AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the approximately $63 million of utility system revenue bonds, series 2016, to be issued by the City of New Braunfels (the city) on behalf of New Braunfels Utilities (NBU).
Bond proceeds will include approximately $48 million of new money to be used to fund a portion of the utility's capital plan. The remaining amounts will refund certain series 2009 and 2009A bonds for level savings and pay cost of issuance. The bonds are scheduled to price March 1, 2016 via negotiation.
In addition, Fitch affirms the 'AA' rating on the following parity bonds issued by the city on behalf of NBU:
--$67.4 million utility system revenue bonds, series 2004, 2009, 2009A, 2012 and 2015 (prior to refunding).
The Rating Outlook is Stable.
SECURITY
Bonds are payable from net revenues of the city's electric, water and wastewater utilities.
KEY RATING DRIVERS
GROWING COMBINED UTILITY SYSTEM: NBU continues to exhibit stable operating performance providing electric and transmission (83% of revenue), water (9%) and wastewater (10%) services to the rapidly growing city and its surrounding area. Customer growth in all three utilities is strong.
PUCHASED POWER SUPPLY: Power supply is provided through an actively managed portfolio approach, with most contracts shorter than three years. Short-term market price exposure and liquidity risks are mitigated by a defined hedging strategy, strong cash reserves and the use of a monthly power cost recovery factor in electric rates.
AMPLE WATER AND WASTEWATER CAPACITY: Water supplies and treatment capacity are robust and position the utility to meet future growth. Wastewater treatment plant investments in the next few years will position that utility similarly.
LARGE CAPITAL PLAN: NBU is moving into a period of large capital spending and debt issuance. Debt levels and rates have been low historically so NBU has the ability to absorb the additional costs necessary to serve a growing customer base.
STRONG FINANCIAL PROFILE: Strong combined cash flow, low leverage, and robust liquidity support NBU's strong financial profile, although debt service coverage levels will decline as the utility takes on additional debt. Given NBU's very high historical debt service coverage, the lower future levels, anticipated to remain above 2.0x, are expected to be acceptable for the rating.
RATING SENSITIVITIES
POWER SUPPLY MANAGEMENT RISK: New Braunfels Utility's 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 electric fund margins, as well the current rating if not managed properly.
FURTHER FINANCIAL MARGIN DECLINE: Strong financial margins and liquidity on a combined basis are expected, even after the anticipated debt issuances. Further sustained declines in financial margins beyond the projected 2.5x coverage in management's financial plan could put downward pressure on the rating.
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 35,455 customers. The water and wastewater service areas are more limited at 88 square miles and serve 31,415 and 24,034 customers, respectively. The electric system exhibits customer concentration with the largest ten customers accounting for 43% of energy sales and 36% of electric revenues in fiscal 2015.
INCREASED POWER SUPPLY MANAGEMENT RESPONSIBILITIES
NBU is a distribution electric system that historically received the majority of its power supply through a 1974 wholesale power agreement with LCRA. The agreement had an expiration date of June 25, 2016 but NBU ceased purchasing from LCRA in January 2013 in combination with a legal dispute regarding LCRA's alleged breach of contract. Litigation followed, and in 2014, NBU received a favorable verdict and a $20.5 million settlement from LCRA.
NBU's business strategy since January 2013 is to remain relatively short - term with its contracts, given the very favorable market energy prices within the Electric Reliability Council of Texas (ERCOT), rapidly changing energy markets, technology advancements, uncertain regulatory climate and adequate capacity in ERCOT at present. The strategy uses a series of short-term power purchase contracts, layered in at different times to create a hedge against real-time market price movement. The utility is 100% hedged for each upcoming month, based on expected loads and 90% hedged for peak periods in the summer of 2016. NBU targets being 75% hedged on a year-ahead basis.
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 revenue protection from purchased power cost fluctuations.
LARGE CAPITAL PLAN; INCREASING LEVERAGE
The overall five-year capital plan is estimated at approximately $250 million, of which $143 million, or 57%, will be funded from debt, including the series 2016 bonds. 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 approved rate increases. In 2015, City Council approved a 3% electric distribution rate increase in fiscal 2016, three annual 4.5% sewer rate increases in fiscals 2016-2018 and five 2.5% water rate increases in fiscals 2016-2020.
Leverage is currently low, as measured by debt to capitalization, which increased from 11.8% at the end of fiscal 2014 to 17.1% at the end of fiscal 2015. However, management expects this ratio to rise to around 33% after the large amount of debt issuance expected over the next three years. This is below the Board's financial policy target of debt to capitalization of no higher than 50%. A ratio of 33% debt to capitalization is below Fitch's sector average of around 45%. NBU's historical practice of funding ongoing infrastructure replacement at a minimum rate of 1% of plant assets from rates (just increased to 1.5% in 2016) and funding growth-related needs from developer contributions has helped keep debt levels low.
STRONG FINANCIAL PROFILE; DECREASING DEBT SERVICE COVERAGE
Financial performance has historically been very strong, as illustrated by the combined utility system's Fitch-calculated debt service coverage of over 5.0x for the past five years. After transfers to the city's general fund, coverage remained robust at over 4.0x. High coverage reflected strong margins, primarily at the electric utility, and a very low debt burden. With significant debt issuance planned, including the series 2016 bonds, debt service will rise over the next few years.
Management's financial projections indicate DSC will decline but remain above 2.5x in the final year of the five year financial forecast. While the projected coverage levels are shown to fall below NBU's historical financial policy target of 3.0x DSC, Fitch considers these projected combined coverage levels as continuing to provide sufficient support for bondholders at the current rating level. Management's assumptions in the financial forecast appear reasonable, although customer growth rates are assumed at levels slightly higher than historical levels.
Liquidity is robust, with unrestricted cash and investments typically above 180 days cash on hand (DCOH). Cash balances were higher in fiscal 2015 (265 DCOH) after the receipt of a $20 million settlement in December 2014 from the Lower Colorado River Authority. The Board approved the use of $5.2 million of the settlement money to fund approximately 50% of the cost of the electric system's advanced meter installation over the next five years and the use of $5 million to establish a fund from which the interest income will be used annually for customer assistance payments. The remaining amount will be retained in a designated power supply fund, to be used for trading liquidity and collateral posting, if needed. Unrestricted cash balances are expected to remain healthy.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Public Power Rating Criteria (pub. 18 May 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000004
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000004
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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