. All of these
projections included a full transfer of at least $220 million of surplus funds to the City,
indicating that the ECAF cap increase was not an assumption that was required to be met
in order for the transfer to occur.
“Since rate relief has not occurred1, LADWP will be forced to use all funds to pay for energy costs
that should otherwise be fully recovered through the ECAF mechanism. There is no surplus
money to transfer at this time.”
LADWP has had an ECAF expense undercollection issue for a number of years. LADWP
has not provided documentation to indicate why this issue must be immediately
addressed through the use of “all” available funds. We also find that even with LADWP’s
proposed ECAF cap increases, an undercollection issue remains. Lastly, based on both
financial projections provided by LADWP and the actual cash balance of the Power
Revenue Fund as of March 31, 2010, we calculate that the Power Revenue Fund had
sufficient funds to offset the undercollection and make the transfer to the City, while
maintaining LADWP’s targeted fund balance.
“…the LADWP had planned to sell over the next 60 to 90 days…a total of $1.21 billion bond sales.
In order to maintain an “AA” rating for the sale of the bonds, it is imperative that the rating
agencies, underwriters, and prospective bonds buyers see a plan that provides for the solid
funding of these bonds into the future. If there is no bond sale by May 2010, cash levels are
projected to drop below the required amount.”
We agree that being able to present a sound financial plan is important when selling bonds.
However, LADWP appears to be at risk of their cash levels dropping below a certain amount
due to an internal practice of using their fund balance to pay for expenditures and significant
capital improvements and using bond proceeds to reimburse themselves. In doing so,
LADWP risks a more permanent drain on their fund balance should LADWP experience
difficulties in securing financing.
“The Board…unanimously resolved to increase and set the Power System’s minimum operating
cash target in its Power Revenue Fund from $150 million to $300 million in order to maintain an
“AA” bond rating…The unrestricted cash reserve amount of $300 million was recommended by
the LADWP’s financial advisors as a minimum target necessary to support the Power System’s
current operation as well as align its cash reserves with similarly AA-rated public power
organizations.”
Through a review of credit rating analyses and various documents provided by LADWP from
both LADWP’s financial advisor and a financial advisor hired by the City, we do not agree
1 As of the date of the Letter.
3
that the maintenance of a $300 million minimum operating cash target will result in LADWP
maintaining its credit rating. The methodology by which credit ratings are assigned includes
a wide range of factors to be considered, and the rating is not likely to hinge on only one
specific criteria. LADWP has not provided us documentation in which its financial advisor
recommends $300 million as the appropriate target. In addition, the rating agencies have
historically included LADWP’s DRTF in the calculation of liquidity, so this fund should be
considered in discussions regarding appropriate levels of cash balances. Based on our
evaluation of provided financial projections, we do not agree that $300 million is the only
operating cash balance target that would achieve LADWP’s objectives in relation to its credit
ratings.
“…any material changes to the level of the funds and restrictions in the DRTF (Debt Reduction
Trust Fund) will have a negative impact on the Power System’s credit ratings and could trigger a
material event disclosure as ruled by the Securities Exchange Commission, in addition to the
potential for accrual of arbitrage liabilities and other tax penalties.”
After reviewing the legal documents which established the DRTF and by which the DRTF is
maintained, we do not believe that “any” material change to the level of funds and restrictions
in the DRTF would require a material event disclosure. In addition, as LADWP has not
provided documentation to indicate that ”new” arbitrage and tax liabilities would be created
above what is already existing on the DRTF balance.
This Executive Summary highlights certain key findings from our limited scope review. The data and
analysis supporting these findings are included in the attached Report. The Report should be
reviewed in full to gain a complete understanding of our analysis of the statements made by LADWP.
In preparing this Report, we have utilized financial statements and projections provided by LADWP,
other schedules prepared by LADWP, reports prepared by both LADWP’s and the City’s financial
advisors, presentations made by LADWP representatives and bond counsel for LADWP, and various
ordinances and resolutions of the City and LADWP. In addition, we have consulted information
from credit ratings agencies and other public utilities in order to substantiate the assertions made by
LADWP regarding the impact of financial condition on credit ratings. Our conclusions have been
drawn from the information specifically identified in this Report. The presence of other
documentation could have resulted in conclusions other than what are stated in this Report.
The engagement was performed in accordance with consulting standards issued by the American
Institute of Certified Public Accountants and this report has been issued in accordance with these
standards. Therefore, we have not conducted an audit or an examination, the objective of which
would be the expression of an opinion of any financial or supplemental data or any of the
assumptions identified in this Report. Accordingly, we do not express such an opinion. We have no
responsibility to update this Report for events and circumstances occurring after the date of this
Report.
4
Background
Surplus Funds Transfer
Section 344 of the City Charter (“Charter”) states, “The Council may, by ordinance, direct that surplus
money in the…Power Revenue Fund…be transferred to the Reserve Fund with the consent of the
board in charge of the fund, but not otherwise.” Historically the calculation of surplus funds available
in any fiscal year has ranged from five percent (5%) to its current eight percent (8%) of the Power
System’s gross operating revenues from the prior fiscal year as identified in the annual audit for
LADWP. Once audited financial statements are available, the Board of Water and Power
Commissioners (“Board”) would typically review the recommended amount of surplus funds
transfer and approve the transfer of the surplus funds. As part of the recommendation and approval
process, the Board reviews the calculation for compliance with bond covenants. The covenants used
are as follows:
1. No transfer may exceed the prior fiscal year’s net income; and
2. No transfer may result in prior year's surplus less the agreed-upon transfer amount being
less than 33.3% of the total indebtedness (including current portion) outstanding, not
more than 10 days prior to the date of such transfer.
Once the Board approves the transfer and the related resolutions and ordinances are completed,
an initial, partial amount is transferred, prorated by the number of months that has transpired
since the close of the prior fiscal year. Therefore if the transfer was approved in March, nine
twelfths of the total would be transferred. The remaining amount would be submitted in equal
installments over the following three months so that by the end of June 30, the full amount
would have been transferred.
For FY 2009, the Power System’s gross operating revenues were $2.756 billion, which would yield a
surplus funds amount for payment in FY 2010 of roughly $220.5 million. However, as the Charter
states, the board in charge of the Power Revenue Fund must consent to this transfer. The board with
oversight of the Power Revenue Fund is the Board of Water and Power Commissioners (“Board”).
In February 2010, the Board provided a report to the City Council (“Council”) regarding the Power
Revenue Fund Transfer. The Board indicated in that report there is a surplus of money in the Power
Revenue Fund as of the close of FY 2009, and the Board consents to the transfer of $147 million of said
surplus money to the Reserve Fund of the City during FY 2010. The Board acknowledges that this
recommendation does not follow the historical methodology for calculation of the surplus and states
that “to ensure operational needs are met in the current fiscal environment it is not prudent to follow
this past methodology.” The Board also indicates that there may be an opportunity for an additional
surplus to be declared during FY 2010. Based on the Board’s recommendation, the Council approved,
by ordinance, a surplus funds transfer of $147 million on March 4, 2010.
During the Council meeting on April 6, 2010, a motion was made and adopted that the Board be
requested to honor its commitment of an additional $73.5 million transfer. According to the motion,
during the March 1, 2010 Council Budget and Finance Committee meeting, a representative from
LADWP reported that LADWP planned to approve a transfer for an additional amount of surplus
funds, estimated at $73.5 million, within two months. The LADWP representative stated that the
surplus funds transfer was being done in segments because of reduced consumption and therefore
reduced revenues in FY 2010, the application of a rate restructuring program, and escalating power
5
costs. The LADWP representative indicated that the remaining cash transfer was tied to cash levels,
with a specific comment on the $300 million in operating cash reserves. However, according to the
motion, no mention was made at that time that the remaining transfer was contingent on approval of
the Energy Cost Adjustment Factor (ECAF) cap increase.
On May 4, 2010, the Board adopted a resolution consenting to the transfer of an additional $73.475
million in surplus revenues to the Reserve Fund.
Energy Cost Adjustment Factor (ECAF)
LADWP’s rate structure for its Power System allows for the addition of an ECAF to the electric bills.
The ECAF is an additional charge to the customers over and above the base rate charges and is based
on consumption. Originally designed to allow LADWP to recapture costs associated with volatile
energy costs, the ECAF has since evolved to include other expenses as well. The ECAF is currently
based on the following items:
Fuel expense, estimated for the twelve months following the effective date of the ECAF;
Purchased power expense, estimated for the twelve months following the effective date of the
ECAF;
Expenses associated with the procurement and acquisition of renewable portfolio standard
(RPS), estimated for the twelve months following the effective date of the ECAF;
Demand-Side Management cost, estimated for the twelve months following the effective date
of the ECAF, provided that such costs may not exceed ten percent of the other expenses
identified above;
The Board’s approved cumulative energy efficiency savings multiplied by a factor, currently
$0.05513 per kilowatt hour;
An amount equal to the City transfer percentage for surplus funds, currently eight percent
(8%), times the sum of the expenses identified above;
The balance in the Energy Cost Adjustment (ECA) Account;
Retail energy sales, estimated for the twelve months following the effective date of the ECAF;
and
A set adjustment amount, currently $0.0125 per kilowatt hour, to reflect a portion of the ECAF
charge that is included in the base rates.
The ECAF is adjusted on a quarterly basis, effective January 1, April 1, July 1 and October 1. While
the ECAF’s theoretical design is to allow LADWP to pass through volatile energy expenses to the
customers, increases to the ECAF are currently capped at $0.001 per kilowatt hour each quarter.
In September 2009, the Board approved a resolution that would allow for an increase in the ECAF cap
as a way to limit LADWP’s exposure to undercollection and to help maintain LADWP’s financial
condition. The Board approved a $0.005 per kilowatt hour cap for ECAF expenses and an additional
$0.001 per kilowatt hour cap for RPS funding, totaling a cap of ECAF increases at $0.006 per kilowatt
hour per quarter.
In response to this action, the Council, through the Los Angeles Chief Legislative Analyst and the City
Administrative Officer, engaged PA Consulting to provide an independent fiscal review of the ECAF
and other rate design issues. PA Consulting provided their report to the City on February 25, 2010
(“PA Consulting ECAF Report”). In their report, PA Consulting recommended an increase in the
ECAF cap to $0.008 per kilowatt hour per quarter.
6
On March 18, 2010, the Board passed a resolution authorizing an increase in the ECAF cap up to
$0.008 per kilowatt hour. The Council elected to assert its jurisdiction over this matter and, on
March 26, 2010, rejected the resolution made by the Board, thereby vetoing the action. The Board
again approved an ECAF cap increase through a verbal resolution on March 31, 2010. That same day,
Council again asserted its jurisdiction and rejected the Board’s new resolution. Therefore, as of the
date of the Letter, changes to the ECAF cap had not yet been approved.
On April 15, 2010, the Board approved a resolution which authorized the ECAF increase to go up by
$0.006 per kilowatt hour for the quarter starting July 1, 2010. At the end of that quarter, the ECAF rate
would not decrease down to its prior level, but the amount the ECAF would be allowed to increase
would return to $0.001 per kilowatt hour. The Energy and Environment Committee of the Council
considered this action and presented it to the Council on April 27, 2010. The Council approved the
increase to the ECAF cap and requested that the Board report back to Council on or before
September 7, 2010, regarding any proposed changes for the quarter starting October 1, 2010.
7
Statement One
“The Board…unanimously resolved to increase and set the Power System’s

