AUSTIN--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the $27.9 million of utility system revenue bonds, series 2015, to be issued by the City of New Braunfels (the city) on behalf of New Braunfels Utilities (NBU). The bonds are scheduled to price Jan. 26, 2015 via negotiation.
In addition, Fitch affirms the 'AA' rating on the following bonds issued by the city on behalf of NBU:
--$$42.1 million utility system revenue bonds, series 2004, 2009, 2009A and 2012.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by net revenues of the combined utility system, inclusive of the electric, water and wastewater utilities.
KEY RATING DRIVERS
GROWING COMBINED UTILITY SYSTEM: NBU's combined utility system continues to exhibit stable operating performance providing electric (80% of operating revenue), water (10%), and wastewater (8%) services to the rapidly growing city and its surrounding area. Customers for all three utilities have increased by over 3% per year since 2008, emphasizing the strong growth experienced in the service area.
POWER SUPPLY MANAGEMENT RISK: The termination of NBU's long-term wholesale power agreement with the Lower Colorado River Authority (LCRA) in favor of a shorter-term actively managed portfolio approach exposes the utility to increased market price exposure and liquidity risks. Fitch expects that these risks will be sufficiently mitigated by a defined hedging strategy and the use of a monthly power cost recovery factor in electric rates.
EXPANSIVE WASTEWATER CAPITAL PLAN: NBU has a substantial five-year capital plan, with $125 million in new debt issuance (inclusive of this series 2015 issuance) anticipated in the next five years. Substantial investment is needed to expand NBU's wastewater treatment capacity.
STRONG BUT DECLINING METRICS: Strong combined cash flow, low leverage, and good liquidity support NBU's robust financial position, although debt service coverage levels will decline as the utility takes on additional debt. Given NBU's low leverage position, the additional debt should be manageable and remain acceptable for the current rating.
COMPETITIVE RATES: All of NBU's utility operations have competitive rates and considerable flexibility for future increases. Recently adopted wastewater rate increases should provide sufficient revenues to help support the debt issuance.
RATING SENSITIVITIES
POWER SUPPLY MANAGEMENT RISK: NBU's newly enacted power supply management strategy introduces contract renewal risks, counterparty exposure and the potential for large liquidity needs. While ERCOT energy and gas prices have been stable in recent years, market volatility could pressure financial margins, resulting in downward rating pressure.
FURTHER FINANCIAL MARGIN DECLINE: Strong financial margins and liquidity on a combined basis are expected, even after the anticipated debt issuances. Further declines in financial margins beyond those projected could put downward pressure on the rating, as they are needed to support NBU's increased power supply risk profile.
CREDIT PROFILE
New Braunfels (GO debt rated 'AA') is located in Comal County and is situated between the cities of Austin and San Antonio, approximately 30 miles from each. NBU provides retail electric, water, and wastewater service within and around the city. Net revenues of the combined system are pledged as payment to the bonds. The utility's electric service area is 169 square miles and currently serves approximately 33,975 electric customers. The water service area is 88 square miles and serves approximately 29,089 customers, while the wastewater system serves 22,885 customers.
INCREASED POWER SUPPLY MANAGEMENT RESPONSIBILITIES
The electric utility's wholesale power was historically supplied through a long-term contract with LCRA that was scheduled to expire on June 25, 2016. NBU terminated its wholesale power agreement with LCRA in January 2013, claiming that LCRA was in breach of the contract. NBU received a $20.5 million settlement from LCRA in December 2014. The board has not determined how to use the funds, but is reviewing various options and will come to a decision over the next six months.
NBU worked with outside consultants to design a new power supply strategy, which provides power supply through staggered, relatively short contracts with multiple investment grade counterparties. NBU prefers shorter contracts given the rapidly changing energy markets, uncertain regulatory requirements, and adequate capacity in ERCOT at present. Board policy permits management to execute power supply contracts up to three years in duration although current contracts extend no longer than about 18 months. Contracts longer than three years are permitted but require Board approval.
The strategy has provided cost savings compared to the LCRA agreement to date, but also increases risks related to commodity price movement, counterparty risk and potential liquidity needs for collateral posting. NBU's electric rates collect purchased power costs from customers in a timely manner through a monthly power cost adjustment factor, providing some revenue protection from purchased power cost fluctuations.
ADDITIONAL DEBT NEEDED TO FUND WASTEWATER CAPITAL
The overall five-year capital plan is estimated at $213.6 million, of which $125 million, or 59%, will be funded from debt, including this issuance. Given NBU's low debt position, strong combined operating results and growing service area, Fitch believes the utility can manage the increased debt service costs and higher debt levels with its planned rate increases at the wastewater system.
The wastewater system accounts for approximately $100 million of capital expenditures with the remaining balance relatively split between the electric and water systems. The capital plan includes expansion to the Gruene Wastewater Treatment Plant, continued renovations to both the North and South Kuehler treatment plants, and construction of the new Sam McKenzie Water Reclamation Facility.
DECREASING DEBT SERVICE COVERAGE WITH ADDITIONAL DEBT ISSUANCE
Financial performance has historically been strong, as illustrated by the combined utility system's Fitch-calculated debt service coverage (DSC) of 6.35x for fiscal 2014, versus Fitch's 'AA'-rated peer median DSC of 2.37x. Management's financial projections indicate that debt service coverage will decline to around 2.7x by fiscal 2018, not including growth-related impact fees, due to the increased debt service costs associated with the additional debt. NBU has been planning for the large-scale capital plan for a number of years. While the projected coverage levels are below NBU's historical financial target of 3.0x DSC, Fitch considers these projected combined coverage levels as providing strong support for bondholders. Management's assumptions in the financial forecast appear reasonable.
Liquidity is robust, with unrestricted cash and investments equal to 187 days cash on hand (DCOH) at the end of fiscal 2014. Unrestricted cash balances are expected to remain healthy.
Leverage is very low as measured by Debt/funds available for debt service (FADS) at 2.1x, given that the utility purchases its power and does not need to fund generation projects. With the system's anticipated debt funding, Debt/FADS is projected to increase to 4.1x, but remain below Fitch's 'AA' median of 5.6x Debt/FADS. NBU's practice of funding ongoing infrastructure replacement at a minimum rate of 1% of plant assets from rates and funding growth-related needs from developer contributions has helped keep debt levels low.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2014' (June 13, 2014);
--'U.S. Public Power Peer Study Addendum - June 2014' (June 13, 2014);
--'U.S. Public Power Rating Criteria' (March 18, 2014);
--'2014 Outlook: U.S. Public Power and Electric Cooperative Sector' (Dec. 12, 2013).
Applicable Criteria and Related Research:
U.S. Public Power Peer Study -- June 2014
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749789
U.S. Public Power Peer Study Addendum - June 2014
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750283
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841
2015 Outlook: U.S. Public Power and Electric Cooperative Sector (Steady as She Goes)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=831228
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=977935
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