AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA+' rating to the following city of San Antonio, Texas' electric and gas systems junior lien revenue refunding bonds, issued on behalf of San Antonio City Public Service (CPS):
--Approximately $300 million, series 2014.
Bond proceeds will be used to refund outstanding senior lien bonds for level savings with no maturity extension. The bonds are expected to price on Sept. 23, 2014. The bonds are junior lien, on parity with $1.5 billion in outstanding junior lien obligations and subordinate to $3.8 billion in senior lien obligations, a portion of which will be refunded from bond proceeds. The junior lien bonds do not have a debt service reserve fund.
In addition, Fitch affirms the following outstanding CPS ratings:
--$3.86 billion senior lien obligations at 'AA+';
--$1.37 billion outstanding junior lien obligations at 'AA+' including series 2003 variable-rate bonds (underlying rating and bank bond rating), series 2010A and 2010B Build America Bonds, series 2012C and series 2013;
--$96 million in outstanding junior lien 2012A and 2012B term bonds at 'AA+/F1+';
--$360 million outstanding commercial paper (CP) notes at 'F1+' and a bank note rating of 'AA+' on each series.
The Rating Outlook is Stable.
Senior lien bonds are secured by net revenues of the combined electric and gas system. The junior lien bonds, including the series 2014 revenue refunding bonds, are secured by net revenues after the payment of debt service on the senior lien bonds. CP repayment is secured by a third lien on net revenues.
KEY RATING DRIVERS
COMBINED SYSTEM: The utility is a combined municipal utility that provides retail electric and natural gas services to the city of San Antonio. The service area continues to enjoy modest but consistent growth.
SOLID FINANCIAL PERFORMANCE: Financial margins have experienced some pressure in the past two years as a result of increased borrowing and delayed rate increases. However, financial margins remain healthy at over 2.0x debt service coverage, or 1.4x all-in coverage including all obligations and a large transfer made annually to the city's general fund.
STRONG POLICIES AND PLANNING: CPS exhibits strong management practices, including responsive, long-range financial and rate forecasting that reflects rapidly changing market conditions. Management sets rates to achieve a minimum of 1.5x all-in coverage.
COMPETITIVE RATES: Electric rates are low for the region. CPS offers the community highly competitive power prices. Both electric and gas rates have automatic adjustment mechanisms to recover fuel costs.
DIVERSE, LONG GENERATION PORTFOLIO: CPS enjoys a competitively priced and sufficient generation portfolio. In practice, CPS is usually in a long resource position, resulting in the need for some amount of wholesale sales to balance assets with demand. The long position is more pronounced following the acquisition of the Rio Nogales gas plant in fiscal 2013.
POWER SUPPLY CHANGES: CPS is in the process of reinvesting in its generation portfolio to include more renewable generation and to replace older coal-fired resources with lower emission gas-fired generation and energy efficiency programs.
MODERATE CAPITAL DEMANDS: The utility's debt burden and equity position are average relative to Fitch's median ratios. Additional capital needs in the range of $2.87 billion over the next five years are expected to fund primarily distribution system improvements and will require additional debt funding; debt levels and rate increases should remain manageable.
SHORT-TERM RATINGS: The 'F1+' rating on CPS' tax-exempt CP program is based on the long-term credit quality of CPS and internal liquidity support that exceeds Fitch's 1.25x threshold.
WEAKER FINANCIAL MARGINS: The rating and Stable Outlook reflect Fitch's expectation that financial margins will improve by fiscal 2015. Should financial margins decline further or remain consistently at lower levels, there could be pressure on the ratings.
CPS provided exclusive electric service to 749,454 primarily residential electric customers and to 332,457 primarily residential gas customers in fiscal 2014 (January 31 fiscal year). CPS is the sole supplier of electricity in its service area and is not subject to retail competition unless city council determines that CPS will opt into retail electric competition. CPS' customer base is large and diverse, and San Antonio continues to attract new industry to the CPS service area. CPS owns sufficient generation totaling 6,557 MW to serve its own native load with a system peak of 4,911 MW. Coal is still the predominant fuel type (42.3% of energy in 2014) but this is expected to decline in 2018 with the closure of its oldest coal plant.
STABLE RETAIL SERVICE AREA; INCREASING WHOLESALE ACTIVITY
Retail sales have been relatively flat with small fluctuations that are likely weather related. Even with continued customer growth in the service area, management expects retail sales growth to stay relatively modest at around 1.5% as a result of extensive investments in energy efficiency programs and industry-wide technology changes.