minimum operating cash target in its Power Revenue Fund from $150 million to
$300 million in order to maintain an “AA” bond rating…The unrestricted cash
reserve amount of $300 million was recommended by the LADWP’s financial
advisors as a minimum target necessary to support the Power System’s current
operations as well as align it cash reserves with similarly AA-rated public power
organizations.”
Background
The Letter states that “the rating agencies have consistently identified the inadequacy of the
LADWP’s cash reserves relative to its current level of operations.” According to the Letter, on
May 21, 2009, the Board unanimously resolved to increase and set the Power System’s minimum
operating cash target in its Power Revenue Fund from $150 million to $300 million in order to
maintain an AA bond rating and ensure its ability to access low-cost borrowing for its planned level
of infrastructure investments. The Letter states that the $300 million amount for unrestricted cash
reserve was recommended by LADWP’s financial advisors as “a minimum target necessary to
support the Power System’s current operations as well as align its cash reserves with similarly AA-
rated public power organizations.” The Letter states that “similar AA- rated public power
organizations maintain roughly 102 to 108 days of operating cash. If the LADWP Power System were
to maintain this level of cash, the unrestricted cash level would be over $800 million.”
Resources
We evaluated the following documents provided by LADWP or gathered by Crowe to analyze this
assertion as stated in the Letter:
The PA Consulting ECAF Report. Specifically, Section Two of the PA Consulting ECAF
Report discusses LADWP’s Financial Objectives.
Moody’s Investors Services (“Moody’s”) Rating Report dated March 19, 2010 providing a
rating of “Aa3” to LADWP.
Standard & Poor’s Rating Report dated March 22, 2010 providing a rating of “AA-” to
LADWP.
Fitch Ratings’ (“Fitch”) Rating Report dated March 18, 2010 providing a rating of “AA-” to
LADWP.
Moody’s Rating Methodology Report for U.S. Public Power Electric Utilities dated April 2008.
Standard & Poor’s Electric Utility Ratings criteria report dated June 15, 2007.
Fitch’s Public Power Rating Guidelines dated June 11, 2009.
Fitch Ratings U.S. Public Power Peer Study dated June 2009.
Memorandum prepared by LADWP’s financial advisor Gardner, Underwood & Bacon LLC
(“GUB”) dated May 11, 2009 (“GUB Memorandum”).
LADWP’s calculation of 100 days unrestricted cash and investments for 2010 through 2014.
8
In addition to the resources identified above, we have also reviewed a ratings report released by Fitch
on May 18, 2010. This rating replaced the March 18, 2010 rating, which was subsequently withdrawn
on April 5, 2010. For the purposes of our analysis, we have limited our discussion to information that
would have been available as of the date of the Letter.
Analysis
Throughout LADWP’s discussion on its financial condition, it is apparent how important the
maintenance of the AA credit rating is to the Power System. In particular, as the LADWP is initiating
a significant capital improvement plan that will require bond financing and as the Power System has
over $1 billion in variable rate debt outstanding, the maintenance of its credit rating will have a direct
impact on its ability to access a favorable bond market and the costs associated with interest for these
bonds. As the PA Consulting ECAF Report states, LADWP “has identified maintaining its AA debt
rating as a core business objective…Strategic objectives such as meeting renewable portfolio
standards and other large scale capital improvement programs are therefore evaluated in the context
of this broader objective.”
Current Credit Ratings and Methodologies for Ratings
The discussion below focuses on the recent credit ratings obtained by LADWP in preparation for their
sale of up to $616 million Power System Revenue Bonds, 2010 Series A (Federally Taxable-Direct
Payment-Build America Bonds) and up to $104 million Power System Revenue Bonds, 2010 Series B
(collectively, “2010 Bonds”). In addition, the rating agencies reaffirmed the ratings assigned to prior
bond issuances. For each rating agency, we have pulled key statements from the ratings report in
order to capture the general conclusions made by the rating agencies in regard to the Power System’s
cash balances.
Moody’s Investors Service – Report released March 19, 2010; Rating: Aa3
“The Aa3 rating considers LADWP’s continued sound financial management and its
favorable comparison to financial metrics of other Aa rated municipal electric utilities.”
“The credit rating could be lowered should LADWP’s anticipated debt service coverage ratios
fall to a level below the median for Aa rated electric utilities or should the city pressure the
utility for additional General Fund transfers.”
“The credit rating could increase if LADWP exhibits consistently stronger debt service
coverage ratios while managing its capital improvement program.”
Strength: “Strong LADWP financial liquidity including maintenance of unrestricted debt

reduction fund balance in excess of $500 million forecasted through 2014.”
Challenge: “Fiscal pressures from recession on city remains a potential challenge for LADWP
since general fund transfers could be increased; the general fund transfer is currently at 8% of
utility revenues, which is the median for a municipal electric utility.”
“The utility’s unrestricted Debt Reduction Trust Fund balance was in excess of $500 million in
2009 and is forecasted to remain in the $500 million range through 2014…LADWP’s days cash
on hand (including the unrestricted trust fund balance) remains strong at 188 days and is
consistent with other Aa rated public power utilities.”
9
“Debt service coverage as calculated by Moody’s from audited financial statements has been
on average more than two times during the prior five year period. FY 2009 debt service
coverage was 2.34x. This calculation includes General Fund transfers as an operating
expense…Forecasted financial results through 2014 show the debt service coverage ratio to
remain in generally the same two times range.”
Standard & Poor’s – Report released March 22, 2010; Rating: AA-
“LADWP exhibits, in our view, sound financial metrics after accounting for direct debt and
off-balance-sheet financial commitment.”
“However, the utility is projecting that $5.1 billion of 2010-2014 capital needs and rising
operating costs will place pressure on financial margins….we believe moderate additional
rate increases could preserve financial metrics.”
“The department projects that substantial additional debt and fixed contractual commitments
needed to meet generation and system capital needs will continue to pose a challenge to
maintaining historically strong financial margins at levels that we believe are only adequate
for the rating.”
Fitch Ratings (“Fitch”) – Report released March 18, 2010; Rating: AA-
“LADWP appears to have the debt capacity to absorb the additional $2.5 billion in debt
expected over the next five years. Debt service coverage is projected to remain above of 2.25
times (x).”
“Liquidity levels are healthy and following adoption of formal financial policies in June 2009,
LADWP no longer expects to draw down its unrestricted cash reserve to fund its capital
spending, mitigating Fitch’s previous credit concerns regarding liquidity.”
“Positive credit developments have occurred since Fitch’s last credit review. The Board of
Commissioners, the governing body of the utility, approved formal financial policies in 2009
that include a debt service coverage target of 2.25x, a minimum unrestricted cash reserve of
$300 million, and a debt to capitalization of less than 60%. The reserve level of $300 million,
when combined with the debt reduction fund of over $500 million, is expected to provide
healthy liquidity as LADWP executes its large capital plan.”
“Financial performance has been consistently strong. Debt service coverage of fiscal year-end
2009 was 3.1x, or 2.3x after the general fund transfer. Debt service coverage is projected to
decline closer to LADWP’s minimum target of 2.25x as new debt is issued to finance a large
portion (approximately two-thirds) of the capital plan.”
“LADWP’s liquidity was strong with $445 million in unrestricted operating cash and $547
million in the debt reduction fund, which acts as a hedge for the utility’s variable-rate debt
exposure and can be used in the future to economically defease debt or to pay current debt
service costs. The combined liquidity resulted in just under $1 billion in reserves, or 177 days
cash.”
10
» Based on this analysis, the days cash on hand based solely on the unrestricted
operating cash would be approximately 79 days.
In addition to the actual ratings reports for LADWP, we have also researched the credit rating
agencies’ rating methodologies for U.S. public power electric utilities. Each of the credit rating
agencies has released a report which describes the criteria being evaluated when assigning a credit
rating to a U.S. public power utility. Below are synopses of these methodologies in order to provide a
better understanding of how cash balances are factored into the rating.
Moody’s Investors Service – Report released April 2008
Moody’s identifies the following six drivers being considered when assigning a credit rating to a U.S.
public power electric utility. Within each of these drivers, Moody’s has also identified sub-factors to
better describe what is being considered in the rating.
1. Market Position
a. Competitiveness
b. Service territory credit characteristics and demand
c. Scope and reliability of power supply, transmission and distribution
2. Local Government Credit Characteristics
a. Degree of legal and financial relationship of utility with local government

