Fitch Ratings has assigned a 'AA-' rating to the following bonds issued by the San Francisco Public Utilities Commission, CA (SFPUC) on behalf of the Power Enterprise.

Approximately $118.5 million power revenue bonds series 2023A.

In addition, Fitch has affirmed the following 'AA-' ratings:

$158.9 million power revenue bonds;

Up to $125 million CP notes (power series) series A-1 (bank bond);

Up to $125 million CP notes (power series) series A-2 (bank bond).

Fitch has assessed SFPUC's Power Enterprise's standalone credit profile (SCP) at 'aa-'. The SCP represents the credit profile of the Power Enterprise on a standalone basis irrespective of its relationship with and the credit quality of the city and county of San Francisco (Issuer Default Rating AA+/Stable).

The Rating Outlook is Stable.

Proceeds will be used to retire approximately $117.7 million in commercial paper (CP) notes used to finance a portion of the capital plan, fund capitalized interest through Nov. 1, 2025, and to fund costs of issuance. Bonds are expected to price during the week of Sept. 25, 2023 via negotiated sale.

RATING ACTIONS

Entity / Debt

Rating

Prior

San Francisco (City and County) Public Utilities Commission (CA)

San Francisco (City and County) Public Utilities Commission (CA) /Electric System Revenues/1 LT

LT

AA-

Affirmed

AA-

Page

of 1

VIEW ADDITIONAL RATING DETAILS

The affirmation of the 'AA-' ratings reflects the very strong financial profile of the Power Enterprise, factoring in sizable capex plans and debt issuance scheduled to occur over the next five years. System leverage, albeit higher, together with ongoing robust liquidity and adequate coverage levels should continue to remain consistent with the current rating, given the enterprise's strong revenue defensibility and low to midrange operating cost burden. Continued strong financial performance will depend heavily on planned rate increases.

The rating is constrained by the customer concentration in the SFPUC's unique service area. SFPUC provides service to certain customers within the city of San Francisco, and some degree of competition exists with Pacific Gas & Electric (BBB+/Stable) for new customer growth in the city. As a result, the customer base is highly concentrated with city-owned enterprises, such as the San Francisco International Airport, the San Francisco Municipal Transportation Agency, and the SFPUC Water Enterprise and the SFPUC Wastewater Enterprise, making up the largest customers.

Fitch's analysis also takes into account an asymmetric risk factor stemming from California's strict legal interpretation of inverse condemnation as it relates to wildfires. Approximately 28% of SFPUC's distribution transmission lines are located in areas that present elevated or extreme wildfire risk, as defined by the California Public Utility Commission Fire Threat Map, and the remaining 72% of the transmission lines are outside the High Fire Threat District. However, Fitch considers the likelihood of a massive wildfire event remote and the utility continues to take steps to reduce its overall wildfire risk through continued investment and power shut-offs during critical fire weather conditions.

SECURITY

The power revenue bonds are payable from the net revenues of the SFPUC's Power Enterprise. While the Hetch Hetchy Water and Power system is operated on a coordinated basis, bondholders are only secured by net revenues of the Power Enterprise. The bank bond rating reflects the pledge securing the commercial paper notes if they become bank bonds and are payable from a subordinate lien on the net revenues of the Power Enterprise.

KEY RATING DRIVERS

Revenue Defensibility - 'a'

Concentrated Customer Base

SFPUC's revenue defensibility is driven by the Power Enterprise's strong revenue source characteristics, including revenues derived largely by enterprise energy sales to municipal customers and city of San Francisco departments. The assessment is further supported by strong customer growth, very favorable demographic trends in San Francisco and very strong rate affordability, but it is constrained by significant customer concentration. The system's top 10 customers provided 62% (Fitch-calculated) of revenues in fiscal 2022.

Electric rates continue to experience annual increases needed to bring the majority of customers to a point where cost of service is recovered, and to fund large planned capital investments for the system. The most recent retail rate increase of 14% was implemented on July 1, 2023 and future annual rate increases ranging between 6% and 10% per year are expected over the next five years, as stated in the most recent 10-year financial plan adopted in February 2023. Additional rate restructuring occurred on July 1, 2023 that brought all customer classes towards a single tariff based on standardized cost of service rates, which ended the prior practice of setting rates at a differential to PG&E rates. SFPUC's highly competitive rates are expected to absorb the planned increases and rate flexibility should remain very strong.

