SAN FRANCISCO--()--Fitch Ratings affirms the 'A+' rating on the following bonds issued by city of Lubbock, TX's on behalf of its municipally-owned electric utility system known as Lubbock Power & Light (LP&L):
--$59.6 million electric light and power system revenue bonds, series 2010;
--$4.1 million electric light and power system revenue bonds, series 2001.
The Rating Outlook is Stable.
Bonds are secured by a pledge of net revenues from the electric system.
RETAIL ELECTRIC SYSTEM: Lubbock Power and Light LP&L is an integrated public utility that provides electricity to approximately 100,500 meters in Lubbock, Texas. LP&L is the largest (95% of total revenues) of the four members of West Texas Municipal Power Authority (WTMPA), a joint powers agency established to assist members in meeting their power supply needs.
UNCERTAIN FUTURE POWER SUPPLY: WTMPA supplies LP&L's power through an all-requirements wholesale contract with Xcel Energy. The all-requirements contract expires in 2019, leaving some uncertainty as to LP&L's future power supply and operating profile.
FINANCIAL METRICS DECLINE AS ANTICIPATED: LP&L's financial performance has remained relatively stable following the acquisition of its principal competitor in fiscal 2011. Acquisition related debt has reduced debt service coverage and equity as a percentage of capitalization below LP&L's historic levels as anticipated, but the metrics remain consistent with the rating.
POTENTIAL FUNDING REQUIREMENTS: LP&L's preliminary five year capital plan anticipates debt financing of up to $100 million through 2018, which could increase based on power supply decisions. While current borrowings amortize rapidly freeing up capacity for additional debt, planned issuance could significantly raise debt levels and pressure financial margins.
Competitive Rates: Electric rates remain very competitive, although rate flexibility may be somewhat limited as recent requests to raise rates were not approved by city council. Fitch views LP&L's ability to raise rates in a timely manner as important, particularly given the utility's debt issuance plans and relatively large capital needs.
Sound Service Area: Lubbock serves as the education and medical center for this largely agricultural area. Unemployment rate remains well below the state and national average and the region benefits from affordable housing and relatively stable home prices. Wealth levels as measured by median household income are below average, but have grown more quickly than the national average over the past two years.
WHAT COULD TRIGGER A RATING ACTION
Unwillingness to Raise Rates: A continued unwillingness on the part of LP&L or the city council to raise rates to preserve credit quality, particularly as capital expenditures and debt rise, could result in negative rating action.
LP&L is a fully integrated electric utility serving approximately 100,500 meters in Lubbock, Texas. Lubbock was largely a duel service area before LP&L's acquisition of its largest competitor, Southwestern Public Service Co. (SPS), in October 2010. LP&L remains in competition in two relatively small overlapping service areas (less than one square mile each) where LP&L does not have a significant presence. Fitch does not view the remaining competition as a significant credit concern as the overlapping services areas are defined, limited in geographical size and customer base, and of minimal importance to LP&L's operations.
FUTURE POWER SUPPLY
LP&L is the largest member of WTMPA, accounting for approximately 95% of WTMPA's revenues. WTMPA purchases power through a full-requirements wholesale power contract with Xcel Energy and sells power to LP&L and three other city systems. LP&L's future power supply is uncertain following the expiration of WTMPA's full-requirements contract with Xcel in 2019.
LP&L projects its June 2019 power needs at 720 MW based on estimates that are currently being updated. The net requirement is expected to be approximately 357 MW (approximately 50% of need) after including: (1) LP&L's owned generation with a dependable natural gas capacity of approximately 193 MW and, (2) 170 MW (plus 1.5% annually) contracted with Xcel as part of the SPS acquisition that begins in June 2019 and expires in 2044.
Supply needs are expected to be partially met through a 13 year contract (beginning 2019) between WTMPA and Elk City II Wind, LLC (a subsidiary of NextEra Energy Resources) for 100 MW of wind generation. WTMPA has submitted a study for the energy transmission to the Southwest Power Pool and expects to receive a decision in March.
ELECTRIC RATE STRATEGY
LP&L is currently undergoing a strategy shift in its electric rate setting process. Prior to the acquisition of SPS's distribution system, LP&L's strategy was to stay modestly below SPS's rates. Since the acquisition, the city council voted on three separate occasions (once in 2011 and twice in 2012) against approving rate increases recommended by the Electric Board. Instead, council requested and the Electric Board initiated a rate study that is expected to provide additional information regarding LP&L's revenue requirements. Management expects that rates will be increased following the study's completion and that future rates increases will be driven by LP&L's business need rather that matching changes initiated by competitors.
Recent financial performance has been below historical levels primarily due to the acquisition of SPS in October 2010. However, Fitch views the benefits of operating in a less competitive environment as outweighing the marginal reduction in financial metrics.
Debt service coverage was solid at 2.07x and 2.10x in fiscals 2011 and 2012 (unaudited). Liquidity levels declined primarily due to LP&L's cash equity contribution in the SPS acquisition ($20.8 million) and budgeted capital investments. Days cash on hand declined to 135 at the end of fiscal 2012, significantly lower than the ending balance of 293 days in fiscal 2010, but still comparable to the 'A+' medians for cash (134 days) and liquidity (139 days). LP&L plans on using an additional $7.3 million in cash in fiscal 2013; no additional draws are planned after fiscal 2013.
SIGNIFICANT CAPITAL PLAN
LP&L's five year CIP, estimated at $181.2 million, is significantly higher than the 2011 plan ($76.9 million). The increase reflects several factors: (1) the higher than expected capital costs associated with upgrading LP&L's distribution system in order to consolidate with the purchased SPS system; (2) overhauling gas resources; and (3) improving the transmission system to improve reliability.
The CIP reflects the issuance of approximately $100.6 million in revenue bonds, including $25 million planned for fiscal 2013. However, Fitch notes that LP&L's remaining debt issuance plans remain uncertain and will depend on future rate increases and power supply decisions.
STABLE SERVICE AREA
The city of Lubbock (rated AA+, with a Stable Outlook by Fitch) is located in northwest Texas. Lubbock has a stable economy that is based on agriculture, manufacturing and wholesale trade. Lubbock serves as the education and medical center for the area and is home to Texas Tech University (rated AA+, Stable by Fitch), which is both the largest employer in the City and the largest customer of LP&L. The top ten customers show less concentration following the acquisition of SPS, but still remain elevated at 21% of energy and 16% of revenues (29% of energy and 22% of revenues in fiscal 2010). However, this concentration is mitigated somewhat by the stability of the two largest customers (Texas Tech University and the City of Lubbock) that comprised 9% of energy and 7% of revenues in fiscal 2011.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria, this action was informed by information from CreditScope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'U.S. Public Power Rating Criteria' (Jan. 11, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
Revenue-Supported Rating Criteria