b. General obligation credit quality of local government
c. General Fund Transfer (GFT)
i. In regard to the GFT, Moody’s states that this transfer can be significant both
directly and indirectly. “If transfers from the utility represent a large part of
the city’s overall operating revenues, then there is a greater likelihood that the
city will ensure the electric enterprise remains healthy. However, when the
transfer represents a substantial portion of the utility’s own resources, this
could have a negative rating impact.” Moody’s states that the median GFT as
a percent of utility gross revenues in the U.S. is 7%. (This contradicts a
statement made by Moody’s in LADWP’s ratings letter which states that
LADWP’s GFT percentage of 8% is the median for a municipal electric utility.)
Moody’s also gives better consideration to GFT policies that are in place and
accepted by both the city and the utility versus GFT policies which allow the
city to set the transfer amount on an annual basis.
3. Governance and Management
a. Governance
b. Cost recovery process/rate setting
c. Management
d. Regulatory compliance
4. Financial Position and Performance
a. Operating performance
b. Debt service coverage
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i. Moody’s provides a table which indicates that Aaa or Aa rated utilities would
be expected to have strong debt service coverage with a stable trend. The
three year average debt service coverage ratio would typically be between
2.25x and 3.00x or 2.00x and 2.50x when including the GFT as an operating
expense.
c. Financial liquidity
i. In discussing financial liquidity, Moody’s focuses largely on days cash on
hand. For this metric, Moody’s states, “While days cash on hand is a useful
ratio for measuring the relative strength of a utility’s liquidity, the level of
cash must be evaluated in conjunction with identified immediate risks to
cash flow.” In addition, Moody’s discusses that the days cash on hand
metric can be directly relatable to the number of days it takes for the utility
to raise its rates and begin to receive additional revenue. “If a utility has a
pass-through mechanism that permits monthly adjustments to customer’s
bills for fuel price increases it may mitigate the need for a higher level of
available cash on hand.” As a general guideline, Moody’s suggests that Aaa
or Aa rated public power utilities should have more than 125 days cash on
hand.
d. Leverage
e. Operating ratios
5. Debt and Capital Plan
a. Power supply and capital plan

b. Debt management
c. Construction risk
6. Covenants and Legal Framework
a. Bond security
b. Rate covenant
c. Additional bonds test
d. Debt service reserve and other required reserves
Standard & Poor’s – Report released June 15, 2007
Standard & Poor’s identifies twelve criteria used in evaluating a U.S. public electric utility. These
criteria are as follows:
1. Management
2. Operations
3. Competitive Position
4. Service Area
5. Regulation
6. Finances
a. Within this category, Standard & Poor’s looks at many key financial ratios including
debt service coverage, fixed charge coverage, unrestricted cash as a percentage of total
12
expenditures and debt to equity, in addition to other ratios. For debt service coverage,
Standard & Poor’s acknowledges its importance, but also states that “reduced
coverage and reserves may be appropriate for some utilities but not for others,
depending upon the degree to which competitiveness can be enhanced and also the
operational and competitive challenges that each utility faces.” In regards to cash
balances, Standard & Poor’s finds that utilities with adequate cash balances have
important flexibility in dealing with future challenges. However, Standard & Poor’s
also goes on to say that “some systems with strong business fundamentals could
reduce their cash balances without impacting their credit ratings.”
7. Legal Provisions of Retail Electric Systems

8. Security
9. Rate Covenant
10. Flow of Funds
11. Additional Bonds Test
12. Reserves
a. This section deals largely with debt service reserve funds. Historically, LADWP has
not been required to fund debt service reserve funds when issuing bonds.
Fitch Ratings – Report released June 11, 2009
Fitch’s rating methodology for public power utilities focuses on five main criteria as follows:
1. Management, governance and business strategy

2. Service area
3. Asset operations
4. Cost structure
5. Financial performance and legal considerations
a. “Fitch focuses on the adequacy of the utility’s cash flow relative to expenses and
financial obligations, as well as its capital structure, liquidity and ability to fund
capital expenditures.” In regards to debt service coverage, Fitch provides 2.00x as a
general guideline for AA rated public power utilities but notes that “other key credit
factors can affect the ultimate level of coverage necessary for a system to reach a given
rating category.”
In addition to its ratings methodology, Fitch has also released a peer study on U.S. public power
utilities. This peer study provides detail on various financial ratios utilized by Fitch in assigning
credit ratings. These ratios include various calculations for debt service coverage, debt to customer,
days cash on hand, variable rate exposure to capitalization, general fund transfer to total operating
revenues and other identified ratios. However, when taken with the ratings methodology, it is
important to note that these ratios would be considered within the financial performance criteria and
would be considered in association with the other criteria considered by Fitch.
As can be seen, the credit rating agencies are reviewing a wide range of factors in assigning a credit
rating. While in many instances the rating agencies may provide some guidelines for where they
would anticipate an AA rated public power utility to be in terms of debt service coverage and days
cash on hand, these guidelines often include additional comments that these metrics need to be
reviewed in the context of other criteria.
13
GUB Memorandum
Prior to the Board’s adoption of a policy targeting a Power Revenue Fund minimum operating
balance of $300 million on May 21, 2009, LADWP received a memorandum from its financial advisor,
Gardner, Underwood & Bacon LLC (“GUB”) on May 11, 2009. This memorandum (“GUB
Memorandum”) provided a peer analysis of the Power System’s financial condition in relation to
other similarly rated public power utilities. The discussion below reviews the GUB Memorandum in
the context of the credit rating guidelines discussed above and the action ultimately taken by the
Board.
In order to provide a picture of how the Power System’s financial condition compared to its peers,
GUB identified seven peers, while acknowledging that given LADWP’s size and services, there were
few comparable peers. The selected peers were based on having at least an Aa3/AA- rating and a
sizeable service population. Table 1 below restates the data provided in the GUB Memorandum
regarding LADWP and the selected peers. Bold font has been added in certain instances to highlight
key statistics which will be discussed below.
The GUB Memorandum uses the information noted in Table 1 to provide analysis regarding both
debt service coverage and days cash on hand. In regards to debt service coverage, GUB notes that if
the transfer to the City is included as an operating expense, LADWP’s debt service coverage drops to
2.56x, making it more in line with its peers. Based on this GUB concludes, “We believe the targeted
minimum debt service coverage of 2.25x is a prudent policy and is consistent with the level of
LADWP’s peers.” While this conclusion mostly plays out in the provided table, it is interesting to
note that Anaheim has the same credit ratings as LADWP but has debt service coverage of 1.68x.
In regard to days cash on hand, GUB notes that the liquidity position of the Power System is “fairly
weak given the size of its operations and debt burden.” This is largely based on a calculation of days
cash on hand. For the purposes of the GUB Memorandum, GUB has computed days cash on hand
based on operating expenses less depreciation and amortization expenses, unrestricted cash and
investments and a 365-day year. The GUB Memorandum also notes that the forecasted Financial Plan
shows this metric dropping to 33 days for FY 2010 and down to 26 days by FY 2014 based on the
Power System’s projected unrestricted cash balance. GUB’s analysis does not take into consideration
the fund balance of the DRTF. GUB concludes that “LADWP should consider increasing its liquidity
position both as a defensive strategy and potentially as an argument for a positive rating action.”
GUB does not make any statements in the GUB Memorandum regarding the appropriate amount of
days cash on hand for LADWP or appropriate level of unrestricted cash balances.
While a strong liquidity position is certainly a good indicator of financial health of an electric utility, it
is clearly not the only determinant. As the table shows, three of the selected peers have days cash on
hand less than the calculated days cash on hand for LADWP. At the same time, these three utilities
(JEA, Nashville Electric System and Omaha Public Power) have a higher credit rating than LADWP
by at least one of the rating agencies, with the Nashville Electric System and Omaha Public Power
having higher credit ratings than LADWP as assigned by all three credit rating agencies. This
indicates that other factors must also be included in the consideration of these ratings.
This information is also confirmed within the Fitch peer study. In that study, Fitch provides tables
which detail ratios for various utilities throughout the United States. In regards to days cash on hand,
Fitch identifies the median days cash on hand for AA- rated retail systems in FY 2008 to be 135 days.
However, individual utility ratios show that within the AA- credit rating, this ratio varies from 33
14
TABLE 1 SOURCE: Gardner, Underwood & Bacon LLC Memorandum dated May 11, 2009
Selected Financials (FY 2008) LADWP Anaheim JEA Nashville Omaha Orlando San Tallahassee
Electric Public Utilities Antonio Electric
System Power Commission
Senior Most Rating Aa3/ Aa3/ Aa2/ Aa3/ Aa1/ Aa1/ Aa1/ Aa2/
AA-/ AA-/ AA-/ AA+/ AA/ AA/ AA/ AA/
AA- AA- AA- AA AA AA AA+ AA-
Operating Revenues ($000) 2,781,324 351,160 1,247,324 1,030,953 787,973 844,182 1,860,677 403,379
Other Income ($000)1 175,906 22,682 32,601 5,736 20,152 23,099 95,728 4,093
Total O&M Expenses ($000) 2,457,597 327,725 1,114,703 980,280 687,620 582,074 1,460,767 326,715
Net Revenues ($000) 499,633 46,117 165,222 56,409 120,505 285,207 495,638 80,757
15
Total Annual Debt Service ($000) 227,359 44,140 140,753 44,400 85,184 116,220 322,706 33,695
Total Annual Debt Service Coverage (x)2 3.44 1.68 2.40 2.19 2.90 2.45 2.36 2.40
Total Long Term Debt ($000) 4,977,183 614,821 2,555,787 524,099 1,853,433 1,352,397 3,327,551 500,545
Unrestricted Cash and Investments ($000)3 389,529 121,958 167,382 94,776 71,504 232,727 795,347 87,466
Days Cash on Hand3 65 149 65 37 46 176 243 108

Sources of Data: Published annual reports, comprehensive annual financial reports, disclosure filings and other publicly available data on issuers’
websites, Bloomberg and through financial subscription services.
1Includes investment income, rent and other sources of income.
2Revenue available for debt service coverage calculation may include rate stabilization funds and other sources while excluding depreciation and
interest and amortization expenses.