In addition to its retail customer base, CPS sells firm energy to a number of regional cities and cooperatives under fixed-price contracts with termination dates ranging from 2016 - 2023 and makes short-term economic energy sales within ERCOT.
Wholesale sales, including the firm contracts, have increased to 24%-28% of total sales since 2012, up from 13% - 15% previously, reflecting the long generation position of the utility. Fitch views the potential revenue fluctuation that may result from the short-term energy sales as a risk that should be manageable even though spot market prices in ERCOT have been soft in the past couple of years.
VERTICALLY INTEGRATED UTILITY; LONG POSITION
CPS owns and operates roughly 6,557 mega-watts (MW) of generating capacity. CPS' generation fleet includes the J.K. Spruce II unit, a 785 MW coal-fired unit brought on line in May 2010, and 192 MW of natural-gas peaking units that came on line in December 2010. More recently in April 2012, CPS purchased a 750 MW gas-fired combined cycle plant (Rio Nogales) that went into commercial operation in 2002.
The Rio Nogales plant capacity is intended to replace the 840 MW Deely coal-fired plant, once the Deely plant closes in 2018. CPS has decided to close the Deely plant by 2018, 15 years ahead of schedule, in lieu of spending an estimated $565 million to install scrubbers to bring it into compliance with potential new Environmental Protection Agency (EPA) emissions standards. In overall cost planning, the purchase price of the Rio Nogales plant replaced the anticipated cost of environmental improvements at Deely that would have likely been needed to maintain the plant. However, in the interim years until Deely's closure, CPS will take additional power supply risk, since the plant is in excess to its native demand.
COMPETITIVE RATES; SOME RATE PRESSURE
Rates are competitive, and regular rate increases historically have occurred approximately every two years. The last base-rate increase occurred in February 2014 at 4.25% for both the electric and gas system, which was slightly below the amount requested of 4.75%. Prior to 2014, the last rate increase had not occurred since 2010. While overall financial performance has been healthy since then, management's decision to forego rate action may also reflect some rate sensitivity in the service area, despite the utility's comparatively low rates. Both electric and gas rates have automatic fuel adjustment factors that help recover variable fuel costs in a timely manner.
STABLE FINANCIAL PERFORMANCE
CPS' financial performance has hovered in a consistently strong range for a number of years, with a slight decline in the past two years. The fiscal year end Jan. 31, 2014 generated Fitch-calculated annual debt service coverage of 2.17x on the revenue bonds and an all-in 1.44x coverage when general fund transfers are included. Management's financial projections anticipate financial margins to improve in fiscal 2015 with the rate increase. Management's financial policies include rate setting to a level that will achieve minimum all-in debt service coverage of 1.5x but management expects to exceed 1.6x based on the current forecast.
Unrestricted cash of $814 million in fiscal 2014 includes the repair and replacement fund. Liquidity remains healthy at 196 days cash on hand. Debt levels are above average at $7,642 debt per customer. Free cash flow after debt service and the city transfer is consistently only around 50% of annual depreciation. Reinvestment in the system is being funded primarily via debt, as well as new asset investment. CPS targets maintaining debt to equity below 65%.
MODERATE CAPITAL NEEDS AND DEBT PROFILE
CPS has invested heavily in generation over the past decade. CPS has identified approximately $2.87 billion of capital improvement projects that it will undertake over the next five years. The capital program shows a slight decline from annual spending levels in recent years but not a substantial difference. The capital plan is expected to be funded by $1.47 billion in additional debt.
Historically, the majority of the outstanding debt has been issued under the senior lien, totaling around $3.86 billion, including the bonds to be refunded. However, CPS will have $1.8 billion outstanding in junior-lien bonds following the issuance of the 2014 refunding bonds, most of which has been issued in the past five years. Both liens are open, but CPS has not used the senior lien since 2012. Fitch rates both liens the same given the high credit quality of the net revenue pledge, but the recent increase in junior-lien debt will create more of a distinction between the financial margins for each lien.
For additional information see Fitch's Report, 'San Antonio City Public Service, TX', dated June 3, 2014.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria' (June 2013);
--'U.S. Public Power Rating Criteria' (March 2014);
--'Rating U.S. Public Finance Short-Term Debt' (December 2013);
--'US Public Power Peer Study' (June 2014).
Applicable Criteria and Related Research:
Rating U.S. Public Finance Short-Term Debt
U.S. Public Power Peer Study -- June 2014
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria