Fitch Rates Garland, TX's 2014 Electric Revs 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'AA-' rating to the city of Garland, TX's electric utility system revenue refunding bonds, new series 2014. Proceeds of the bonds, which are scheduled to price via negotiation on May 19, 2014, will be used to redeem GP&L's outstanding commercial paper (CP) notes.

In addition, Fitch has affirmed the 'AA-' ratings on Garland's $85.2 million of outstanding senior (prior) lien electric utility system revenue bonds, various series, and $135 million of subordinate lien electric utility system commercial paper (CP) bank notes, series 2012A and 2012B.

The current offering of subordinate lien bonds will close the prior lien and terminate the existing CP program.

The Rating Outlook is Stable.

SECURITY

The new series 2014 bonds are secured by a subordinate lien on the net revenues of Garland, TX's electric utility system, known as Garland Power & Light (GP&L).

KEY RATING DRIVERS

Texas Retail Utility: GP&L serves approximately 69,000 retail customers in a strong service territory located just outside the city of Dallas. The utility owns and operates various generating units, but its principal power source is the Texas Municipal Power Agency (TMPA; rated 'A+'/Stable by Fitch).

Robust Liquidity: Its sizable rate mitigation fund (RMF) enables GP&L to offset increased obligations to TMPA in fiscal years 2013 - 2018 with minimal rate increases, which preserves the utility's future revenue-raising flexibility. The RMF balance grew ahead of schedule to a peak of $194 million in fiscal 2012 versus far more modest expectations during Fitch's prior ratings.

Financial Strategy in MOTION: GP&L's forecast cash flow and liquidity metrics remain satisfactory, if not below Fitch's 'AA-' rating category medians. A decline in Fitch-calculated debt service coverage ratios beginning in fiscal 2013 (2.3x) reflects GP&L's financial strategy of augmenting cash flows with draws on its RMF. Nevertheless, forecast coverage, including RMF transfers, averages over 2.0x.

Good Power Supply: GP&L's 47% entitlement (220MW) in TMPA's coal-fired Gibbons Creek Steam Electric Station (GCSES) provides a sound baseload power supply currently requiring minimal environmental modifications. The utility's typically high (two-thirds) proportion of energy from the facility poses some degree of single-site generation risk.

Financials Offset Weak Legal Provisions: Healthy financial results offset concerns about the otherwise weak legal provisions on the bonds that allow for a sum sufficient rate covenant, including transfers from the RMF, and require a debt service reserve fund only under certain conditions.

RATING SENSITIVITIES

Strong Planning Supports Stability: GP&L's strong planning for increased fixed cost obligations through fiscal 2018 should continue to support its financial and rating stability.

Wholesale Business Adds Risk: An expansion of GP&L's wholesale business, absent the appropriate controls, could weigh on the rating. GP&L currently manages wholesale market and credit risk by entering into purchase arrangements with established counterparties.

Possible Prior Lien Uplift: A decreasing proportion of prior, closed lien debt and improving lien-specific metrics, coupled with the successful realization of GP&L's overall financial strategy, could cause Fitch to upgrade the lien in the next several years.

CREDIT PROFILE

Proactive planning has enabled GP&L to maintain a healthy financial position, as well as historical and forecast rate stability. The utility's overall strategy has been to effectively prefund a large portion of its increased financial obligations to TMPA through fiscal 2018 by increasing reserves over a number of years.

The expansion of its wholesale business presents additional financial benefits, as well as accompanying challenges.

STRONG LIQUIDITY

GP&L's outsized RMF provides exceptional liquidity and flexibility to manage financial obligations through fiscal 2018 while preserving rate-raising flexibility. The RMF grew to a peak of $194 million in fiscal 2012, which is considerably higher than early projections in 2011. Moreover, planned draws totaling $164 million are well below the $191 million forecast as recently as last year. Additional margins from contracted wholesale sales have contributed to stronger RMF balances.

The utility is entering a period of increased demand charges to TMPA. This follows a two-year reprieve in fiscal years 2011-2012 resulting from the refinancing of certain TMPA generation debt that allowed GP&L to continue building its RMF. GP&L's total obligations fall slightly below historical norms after TMPA's currently remaining power supply bonds fully mature in fiscal 2018.

ROBUST FINANCIAL RESULTS

Fiscal 2013 financial metrics reflect the first year of GP&L's augmented cash flows with draws on its RMF. Debt service coverage moderated to still healthy levels (2.3x), as expected. Cash on hand likewise fell to 336 days from 647 days in fiscal 2012.

GP&L's average debt service coverage ratio over the past five years (3.9x) was nearly double Fitch's 'AA-' median (2.2x).

FORECAST METRICS REFLECT FINANCIAL STRATEGY

Forecast coverage ratios decline but remain satisfactory, given the utility's overall financial strategy. Drawing on the RMF will naturally limit the high operating margins and debt service coverage ratios that GP&L has produced to generate additional cash flows in recent years.

By Fitch's calculations, GP&L's coverage of total debt service averages 2.2x through fiscal 2022, including transfers from the RMF. Excluding the transfers, coverage averages 1.5x. These ratios include the next proposed issuance of debt in fiscal 2017 ($60 million).

A large portion of the utility's outstanding debt carries a pledge of ad valorem revenues. However, in practice, debt related to the electric system is serviced by electric revenues. Consequently, Fitch measures the entity's ability to service the entirety of its financial obligations from the electric system's net revenues.

PRESERVING RATE FLEXIBILITY

GP&L's rates should ultimately become more competitive over time. Its RMF causes limited rate action through the fiscal 2022 forecast period, and GCSES provides a low-cost source of power. Existing retail rates are above the Texas average (114%).

GP&L's 10-year financial forecast calls for 1 cent/kWh and 0.15 cent/kWh rate increases in fiscal years 2016 and 2022, respectively. Better than expected cash flows principally from wholesale operations have pushed out a fiscal 2018 rate increase that had been planned during Fitch's 2013 review of the utility.

WHOLESALE BENEFITS AND RISKS

GP&L's extensive wholesale sales should provide additional benefit, but they present their own risks. The utility's nearly 1,800,000MWh of fiscal 2013 wholesale sales rivaled its native load. Accordingly, its overall enterprise risk is now higher than for a comparable retail utility serving a retail base. Any measurable expansion of this business without commensurate controls could ultimately lead to negative rating pressure.

As a qualified scheduling entity within the ERCOT market, GP&L's measurably increased its wholesale sales in fiscal 2013. The additional margins have enabled GP&L to limit planned draws from its RMF and maintain retail rate stability. Nevertheless, these wholesale operations require active management of counterparty credit risk and market risk.

GP&L provides contracted full- or partial-requirements service to nine municipal and distribution cooperatives for various terms through December 2021. Each customer contract has its own heat rate or fixed rate price, depending on the nature and term of the provided services. GP&L principally enters into bilateral contracts with highly rated suppliers marketers under industry standard master agreements, including EEIs and ISDAs, to cover its customers' requirements. In addition, its wholesale purchasers enjoy full rate-setting authority.

LARGE BASELOAD RESOURCE

GP&L's primary source of power is TMPA's 470MW GCSES, which typically supplies about two-thirds of its energy requirements. The utility rounds out its power supply with purchase power contracts and other owned, peaking facilities.

GCSES' historical operating metrics are in line with industry averages, and the facility has been a low cost resource for GP&L. Declining natural gas prices resulted in a 49% decrease in the unit's fiscal 2012 net generation. However, output rebounded in fiscal 2013 with a rise in natural gas prices. Moreover, GP&L estimates a healthy 80%-85% capacity factor going forward.

Additional information is available at 'www.fitchratings.com'.

This rating action was informed by information identified in Fitch's U.S. Public Power Rating Criteria and Revenue-Supported Rating Criteria.

Applicable Criteria and Related Research:

--'Fitch Rates Garland, TX's Water & Sewer New Lien Revs and Rfdg Bonds at 'AA+'; Outlook Remains Negative' (May 9, 2014);

--'U.S. Public Power Rating Criteria' (March 18, 2014);

--'U.S. Public Power Peer Study Addendum - February 2014' (Feb. 7, 2014);

--'Fitch Rates Garland, Texas' 2014 GO Rfdg Bonds 'AAA'; Outlook Stable' (Jan. 13, 2014);

--'Fitch Affirms Texas Muni Power Agency Revs at 'A+'; Outlook Stable' (Sept. 27, 2013).

Applicable Criteria and Related Research:

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841

U.S. Public Power Peer Study Addendum -- February 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735601

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829492

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Contacts

Fitch Ratings
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Matthew Reilly
Director
+1-415-732-7522
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Matthew Reilly
Director
+1-415-732-7522
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com