3Calculation based on unrestricted cash and investments and assumes a 365 day fiscal year calendar. The rating agencies may have differing methods
and/or may include other funds into their calculation.

days up to 376 days. For AA rated systems, which is a higher credit rating than what LADWP
currently has, this ratio ranges from 25 days up to 331 days. Going the other direction, A+ rated
utilities have days cash on hand ranging from 19 up to 875 days. This data provides further
recognition that the rating agencies consider a wide range of criteria in evaluating utilities.
PA Consulting ECAF Report
PA Consulting also provided an analysis of LADWP’s financial condition in its PA Consulting ECAF
Report released in February 2010. PA Consulting focused on the three financial targets identified by
the Board:
Debt service coverage ratio of 2.25x
Unrestricted cash balance of $300 million
Capitalization ratio of no more than 60% debt
For the purposes of this Report, we will focus our analysis on the debt service coverage ratio and
unrestricted cash balance metrics as these are the same metrics discussed in the credit rating analysis
and GUB Memorandum analysis above.
PA Consulting identifies three debt service coverage ratios commonly used in financial analysis. The
first is the typical Debt Service Coverage ratio which excludes fixed charge obligations (“off-balance-
sheet” debt) and the general fund transfer from consideration. The second metric is the Adjusted
Debt Service Coverage Ratio which takes into account the fixed charge obligations. Finally, the
Coverage of Full Obligations ratio takes into account all long-term debt and fixed charge obligations
while considering the general fund transfer to be an operating expense. PA Consulting provides the
following table in the PA Consulting ECAF Report.
TABLE 2 SOURCE: PA Consulting ECAF Report

Peer group defined as Retail municipal utilities, AA+/AA/AA- Ratings, >100,000 meters served
FY2008 data, median vales shown
Debt Service Adjusted Debt Coverage of Full
Coverage Service Coverage Obligations
Peers 2.31 1.63 1.44
LADWP Target 2.25 ~1.75 (implied) ~1.4 (implied)
PA Consulting’s Source: Fitch Ratings U.S. Public Power Peer Study, June 2009
Based on this peer analysis (for which specific peers used are not identified), PA Consulting
concludes, “that LADWP’s target of 2.25x, while slightly below the median of other companies, is
reasonable.”
PA Consulting also provides an analysis of liquidity measures, starting from LADWP’s minimum
target of $300 million for operating cash reserves. PA Consulting indicates that “this level of liquidity
corresponds to slightly less than 50 days of cash given projected 2010 expenses, and can be compared
to a median of 102 days for the peers considered by PA and 108 days for the peers considered in a
recent analysis by LADWP’s financial advisor.” (According to a footnote, the analysis being referred
to is the GUB Memorandum.) The method by which PA Consulting is calculating days cash on hand
16
cannot be determined based on the analysis provided in the PA Consulting ECAF Report. PA
Consulting notes that with the addition of the debt reduction trust funds, LADWP’s liquidity levels
increase to well over 100 days, making it more in line with comparable peers. PA Consulting
concludes by stating that “LADWP’s minimum cash target of $300 million appears to be adequate to
maintain its AA rating.” PA Consulting does not make its own recommendation as to the
appropriate level of operating cash but rather focuses on the LADWP’s stated minimum target.
LADWP’s Calculation of Days Cash on Hand
In addition to the commentary provided by GUB and PA Consulting, LADWP has also provided
their own calculation of days cash on hand. Table 3 below restates the calculation as provided by
LADWP. The numbers in this calculation are based on the FY 2010 Financial Model approved with
the FY 2010 budget and are in millions of dollars.
TABLE 3 SOURCE: LADWP

Fiscal Year Ended June 30,
Description 2010 2011 2012 2013 2014
Total Operating Expenses $ 2,704 $ 2,996 $ 3,163 $ 3,300 $ 3,418
Less Depreciation (319) (361) (385) (411) (440)
Interest on Fixed Rate Bonds 196 247 299 342 378
Interest on Variable Rate Bonds 56 56 56 56 56
Principal Payments on Debt 101 121 135 142 148
City Transfer 232 259 287 310 331
Total Planned Cash
Disbursements $ 2,970 $ 3,318 $ 3,555 $ 3,739 $ 3,891
Average Cash Spent Per Day $ 8.14 $ 9.09 $ 9.74 $ 10.24 $ 10.66
At $300 Million (Unrestricted
Cash Balance), Days Cash on 37 33 31 29 28
Hand
Cash Balance) plus Debt
104 93 87 83 79
Reduction Fund of $546 Million,
Days Cash on Hand
As noted in Table 3, LADWP’s calculation of days cash on hand shows that LADWP’s liquidity
position is low, even at the $300 million in unrestricted cash balance. This calculation shows a much
different, more conservative picture than other calculations of days cash on hand due to the inclusion
of a number of other non-operating expenditures, such as interest and principal payments and the
transfer to the City. While PA Consulting’s calculation of days cash on hand could not be verified, the
GUB calculation of days cash on hand did not include these other extraneous disbursements. As
GUB’s results seem to be more in line with the days cash on hand analysis documented in the ratings
reports, we believe the rating agencies also do not include these extraneous expenses in their
calculation of days cash on hand. As shown in the table below, if these items were removed from
consideration, the days cash on hand based solely on the $300 million unrestricted cash balance target
would range from 46 days in 2010 to 37 days in 2014. When including a Debt Reduction Trust Fund
balance of $546 million, these days climb to 129 days in 2010 down to 104 days in 2014.
17
TABLE 4 SOURCE: Revised from Table 3 above
Fiscal Year Ended June 30,
Description 2010 2011 2012 2013 2014
Total Operating Expenses $ 2,704 $ 2,996 $ 3,163 $ 3,300 $ 3,418
Less Depreciation (319) (361) (385) (411) (440)
Interest on Fixed Rate Bonds ----------------------------------EXCLUDED-----------------------------------
Interest on Variable Rate Bonds ----------------------------------EXCLUDED-----------------------------------
Principal Payments on Debt ----------------------------------EXCLUDED-----------------------------------
City Transfer ----------------------------------EXCLUDED-----------------------------------
Total Planned Cash
Disbursements $ 2,385 $ 2,635 $ 2,778 $ 2,889 $ 2,978
Average Cash Spent Per Day $ 6.53 $ 7.22 $ 7.61 $ 7.92 $ 8.16
Cash Balance), Days Cash on 46 42 39 38 37
Hand
Cash Balance) plus Debt
129 117 111 107 104
Reduction Fund of $546 Million,
Days Cash on Hand
Conclusion
As the analysis above identifies, two key metrics used in evaluating financial condition are debt
service coverage ratios and days cash on hand. All parties identified above, including the credit
rating agencies, GUB and PA Consulting, agree that these are valuable metrics. Being able to show
strong and consistent results in these metrics will clearly be of benefit to an electric utility for the
purposes of credit ratings and bond market presence.
LADWP has indicated its commitment to achieving a minimum of 2.25x debt service coverage and
$300 million in unrestricted operating cash balances in order to maintain its AA credit rating.
However, our analysis of the rating agencies’ evaluation methodology and the peer comparables
provided by GUB and PA Consulting demonstrate that these commitments alone would not
necessarily result in LADWP maintaining its current AA rating. As discussed above, the credit rating
agencies have historically considered a wide range of criteria in order to establish a credit rating and
will continue to use this approach according to the publicized methodologies. It would be inaccurate
to state that one or two particular metrics would be the sole indicators of financial health and
therefore credit worthiness. Even as the methodologies state, in many cases there are caveats
associated with particular metrics as in some instances lower metrics may be appropriate within the
context of the utility being evaluated.
Prior to the establishment of the 2.25x debt service coverage policy, the Board received a
recommendation from LADWP’s financial advisor, GUB, indicating that 2.25x debt service coverage
would be an appropriate targeted coverage. However, it is important to note two key aspects of the
calculation of debt service coverage in relation to the Letter. First, the calculation of debt service
coverage is based on operating revenues compared to operating expenses. It would not include
consideration of the fund balance in the Power Revenue Fund. Secondly, the calculation of debt
service coverage does not consider the transfer to the City as an operating expense. Therefore, the
18
transfer of the surplus funds would have no bearing on LADWP’s ability to meet its debt service
coverage policy.
In regard to LADWP’s statement in the Letter that the unrestricted cash reserve amount of $300
million was recommended by the LADWP’s financial advisors as a minimum target necessary to
support current operations and align the Power System with other similarly rated utilities, the
documentation provided to us by LADWP does not include a recommendation from GUB that $300
million is the appropriate level of reserves. GUB does not comment on specific levels of cash balances
or days cash on hand that would be necessary. PA Consulting also did not make an independent
recommendation as to level of operating cash balance, but rather utilizes LADWP’s stated target. In
addition, in the Letter, LADWP states that similar AA- rated public power organizations maintain 102
to 108 days of operating cash. As the GUB Memorandum and the Fitch peer study demonstrate, this
is not a hard and fast rule, as in some instances, public power utilities with ratings higher than AA-
had operating cash balances which yielded much less than 102 to 108 days cash on hand and utilities
with ratings lower than AA- may have days cash on hand higher than these identified targets. Again,
this supports the conclusion that credit ratings are not based solely on one or two metrics but rather
on the complete picture of the entity being evaluated.
We also disagree with LADWP’s implied assertion that the target $300 million minimum cash balance
is needed to achieve 100 days of cash on hand. In calculating days cash on hand, the fund balance
of the Debt Reduction Trust Fund (DRTF) is regularly included by both the rating agencies and
the financial advisors to calculate days cash on hand. Using the budgeted numbers presented by
LADWP in its calculation of days cash on hand, the DRTF balance is forecasted to be $546 million for
FY 2010 and forward. Assuming this balance and assuming the operating and depreciation expenses
identified by the LADWP for the FY 2010 budget to be accurate, unrestricted cash balances would
need to equal only approximately $107 million in order to achieve 100 days cash on hand. Under this
calculation, even LADWP’s original minimum target of $150 million would be sufficient to achieve
100 days of cash on hand for FY 2010.
We agree with the concept of setting targeted minimum debt service coverage ratios and cash
balances, in addition to a multitude of other possible metrics, as a matter of sound fiscal policy.
However, we conclude that LADWP’s statement that it “must” increase the minimum target
operating balance from $150 million to $300 million is not supported by documentation provided by
LADWP or our analysis of credit rating methodology as a guaranteed method for maintaining
LADWP’s AA- credit rating.
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Statement Two
“…any material changes to the level of the funds and restrictions in the DRTF
(Debt Reduction Trust Fund) will have a negative impact on the Power System’s
credit ratings and could trigger a material event disclosure as ruled by the
Securities Exchange Commission, in addition to the potential for accrual of
arbitrage liabilities and other tax penalties.”
Background
The April 5, 2010 letter from LADWP stated that “rating agencies include the $500+ million of funds
in the Debt Reduction Trust Fund (DRTF), albeit restricted, when assessing the Power System’s total
liquidity.” The letter goes on to state that “for more than a decade, the rating agencies, bondholders,
and potential investors have relied on the DRTF both as a source of liquidity as well as a back stop for
future debt service payments. The DRTF also acts as an interest rate hedge for the Power System’s
variable rate debt obligations totaling over $1.2 billion.” Based on statements made by LADWP’s
financial advisor and bond/tax and disclosure counsel, LADWP concludes that reductions in the
DRTF cash balance could trigger a material event disclosure and place the LADWP at risk for
arbitrage and other tax penalties.
Resources
Resolution No. 97-116 authorizing the establishment of the Electric Plant Revenue Bond
Reduction Escrow Fund (“DRTF Resolution”).
Electric Plant Revenue Bond Reduction Escrow Fund, Trust Agreement by and between Los
Angeles Department of Water and Power and First Trust of California, National Association
as Trustee, Dated as of June 25, 1997 (“Trust Agreement”).
Master Bond Resolution of the Board of Water and Power Commissioners of the City of Los
Angeles Establishing the Terms and Conditions of Department of Water and Power of the
City of Los Angeles Power System Revenue Bonds, Resolution No. 4596 (“Master Bond
Resolution”).
Memorandum prepared by GUB dated March 31, 2010 (“GUB DRTF Memorandum”) that
discusses the City Council Motion on Feasibility of Removing Existing Restrictions on Power
System’s Debt Reduction Trust Fund.
Audio Transcript from the Board meeting on March 31, 2010 in which Gene Carron from
Orrick, Herrington & Sutcliffe LLP, Bond Counsel and Disclosure Counsel, verbally discussed
the arbitrage and material event disclosure.
20
Analysis
In order to understand the potential implications associated with changes to the DRTF, we have first
studied the DRTF Resolution which authorizes the establishment of the DRTF. The bullet points
below identify key sections of DRTF Resolution in relation to LADWP’s statement.
Section 1 of the DRTF Resolution discusses the fact that the DRTF was established:
“To maintain and improve the competitive position of the Electric Works and to provide
the Department with flexibility in establishing rates and charges and providing
alternatives in the purchase of Bonds or the payment, when due and payable, whether at
maturity or upon redemption , of the principal and interest on the Bonds,…”
Section 2 of the DRTF Resolution states that “Deposits to the Fund”:
“Funds dedicated solely for debt reduction from rates or any other revenue generating
sources may be deposited upon receipt or at the end of each month.” (Page 2 of Trust
Agreement)
Also, Section 3 of the DRTF Resolution gives definition as to the “Application of Moneys in
the Fund”:
“Amounts on deposit in the Fund shall be applied at such time or times and for any of the
following purposes as shall be determined by the Chief Financial Officer:
(i) to the payment when due of principal or of interest on Bonds;
(ii) to the purchase of Bonds, including the payment of accrued interest thereon;
(iii) to the redemption of Bonds;
(iv) to making provisions for the payment of Bonds in accordance with the provisions of
the resolution authorizing such bonds such that such Bonds are defeased and deemed
paid for purposes of such resolution;
(v) to redeem commercial paper issued to purchase such Bonds; or
(vi) to making provision for the payment of Bonds in a manner that such Bonds continue
to be outstanding under the resolution authorizing such Bonds.”
The language of the Trust Agreement also gives some insight into the purpose for the establishment
of the DRTF and the use of any moneys being held within the DRTF:
“Whereas, the purpose of the Debt Reduction Fund is to serve as a depository for funds
accumulated for debt reduction in order in improve LADWP’s competitive position in a
deregulated electric industry and potential sources will come from contributions for
operating revenues, transfers from stabilization account, revenue from competitive
transition charge, and budget savings from Joint Power Agencies;” (Page 1 of Trust
Agreement)
“Whereas, moneys in the Debt Reduction Fund will be used to (1) purchase bonds in the
open market or make tender offers, (2) establish escrow funds to defease certain high
coupon bonds, (3) perform current refundings, (4) retire commercial paper issued to
purchase or call long-term bonds, (5) offset debt service payments, and (6) generate
21
investment earnings to accomplish the above mentioned purposes;” (Page 1 of Trust
Agreement)
Other sections of the Trust Agreement also discuss the DRTF and LADWP’s rights in relation to the
DRTF.
The following provisions are found within the “Dispositive Provisions” section (Section II) of
the Trust Agreement:
“2.04 Termination of Fund. The Fund may be terminated at any time upon thirty (30)
days written notice by LADWP to the Trustee.”
“2.05 Distribution of Fund Upon Termination. Upon the termination of the Fund, the
Trustee shall, at the written direction of LADWP, (a) immediately transfer all or any
portion of the remaining monies and assets in the Fund to or as Directed by LADWP, or
(b) liquidate all or any portion of the assets of the Fund and immediately distribute the
proceeds of such liquidation(s) to or as directed by LADWP.”
“2.06 Alterations and Amendments. The Trustee and LADWP understand and agree
that modifications or amendments may be required to the Agreement from time to time to
effectuate the purpose of the Fund. No amendment to the Agreement shall be effective
unless it has been signed by the Trustee and LADWP.”
The following statement is found within Section VIII “Miscellaneous” of the Trust
Agreement”:
“Parties Interested Herein. Nothing expressed or implied in this Agreement is intended