Operating Risk - 'a'

Increased Operating Cost Burden and Capex Spending

Operating cost burden is considered low, but recent inflationary cost pressures have moved it to borderline midrange/low. The operating cost burden increased to 17.3 cents per kilowatt hour (kWh) in fiscal 2022, as calculated by Fitch, as sales remained low coming out of the pandemic and replacement power costs for low hydro conditions increased expenditures. Average operating costs over the last three years were 15.1 cents/kWh and with improved hydro conditions, the operating cost burden is expected to decline from 17.3 cents (Fitch-calculated operating cost burden).

SFPUC's resource portfolio is almost entirely comprised of hydroelectric generation, contributing to a weaker operating flexibility assessment due to a lack of resource diversity. However, this risk is offset by California's renewable and clean energy mandates and available market alternatives in the CAISO energy market.

Capital improvement spending is substantial with the most recent ten-year financial plan estimating $1.13 billion of the combined Hetch Hetchy Water and Power capex with $671 million to be allocated to the Power Enterprise over the next five years. The remaining $441 million will be allocated to the water system. Much of the infrastructure affects both systems. In cases where the infrastructure is shared, the power system pays 55% of the capex. The majority of the Power Enterprise's needs (83%) are expected to be debt financed.

Financial Profile - 'aa'

Very Strong Financial Profile; Anticipated Leverage Increase

The system's financial profile is supported by robust liquidity and variable financial margins dependent on weather and water conditions. Significant debt issuance expected over the next 10 years is projected to compress coverage and increase leverage, but Fitch expects the financial profile to remain at the 'aa' assessment. Rate increases are needed to keep pace with debt-funded capex and to preserve the 'aa' financial profile assessment, while SFPUC plans to use fund balances to help meet higher costs through fiscal 2025 or 2026.

Fitch expects SFPUC's leverage ratio, measured as net adjusted debt-to-adjusted funds available for debt service (FADS), to spike above 6x over the next two or three years, before returning to below 6x by fiscal 2027 as rate increases begin to achieve full cost recovery.

Asymmetric Additional Risk Considerations

Wildfire Risk in California: The potential scope of wildfire liability that could be faced by California utilities poses an asymmetric additional risk to credit quality since the financial liability could occur even in the absence of negligence on the part of the utility. However, the likelihood of a massive wildfire event is considered remote and the utility continues to take steps to reduce its overall wildfire risk. The asymmetric risk does not currently constrain the rating.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Sustained leverage above 6x in Fitch's base and stress scenarios;

Failure to implement timely rate increases in support of bringing all customers to full cost recovery and to support the capital program;

Extraordinary wildfire liability that results in long-term dilution of SFPUC's financial profile.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade in the near term is considered unlikely given the level of customer concentration as well as the significant debt-financed capex plans.

PROFILE

Hetch Hetchy Water and Power is a department of the SFPUC that operates the collection and conveyance of approximately 85% of SFPUC's water supply and the generation and transmission of electricity by hydroelectric plants located along the water conveyance system. The water and power operations within Hetch Hetchy Water and Power are accounted for separately, although the systems are jointly operated and share various assets. Fitch's analysis is based on the Power Enterprise fund, which is the sole source of pledged funds to bondholders.

The Power Enterprise provides hydroelectric, solar, and other power, serving city municipal customers, the Modesto Irrigation District and the Turlock Irrigation District, as well as other public agencies and retail customers. SFPUC provides approximately 19% of electricity consumed in San Francisco, with the remaining parts of the city and county served primarily by CleanPowerSF, the city's Community Choice Aggregator (CCA) at 58%, and Direct Access providers and by Pacific Gas & Electric serving the remaining. Federal law also requires SFPUC to make any excess power available to Modesto Irrigation District, CA and Turlock Irrigation District, CA at cost. Sales to these two entities and excess market sales exhibit a high degree of variability, and revenues are dependent on price and water supply availability.

Fitch considers the SFPUC Power Enterprise a related entity of the city and county of San Francisco (AA+/Stable) for rating purposes, given the dependent relation on the host government. The rating on the power system bonds is not constrained by the credit quality of the city and county of San Francisco. However, as a result of being a related entity, the rating on the power system bonds could become constrained in the event of a material decline in the credit quality of the city and county.

Sources of Information

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The ESG Relevance Score of '2' for GHG Emissions & Air Quality for San Francisco Public Utility Commission varies from the public power sector guidance score of '3' since carbon-free systems (hydro, wind, nuclear, biomass and biowaste, geothermal) are not significantly exposed to the generation of GHG emissions from operations.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.

Additional information is available on www.fitchratings.com

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