or shall be construed to confer upon, or to give to, any person or corporation, other than
LADWP and the Trustee, any right, remedy or claim under or by reason of this
Agreement, or any covenant, condition or stipulation contained herein.”
The Master Bond Resolution, which was adopted at the Board’s meeting on February 6, 2001, makes
no specific mention of: (a) the DRTF Resolution, which was adopted at the Board’s meeting on
November 19, 1996; (b) the Trust Agreement which is dated as of June 25, 1997; or (c) the existence of
monies in the DRTF.
LADWP’s financial advisor addressed the DRTF in a memo to the Assistant Chief Financial Officer
and Treasurer for LADWP on March 31, 2010. The GUB DRTF Memorandum makes the following
comments about the DRTF:
“Given this context, changes to the DRTF would have a negative impact on the
Department’s credit ratings from Fitch Ratings, Moody’s Investors Service and Standard
& Poor’s. This impact could range from a move to “negative outlook/watch” to a
downgrade of the Department’s ratings.”
The GUB DRTF Memorandum also lists the following comments from the rating agencies discussed
above:
22
“Fitch Ratings: “The reserve level of $300 million, when combined with the debt
reduction fund of over $500 million, is expected to provide healthy liquidity as LADWP
executes its large capital plan.””
“Moody’s Investors Service: “Strong LADWP financial liquidity including maintenance

of unrestricted debt reduction fund balance in excess of $500 million forecasted through
2014.””
“Standard & Poor’s: “The utility’s strong liquidity in the form of a $540 million debt
reduction trust fund. The utility forecasts that it will maintain this fund with a balance of
$500 million - $600 million during the next five years.””
Conclusion
The Letter’s statement that “…any material changes to the level of the funds and restrictions in the
DRTF…will have a negative impact on the Power System’s credit ratings…” (emphasis added) does
not appear to be supported by the analysis of the documents provided. For example, Moody’s
Investors Service refers to the DRTF as “unrestricted” and all three rating agencies refer to the DRTF
as part of LADWP’s overall “liquidity”. It would appear that any current restrictions on the DRTF
were not an important part of the analysis performed by the rating agencies. Therefore, it is very
possible that changes to remove existing restrictions on the DRTF could have no effect on LADWP’s
credit ratings.
This would also appear to be supported by the fact that the Dispositive Provisions for the Trust
Agreement allow for the termination of the fund “…at any time upon thirty (30) days written notice
by LADWP to the Trustee.” The current Trust Agreement does not require any notice to LADWP’s
bondholders or creditors if a decision is made to terminate the fund that is being held as part of the
Trust Agreement. Section 2.05 of the Trust Agreement makes it clear that, upon termination of the
fund, the monies within the fund will be transferred or distributed as “…directed by LADWP.”
Finally, with regard to the flexibility to modify any of the current restrictions on the DRTF, the Trust
Agreement makes it clear that no outside parties have any rights or claims being conferred on them as
part of the trust arraignments. Therefore, changing the restrictions on the DRTF, the DRTF Resolution
or the Trust Agreement would not appear to impact the position of any outside parties with respect to
any claims of the monies in the DRTF. Again, this flexibility would support the rating agencies’ view
of the DRTF as either unrestricted or part of the overall liquidity.
With regard to the impact that “…any material changes to the level of the funds … in the DRTF…”
would have on LADWP’s credit ratings, this has been discussed in the previous section of the report.
As mentioned in the Statement One, the rating agencies review an issuer’s creditworthiness based on
a variety of areas that are analyzed. The overall cash or liquidity position of an issuer is just one of the
areas that would be examined. The rating agencies have not given a specific amount that an issuer is
required to keep in a specific fund in order to achieve a desired rating.
It is clear from the analysis provided in the previous section that LADWP could experience a
reduction in the level of its overall liquidity (which would include the DRTF and the Power Revenue
Fund) and still be in a better “cash position” than some of the other issuers in the peer group that was
provided. Therefore, the statement in the GUB DRTF Memorandum that states: “Given this context,
changes to the DRTF would have a negative impact on the Department’s credit ratings from Fitch
23
Ratings, Moody’s Investors Service and Standard & Poor’s” (emphasis added) does not appear to be
accurate. Where the GUB DRTF Memorandum goes on to state that: “This impact could range from
a move to “negative outlook/watch” to a downgrade of the Department’s ratings.”, it would be more
accurate to state that: “The impact of a change in the balance of monies in the DRTF could range from
maintaining LADWP’s current credit rating to a change in the ratings depending on a variety of other
factors affecting LADWP’s credit ratings.” A less definitive statement would better account for all of
the various factors that may influence a credit rating.
With regard to the statement that “…any material changes to the level of the funds and restrictions in
the DRTF… could trigger a material event disclosure as ruled by the Securities Exchange
Commission, …”, this also does not appear to be supported by the documentation provided by
LADWP. While the decision to report a material event is at discretion of the issuer and it is usually
based on advice from the issuer’s bond counsel and / or financial advisors, that disclosure is usually
guided by the covenants provided within the legal documents governing the outstanding bond issues
as well as the outstanding fund balances. Material event disclosures are issued with the intent of
notifying the bondholders or the bond market of specific events that may have occurred within clearly
defined areas. It is clear from the language regarding the original purpose of the DRTF and the
application of the monies that bondholders have no specific rights or claims to the DRTF. In addition,
the description of the “Application of Moneys in the Fund” as provided in the DRTF Resolution
provides that the balance in the DRTF will be used from time to time to: make principal and interest
payments; retire, purchase, redeem or defease outstanding bonds; or redeeming commercial paper. A
material event disclosure is normally not required when the monies within a fund are used for the
purpose provided for within the enabling resolution or authorizing document. Therefore, we do not
believe that utilizing the DRTF to make debt service payments, even if this action resulted in a
material change in the fund balance, would necessarily trigger a material event disclosure.
Finally, it is unclear from the documents provided by LADWP how “…any material changes to the
level of the funds and restrictions in the DRTF …could trigger …the potential for accrual of arbitrage
liabilities and other tax penalties.” The Letter leaves the impression that any material changes to the
level of funds in the DRTF would “trigger” an arbitrage or tax liability that would be out of the
ordinary course of business. From information provided by LADWP, the potential for arbitrage or
tax penalties already exists because the DRTF has been treated as “replacement proceeds” under
Treasury Regulation Section 1.148-1(c)(1) since the fund was first established. Arbitrage and tax
penalty calculations are accomplished as part of the normal course of making any distribution from
the DRTF. Therefore, the inference in the letter that “new” tax issues would be raised by a material
change to the level of funds in the DRTF is unsupported by the documents that have been provided.
24
Statement Three
“…the LADWP had planned to sell over the next 60 to 90 days…a total of $1.21
billion bond sales. In order to maintain an “AA” rating for the sale of the bonds, it
is imperative that the rating agencies, underwriters, and prospective bonds buyers
see a plan that provides for the solid funding of these bonds into the future. If
there is no bond sale by May 2010, cash levels are projected to drop below the
required amount.”
Background
The Power System has established a significant capital improvement plan for the next five years and
forward, mainly including investments to replace aging infrastructure and add new renewable
generation resources as part of the RPS. In order to fund these improvements, LADWP anticipated
selling $720 million in Power Revenue Bonds and $473 million in Southern California Public Power
Authority prepayment bonds between the date of the Letter (April 5, 2010) and roughly the end of
June 2010. The Letter states, “If there is no bond sale by May 2010, cash levels are projected to drop
below the required amount.”
Resources
Draft Preliminary Official Statement for the Department of Water and Power of the City of
Los Angeles Power System Revenue Bonds, 2010 Series A (Federally Taxable – Direct
Payment – Build America Bonds) and 2010 Series B.
LADWP’s FY 2010 Fiscal Year Financial Plan Presentation dated May 19, 2009.
Financial projections prepared by LADWP dated May 29, 2009.
LADWP’s Power System Presentation to Standard & Poor’s dated March 8, 2010.
Financial projections prepared by LADWP dated March 3, 2010.
LADWP.
LADWP.
Moody’s Rating Methodology Report for U.S. Public Power Electric Utilities dated April 2008.
Standard & Poor’s Electric Utility Ratings criteria report dated June 15, 2007.
Fitch’s Public Power Rating Guidelines dated June 11, 2009.
LADWP Cash Position as of March 31, 2010 prepared by LADWP Controller.
LADWP Cash Projections for FY 2010 prepared by LADWP Controller.
25
Analysis
In the Letter, LADWP identifies its plan to issue $1.21 billion in bonds “over the next 60 to 90 days”.
The $1.21 billion in bonds is composed of two parts, according to LADWP. The first part is the
issuance of $720 million in Power Revenue bonds and the remainder ($473 million) would be issued
as Southern California Public Power Authority (SCPPA) prepayment bonds. Based on a review of
the ratings letters, we would further breakdown these amounts into three categories. The first would
be a new money bond issuance of $616 million. This bond issue has been proposed as the 2010 Series
A Bonds. The second component would be up to $104 million in advance refunding bonds. These
bonds, 2010 Series B Bonds, would advance refund the Department of Water and Power of the City of
Los Angeles Power System Revenue Bonds, 2001 Series A, Subseries A-1 and the Department of
Water and Power of the City of Los Angeles Power System Revenue Bonds, 2003 Series B. According
to LADWP’s Draft Preliminary Official Statement for the 2010 Series A and 2010 Series B Bonds, the
2010 Series B Bonds will also generate new money project funds. The final portion of the $1.21 billion
in bond issuance would be the SCPPA Bonds as proposed.
We distinguish between these bond issues in such a manner for the following reasons. Of the $1.21
billion, less than $720 million is new money issued in the name of LADWP. A portion of the 2010
Series B Bonds are refunding bonds and therefore would supersede debt currently on the Power
System’s balance sheet. This is not to say that the AA rating is not important to the issuance of the
refunding bonds, but it helps to clarify the funding to be received by LADWP for new capital
improvements. The most recent rating agency actions, as summarized in the discussion for Statement
One, applied to both the 2010 Series A Bonds and the 2010 Series B Bonds.
The SCPPA prepayment bonds proposed to be issued would not be a direct obligation of the
LADWP. These bonds would be issued by SCPPA, not LADWP. While LADWP would make a
commitment as to its portion of the potential payment towards these bonds through its payments to
SCPPA for the services provided, these bonds (as with other SCPPA bonds issued prior) would not
show up on LADWP’s balance sheet. SCPPA receives its own credit rating when issuing bonds. It is
logical to consider that LADWP’s credit worthiness may be evaluated as a participant in this
transaction; however, LADWP’s rating would not be directly applied to this transaction.
As of the date of this report, the bonds identified above have been issued.
In discussing the issuance of $1.21 billion in bonds, LADWP indicates that the rating agencies,
underwriters and prospective bond buyers need to see a plan for solid funding of the bonds into the
future. This is certainly a true statement, as each stakeholder involved in the bond market for these
bonds would conduct an evaluation of the ability of LADWP to repay these bonds in the future.
Oftentimes, the ability to repay bonds into the future can be established through the preparation of a
consultant’s report or a parity report. Both reports would demonstrate that the LADWP has, based
on financial circumstances at the time of bond issuance, sufficient funds to pay both the bonds being
issued and all parity bonds. To do this, these reports would calculate a debt service coverage ratio on
all parity bonds. However, even as the LADWP may prepare or cause to be prepared one or both of
these reports, many times, the stakeholders will also conduct their own analysis and draw their own
conclusions.
This is particularly true in the case of the rating agencies. As detailed in the discussion for Statement
One, each rating agency has its own methodology for reviewing credit worthiness. These
methodologies focus on a wide range of criteria. While financial performance and a sound financial
26
plan are key factors in a credit rating, as discussed above, they are not the only factors and are
typically considered in the wider context of the issuer’s circumstances.
The last assertion made by LADWP in this statement is that its cash balances would drop below
required amounts if the bond sale did not occur by May 2010. In addition, LADWP did not provide
an indication in the Letter of the “required amount” being referred to in this statement. Based on
other statements made in the Letter, we assume that this amount may be the minimum target of $300
million in unrestricted cash balance, but this is not explicitly stated in the Letter.
To analyze this statement, we reviewed financial projections prepared by LADWP in March 2010 for
their rating agency presentations. These projections include actual data through the end of January
2010 and include an FY 2010 transfer to the City of the full amount of $220 million. In addition, these
projections include bond proceeds of $600 million. Based on these projections, LADWP was
estimating that the Revenue Fund would end FY 2010 with a cash balance of $746 million. This
scenario assumes an increase in revenue of $45 million due to the assumed increase in the ECAF cap.
As the ECAF cap had not been raised as of the date of the Letter, we have removed these additional
revenues. By removing the effect of these revenues, the year-end projection is assumed to drop to
roughly $701 million. This projected fund balance is more than double the Board’s minimum target
of $300 million. However, as mentioned above, this includes $600 million in bond proceeds.
To corroborate the projections, we received from LADWP its fund balances as of March 31, 2010. As
of this date, the Power Revenue Fund had a cash balance of over $744 million. In addition, we also
received a monthly cash flow projection for FY 2010. Based on this cash flow projection, LADWP is
estimating an ending fund balance of $385.7 million at the end of June 2010. However, as LADWP
points out, this assumes the issuance of bonds and the contribution of $300 million of bond proceeds
to a construction fund. This number is significantly different from what LADWP was predicting as of
the date of the Letter, as the projections used in the Letter assumed $600 million in bond sales.
Assuming the $600 million to be accurate, the projected ending balance would be $685 million, much
higher than the LADWP’s targeted fund balance.
LADWP has indicated that the proposed bond sales would reimburse expenditures within the Power
Revenue Fund, yielding the projected year-end balance. Neither the ratings presentation given to
Standard & Poor’s on March 8, 2010 nor the draft preliminary official statement for the 2010 Series A
and 2010 Series B Bonds indicate that bond proceeds would be used for reimbursements of
expenditures. LADWP indicated that it was necessary to fund capital improvements prior to the
issuance of the bonds because the bond sales could not be conducted prior to ECAF rate relief being
approved. This assertion is discussed further in Statement Four. In general, we question the
soundness of utilizing bond proceeds to reimburse expenditures in regards to the overall financial
plan of LADWP. While many jurisdictions allow for bond proceeds to be utilized for
reimbursements, these reimbursements are often associated with the professional services required to
plan the proposed capital improvements or to issue the bonds. This would normally not include
reimbursement for significant capital expenditures made prior to the issuance of the bonds.
Oftentimes, municipalities or their subsidiaries would not let contracts for or begin the construction of
significant capital improvements until the project funding is in place. This is done to ensure that the
entity will be able to fully fund the project prior to its initiation. By doing this, the entity can reduce
its risk associated with difficulties in securing financing.
LADWP’s approach could yield a situation in which bond financing cannot be obtained, thereby
creating a drain on fund balances that would need to be made up through other means, including the
27
possibility of rate increases. At the same time, this practice demonstrates disregard for LADWP’s
commitment to maintain an unrestricted cash balance of $300 million. Drawing down the cash
balance to fund significant capital expenditures without having the bond issuance in place could
result in LADWP dropping below their established minimum target. According to LADWP, this
draw on the cash balance could result in potential changes to their current AA rating, the
maintenance of which has been established as a core business objective. This is a particular risk to
LADWP as they have utilized their commitment to the fund balance as a positive influence on their
current ratings. According to Fitch, “Liquidity levels are healthy and following adoption of formal
financial policies in June 2009, LADWP no longer expects to draw down its unrestricted cash reserve
to fund its capital spending, mitigating Fitch’s previous credit concerns regarding liquidity.”
Conclusion
Given the significant capital improvement plan of the LADWP for FY 2010 and future years, we agree
that it is important for LADWP to have a sound financial plan. LADWP needs to be able to show that
it will be able to repay the bonds that it issues both in FY 2010 and going forward. However, we do
not agree that the financial plan alone would be the driving factor in maintaining LADWP’s current
credit ratings. As discussed in Statement One, credit rating agencies utilize many criteria in assigning
credit ratings and the financial plan would be only a component of this evaluation.
Utilizing LADWP’s budget projections and given their declaration that they are utilizing their Power
Revenue Fund balance to fund significant capital expenditures that will be reimbursed through the
proposed bond issuances, the fund balance of the Power Revenue Fund is projected to be rapidly
approaching LADWP’s minimum cash balance target as of the date of this Report. This can be
attributed to LADWP’s decision to fund significant capital expenditures prior to having actual project
funding in place through the bond issues. While LADWP had the money available as of March 31,
2010, to finance expenditures with cash on hand, this approach opens LADWP up to the risk that this
money would not be reimbursed if bond financing cannot be obtained, thereby yielding a permanent
drain on fund balances. This practice puts LADWP’s commitment to a minimum target balance and
their AA credit rating at risk. While we do not necessarily agree that the minimum required cash
balance is $300 million, as LADWP asserts or that the maintenance of this level of fund balance will
ensure the maintenance of the AA credit rating, LADWP has used their commitment to this fund
balance as a selling point in presenting to the rating agencies. By spending down the cash balance
without having the reimbursement in place, LADWP runs the risk of going against the commitments
they have made to the rating agencies, which could result in future ratings actions.
28
Statement Four
“LADWP stated at Committee that we expected to make the additional transfer of

$73.5 million. This statement was based on the assumption that the ECAF (Energy
Cost Adjustment Factor) increases needed…would be approved. This is
documented in our financial plan.”
Background
The Letter addressed the LADWP representative’s statement during the March 1, 2010 Budget and
Finance Committee meeting that the LADWP expected to make the additional $73.5 million transfer
in FY 2010. The Letter stated that “this statement was based on the assumption that the ECAF
increases needed, as confirmed by the independent review by PA Consulting Group, would be
approved.” LADWP indicates that the approval of the ECAF cap increases is documented in the
financial plan for the Power System.
Resources
Financial projections prepared by LADWP dated May 29, 2009.
LADWP’s Power System Presentation to Standard & Poor’s dated March 8, 2010.
Financial projections prepared by LADWP dated September 8, 2009.
LADWP.
LADWP.
LADWP’s Financial Services Organization Monthly Activity Report for February 2010.
Analysis
In order to get a complete picture of LADWP’s financial plan for FY 2010, we first analyzed LADWP’s
FY 2010 Financial Plan as presented on May 19, 2009. This presentation was made during the budget
process for FY 2010. In this presentation, LADWP includes a transfer to the City in the amount of
29
$232 million.2 The presentation indicates that the financials presented in the plan assume an increase
to the ECAF cap. At that time, the proposed increase was as follows:
If undercollection is greater than $200 million, increase the quarterly cap by $0.02 per kilowatt
hours.
If undercollection is greater than $400 million, increase quarterly cap by an additional $0.02
per kilowatt hour.
For the financial projections used in ratings presentations in March 2010, LADWP’s approach to the
ECAF cap increase had changed. For these presentations, LADWP assumed that the ECAF cap
would be raised to $0.008 per kilowatt hour effective April 1, 2010. In these projections, LADWP is
shown transferring $220 million to the City as a result of audit adjustments to FY 2009 revenues.
While these two financial projections have included proposed increases to the ECAF cap, LADWP has
also prepared additional financial scenarios which have not included proposed increases to the ECAF
cap. In a September 8, 2009, projection, LADWP assumed no change to the ECAF rate cap but a full
transfer to the City of $220 million. In this projection, the Power Revenue Fund is projected to end FY
2010 with a fund balance of $582 million. This scenario also included additional notes regarding the
credit rating being downgraded due to the $0.001 cap on ECAF increases, and accounted for an
increase in the cost of LADWP’s variable rate debt financing.
Conclusion
Based on the information provided, we agree that discussions regarding proposed increases to the
ECAF cap have been ongoing since before FY 2010 and that LADWP has included this in their
financial plan for FY 2010. However, LADWP did not provide documentation showing that it
informed Council prior to the Letter that the ECAF cap rate increase was required in order to make
the full surplus funds transfer. In addition, throughout FY 2010, LADWP also made projections
which assumed payment of the full transfer with no increase to the ECAF cap while still projected to
meet the Board’s commitment to a $300 million unrestricted cash balance. Because of this, we do not
agree that LADWP’s statement that the commitment made during the March 1, 2010, Budget and
Finance Committee meeting to transfer the remaining surplus amount of $73.5 million to the City was
made only under the assumption that the ECAF cap increase was approved. Throughout the year,
various projections had been run both with and without ECAF cap increases, but we have not seen
any projections which included less than a $220 million transfer to the City’s Reserve Fund. The
ECAF cap increase, therefore, does not appear to be assumed for the purposes of projecting the
transfer to the City.
While the statement being evaluated does not specifically address LADWP’s credit ratings, LADWP’s
assumptions regarding the ECAF cap increases have the potential to impact LADWP’s credit rating
going forward. In presenting its financial plan to rating agencies for the purposes of obtaining a credit
rating on the proposed 2010 Series A and 2010 Series B bonds, LADWP provided the rating agencies
with financial projections which included a $0.008 per kilowatt hour increase to the ECAF rate per
quarter. In light of the Council’s rejection of this proposal on March 31, 2010, we question the use of
2 The originally calculated amount prior to finalization of the FY 2009 audit.
30
proposed rate increases for the purposes of obtaining a credit rating. By utilizing assumed changes to
the ECAF cap to obtain a credit rating, LADWP has created an opportunity for the rating agencies to
further review LADWP’s credit and possibly take action on the credit ratings as the information on
which the AA credit ratings were obtained has not occurred as LADWP anticipated.
The additional revenue generated by increasing the ECAF rate by $0.008 per kilowatt hour for each
quarter going forward versus the revenue generated by an increase to the ECAF rate of $0.006 per
kilowatt hour in one quarter with subsequent increases limited to $0.001 per kilowatt hour would
clearly make significant changes to LADWP’s financial projections. This is particularly true as PA
Consulting identifies that the ECAF represented 39% of the total revenues in 2009 and that number is
projected to continue to increase. With the ECAF as such a large percentage of total revenues,
significant changes to the ECAF cap increase will have significant changes on the financial projections.
As the credit rating agencies based their ratings on projections that will not be realized, LADWP’s
credit rating is vulnerable to further review. As noted earlier, Fitch did withdraw its credit rating
issued on March 18, 2010, shortly after Council rejected the proposed ECAF cap increase and reissued
its rating after the ECAF cap increase issue had been resolved in April 2010.
In addition, we find the actual practice to contradict statements made by LADWP representatives
regarding postponing the proposed bond sales until the ECAF cap increase was in place. LADWP
stated, in a separate email on May 24, 2010, that “no bond sales could be conducted until LADWP
could report to the rating agencies what changes to the ECAF were approved to meet the 20%
renewable energy goal by 2010.” LADWP’s actions taken to obtain ratings in March of 2010 using
proposed ECAF cap increase projections and prior to official acceptance by the Council, do not agree
with these further statements made by LADWP. These additional comments by LADWP seem to
support our analysis and conclusions regarding the risk associated with presenting projections to
rating agencies.
Finally, we also point to the cash position of LADWP as of the end of March 2010. Based on the
projections provided, the cash balance in the Power Revenue Fund of over $744 million seems to be
ahead of projections. Even as of the end of February 2010, prior to the March 1, 2010 Budget and
Finance Committee meeting, the Power Revenue Fund had a cash balance of $720 million. Given
these cash balances, we disagree with the assumption that the ECAF cap increase would be necessary
in order to make the $73.5 million transfer. This assumption does not appear to be supported by the
financial condition of LADWP on the date this statement was made in the Budget and Finance
Committee meeting.
31
Statement Five
“Since rate relief has not occurred3, LADWP will be forced to use all funds to pay for energy
costs that should otherwise be fully recovered through the ECAF mechanism. There is no
surplus money to transfer at this time.”
Background
The Letter indicates that the Power System had an undercollection of $113.9 million in energy costs.
The Letter also discusses that the ECAF expenditures are increasing by $550 million over the FY 2010
to FY 2011 time period. LADWP believed that, after proper vetting, an increase to the ECAF rate cap
would be approved by Council, thereby providing some relief for FY 2010. Since, as of the date of the
Letter (April 5, 2010), the Council had rejected the proposal to increase the ECAF rate cap, LADWP
indicated that it would now “be forced to use all funds to pay for energy costs that should otherwise
be fully recovered through the ECAF mechanism.” Because of this, LADWP concluded that there
was no surplus money available to transfer at that time and that, “without increases, we have deficits,
not surplus.”
Resources
LADWP’s General Provisions regarding Electric Rates effective September 1, 2008.

The PA Consulting ECAF Report.
Financial projections prepared by LADWP dated September 8, 2009.
LADWP Energy Cost Adjustment Factor Modification Financial Impact of Council Motions
presentation dated March 31, 2010.
Analysis
In order to understand the implication of the ECAF cap to the financial condition of the Power
System, we first considered the various components of the ECAF. In particular, we focused on the
Energy Cost Adjustment (ECA) Account. The ECA Account is a recording mechanism for tracking
revenues and expenses associated with the ECAF. Each month, ECAF expenses are recorded into the
account as are ECAF collections. If, in a given month, ECAF revenues exceeded the ECAF expenses,
the ECA Account would show an overcollection of ECAF revenue. If, however, ECAF expenses
exceeded the ECAF revenue, then the ECA Account would show an undercollection. As of the end of
3 As of the date of the Letter.
32
FY 2009, the ECA Account was showing an undercollection of approximately $114 million, as
documented in the LADWP’s Letter.
As LADWP accumulates an undercollection in the ECA Account, the impact of this undercollection to
ratepayers is simply delayed. As PA Consulting explains in its ECAF Report, “Ultimately, customers
are responsible for paying the ECAF costs that accumulate in the undercollection balance. As this
undercollection accumulates, the Department is in essence loaning these funds to the customer to be
paid back at a later date when rate levels eventually catch up to and exceed cost levels.”
Since the May 19, 2009, presentation of the proposed financial plan for FY 2010, LADWP has been
showing significant increases in ECAF expenses over time. Table 5 below summarizes projected
ECAF expenses presented by the Board during the FY 2010 budget process.
TABLE 5 SOURCE: LADWP data

Fiscal Year 2009 2010 2011 2012 2013 2014
ECAF Expenses (Millions) $ 1,372 $ 1,670 $ 1,876 $ 1,948 $ 2,029 $ 2,106
Cumulative Increase from FY 2009 298 504 576 657 734
While these projections indicate a $500 million increase in ECAF expenses from FY 2009 to FY 2011, it
is reasonable to expect that these numbers were revised from May 19, 2009 to April 5, 2010, which
may account for the Letter’s assertion that ECAF expenses will increase by $550 million over that
same time period. To the extent that financial projections have been updated since May 2009, we
believe it is reasonable that ECAF expenses may increase by $550 million from FY 2009 to FY 2011.
In the letter, LADWP implies that because the ECAF cap increase was rejected by Council, LADWP
would now need to use “all funds” to pay these ECAF expenses. LADWP has not provided
documentation that would indicate why it is imperative that they address the ECAF expenses and
their undercollection so aggressively at this point in time.
We have identified a number of issues which contradict this statement. The first would be the
undercollection issues that LADWP has had over time. As of the end of FY 2008, LADWP had an
ECAF undercollection of $187 million. This dropped in FY 2009 to $114 million. Using LADWP’s FY
2010 budget projections from May 2009, in which they were assuming the two-tier ECAF cap increase
as discussed in Statement Four, LADWP was projecting an undercollection of $275 million at the end
of FY 2010. This undercollection continued throughout the projection period to 2014 when the
undercollection was projected to be $168 million. We therefore question the timing associated with
indicating that “all” funds would be needed to pay off the undercollection when LADWP has
historically had an undercollection and projected an undercollection under various ECAF cap
scenarios. Even assuming the $0.008 per kilowatt hour ECAF cap increase had been approved by
Council, according to the PA Consulting ECAF Report, it could take three to four quarters before the
undercollection is fully addressed. During that time, LADWP would still be carrying this deficit.
While the Council and the Board took several unsuccessful actions to increase the ECAF cap, it is
accurate to say that ECAF cap relief had not occurred as of the date of the Letter. We do not
believe, however, that the discussion could be considered closed at that point in time. Ten days
after the Letter, the Board adopted a resolution that was subsequently approved by the Council,
allowing LADWP to increase the ECAF rate by $0.006 per kilowatt hour effective July 1, 2010. After
the July 1, 2010 quarter, the ECAF rate will not revert back to its prior levels but LADWP’s ability to
increase the ECAF rate in future quarters will again be capped at $0.001 per kilowatt hour.
33
In analyzing LADWP’s statement that there is no surplus money available as of the time of the Letter,
we refer back to the September 8, 2009 financial projection which assumes that the $0.001 per kilowatt
hour ECAF cap remains in place. Under this scenario, LADWP is projected to have $582 million in
the Power Revenue Fund at the end of FY 2010. This includes an assumption that the full transfer
amount of $220 million is paid to the City. In this scenario, therefore, LADWP could offset all of the
projected ECAF undercollection of $260 million and still meet its financial target of a minimum
balance of $300 million in the Power Revenue Fund. In addition, the fund balance in the Power
Revenue Fund as of March 31, 2010 seems to indicate the LADWP may be ahead of its projections as
of the end of March, meaning LADWP would have even more access to funds, should it find it
necessary to pay down the ECAF undercollection immediately.
Finally, in evaluating the statement that no surplus funds were available as of the date of the Letter,
we also refer to our analysis in Statement Three. LADWP representatives have indicated that part of
the reason why surplus funds would not be available is because they had been funding capital
improvements since September 2009 as it was not possible to conduct bond sales prior to the ECAF
cap increase being approved. As discussed in Statement Three, it is generally risky to pay for
significant capital improvements anticipating reimbursement from bond proceeds if there is a
possibility that bond proceeds may not be received in a timely manner. To the extent that LADWP
implemented this practice, the suggested lack of surplus funds can be associated with LADWP’s
internal policies to spend down cash balances without regard for the Board’s targeted minimum cash
balance and generally accepted obligations such as the transfer to the City.
Conclusion
Based on the data and documentation obtained, we do not believe this to be an accurate statement.
We agree that it is important to be proactive in addressing the undercollection issue and believe the
subsequent adoption of a one-time increase to the ECAF cap to be a positive move in addressing this
situation. However, LADWP has not provided reasons why it must address the undercollection
immediately, either through a change in the ECAF cap or through payment of those expenses
through available cash. LADWP has had an issue with undercollection for a number of years and has
not addressed this situation in the past. In addition, even under the Board’s original March proposal
of an increase in the cap to $0.008 per kilowatt hour, it could take up to a year to fully address the
undercollection, meaning LADWP would still be carrying the burden of the undercollection for at
least another year.
Throughout the preparation of this Report, we have evaluated various financial projections prepared
by LADWP. Many of these projections included various assumptions regarding increases to the
ECAF cap. However, the one projection provided by LADWP which does not include an increase to
the ECAF cap still demonstrated that LADWP would have sufficient funds as of the end of FY 2010 to
pay down the ECAF undercollection and meet its minimum cash balance target of $300 million. This
indicates that even if the funds are diverted to fund the undercollection at this point in time, the Board
would not be in a deficit situation as stated by the LADWP.
While this discussion of the ECAF focuses on its ability generate revenue and correct undercollections
over time, we believe it is also important to highlight certain comments made by PA Consulting
regarding the current structure of the ECAF. These comments are as follows:
34
“The ECAF as currently constituted at LADWP contains several elements that typically would
not be found in a cost adjustment factor.”
“…the presence of so many elements into a single cost adjustment factor reduces transparency
into the cost drivers behind ECAF increases.”
“Under the current structure, commitments that are both predictable and within the
Department’s control can be passed through to ratepayers without review. While this may be
appropriate for market-based fuel and purchased power, major capital project commitments
represent strategic and not operation decisions.”
“The current ECAF design does not provide for adequate oversight and transparency into
long-term commitments made by the Department…”
These comments cause us to question what portion of the ECAF undercollection is due to the addition
of these atypical expenses for this type of factor. It appears that LADWP has driven up its ECAF
expenses, even as the ECAF rate has been capped during the same time period as these additional
expenses have been added to the calculation of the ECAF rate. LADWP has indicated that it would
be preparing proposals to reconstitute the ECAF in order to provide the Council with greater visibility
of the LADWP’s cost structure. While this will help with future expenses and transparency into long-
term commitments for capital projects, it does not address the current undercollection issue and how
much of this may be attributable to these atypical elements of the ECAF calculation.
35
APPENDIX A
Los Angeles Department of Water and Power’s April 5, 2010 Letter
A-1

Audit of Los Angeles Department of Water and Power

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Report on the Los Angeles

Department of Water and Power’s

June 10, 2010

STATEMENT TWO ........................................................................................................................................................................ 20

STATEMENT THREE ..................................................................................................................................................................... 25

STATEMENT FOUR ....................................................................................................................................................................... 29

APPENDIX A ......................................................................................................................................................... A-1

The following is a summary of our findings on each of the five statements.

1 As of the date of the Letter.

Surplus Funds Transfer

Energy Cost Adjustment Factor (ECAF)

“The Board…unanimously resolved to increase and set the Power System’s

Current Credit Ratings and Methodologies for Ratings

Strength: “Strong LADWP financial liquidity including maintenance of unrestricted debt

Moody’s Investors Service – Report released April 2008

2. Local Government Credit Characteristics

a. Degree of legal and financial relationship of utility with local government

3. Governance and Management

4. Financial Position and Performance

5. Debt and Capital Plan

a. Power supply and capital plan

6. Covenants and Legal Framework

Standard & Poor’s – Report released June 15, 2007

7. Legal Provisions of Retail Electric Systems

Fitch Ratings – Report released June 11, 2009

1. Management, governance and business strategy

Days Cash on Hand3 65 149 65 37 46 176 243 108

interest and amortization expenses.

and/or may include other funds into their calculation.

PA Consulting ECAF Report

Debt service coverage ratio of 2.25x

Unrestricted cash balance of $300 million

Capitalization ratio of no more than 60% debt

TABLE 2 SOURCE: PA Consulting ECAF Report

LADWP’s Calculation of Days Cash on Hand

TABLE 3 SOURCE: LADWP

Section 2 of the DRTF Resolution states that “Deposits to the Fund”:

“Parties Interested Herein. Nothing expressed or implied in this Agreement is intended

“Moody’s Investors Service: “Strong LADWP financial liquidity including maintenance

“LADWP stated at Committee that we expected to make the additional transfer of

2 The originally calculated amount prior to finalization of the FY 2009 audit.

LADWP’s General Provisions regarding Electric Rates effective September 1, 2008.

3 As of the date of the Letter.

TABLE 5 SOURCE: LADWP data

Los Angeles Department of Water and Power’s April 5, 2010 Letter

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