Fitch Rates Floresville's (TX) Electric System Junior Lien Revs 'AA-'; Outlook Negative

AUSTIN--()--Fitch Ratings has assigned an 'AA-' rating to the following Floresville Electric Light and Power System (FELPS) bonds:

--Approximately $1,955,000 junior lien revenue refunding bonds series 2014.

The 2014 bonds are expected to price on Oct. 2, 2014 via negotiated sale. Bond proceeds will refund outstanding senior lien, series 2002 bonds for level savings in order to provide relief from senior lien bond covenants. .

Fitch also affirms the 'AA-' rating on the following outstanding parity revenue bonds:

--$31.1 million improvement revenue bonds series 2002, 2005, 2009, 2011 and 2014.

The Rating Outlook is Negative.

SECURITY

The outstanding bonds are special obligations of the city of Floresville, secured by a junior lien on the net revenues of the electric light and power system. The junior lien is a newly created lien and includes the provision that a debt service reserve fund is only required to be funded if pledged revenues fall below 1.1x average debt service for two consecutive years.

KEY RATING DRIVERS

DECLINING DEBT SERVICE COVERAGE: The Negative Outlook reflects Fitch's concerns related to the declining trend in debt service coverage levels, largely as a result of increasing debt service costs. Fitch-calculated coverage declined from historical levels of nearly 3x to 1.95x in 2013. Forecasted additional debt issuance could drive all-in debt service coverage lower.

SMALL GROWING DISTRIBUTION SYSTEM: FELPS is a small distribution system owned by three cities. Load growth in the service area is healthy, averaging 2.3% over the past five years, partly driven by the Eagle Ford Shale exploration in east and south Texas.

LOW RISK POWER CONTRACT: FELPS has a limited operating risk profile in that it meets customer load demand with an all-requirements contract with San Antonio's City Public Service (CPS; rated 'AA+' with a Stable Outlook by Fitch) through 2020. Price adjustments permitted in the contract are limited and the embedded fuel cost is tied to the diversified fuel portfolio of CPS.

ADDITIONAL DEBT NEEDS: Despite its role as a distribution only system, the utility's debt burden has continued to increase. Increased revenue funding as a share of the capital plan is expected to occur over the next five years.

REVENUE STABILITY EXPECTED: FELPS' recent rate restructuring to generate more revenues through fixed charges, together with its purchased power pass-through mechanism, provide revenue stability in the event of weather-related demand fluctuations and alternative growth scenarios.

STRENGTHENING OF UTILITY PRACTICES: Management's recent review of various internal practices, the completion of a cost of service study and investment in software upgrades are all viewed positively. Financial policies are currently under review.

NO RATING DISTINCTION: Fitch rates the senior and junior lien bonds the same given the modest amount of junior lien debt and limited distinction between financial margins for each lien.

RATING SENSITIVITIES

FURTHER DECLINES IN COVERAGE: A further sustained decline in all-in debt service coverage below the current level is more consistent with Fitch's 'A+' metrics would likely result in a rating downgrade.

CREDIT PROFILE

FELPS is an electric distribution system located 30 miles southeast of San Antonio. The system serves 14,685 electric retail customers in a large 600-square-mile, fast-growing region of Texas that includes the cities of Floresville, Poth, Stockdale, Falls City, and La Vernia, as well as unincorporated portions of Wilson County. The service area is almost entirely exclusively served by FELPS with two very small portions that are dual-certified with another provider.

DECREASING DEBT SERVICE COVERAGE WITH ADDITIONAL DEBT ISSUANCE

While revenues and expenditures have exhibited stability, increased leverage and higher debt service costs following the issuance of the series 2011 bonds have led to lower debt service coverage. In fiscals 2013 and 2012 Fitch-calculated debt service coverage declined to 1.95x and 2.02x, respectively; levels below Fitch's median for the 'AA-' rating category (2.35x). Coverage was even lower at around 1.5x after the required earnings distributions to member cities. Prior to fiscal 2012, debt service coverage had consistently averaged 2.8x, or over 2.0x after earnings distributions.

Management's financial forecast indicates a possible further decline in debt service coverage in fiscals 2015 and 2016 with the increased debt service related to the series 2014 senior lien new money bonds. However, management is currently reviewing its financial policies and actual performance could be stronger. Assumptions included in management's financial forecast appear reasonable and include additional assumed revenues related to load growth of between 2.5% and 3.5% annually. This is slightly higher than the historical load growth average of 2.3% over the past five years but reflects current strong growth within FELPS' certified electric territory. The forecast includes a 2% rate increase implemented in August 2014 and assumed additional rate increases that coincide with planned debt issuance.

Cash levels in fiscal 2013 are higher and have improved as a result of some of the management initiatives discussed above, as well as the appropriation of construction funds. Funds on hand totaled 143 days at the end of fiscal 2013, but could be lower as appropriated funds are spent down.

ADDITIONAL DEBT EXPECTED TO FUND CAPITAL

Historically, management has targeted a 25% to 35% debt-to-capitalization ratio as its guideline for debt issuance. Debt-to-capitalization was 38% at the end of fiscal 2013 and will increase with the senior lien series 2014 bonds. Debt to funds available for debt service (Debt/FADS) was 5.5x in fiscal 2013, but is also expected to weaken to 7.9x in fiscal 2014. Fitch's median leverage ratio for the current rating category is 5.1x.

The level of projected debt issuance of around $9 million-$10 million every three years outpaces the amortization of existing debt of around $1.5 million annually. Debt levels are therefore expected to continue to increase, although the trend should be more moderate as management intends to increase revenue funding of capital to a level of 50%. This is in comparison to the historical practice of funding 75% of capital needs from debt. While growth in the system may require continued debt issuance, a share of the capital plan relates to the repair and reinvestment of the system.

LOW-RISK ALL-REQUIREMENTS POWER SUPPLY CONTRACT

Fitch views the all-requirements contract with CPS as a credit positive because of the stable and low-cost power supply CPS provides. Following an extension, the contract expires on Dec. 31, 2020. Contract provisions include limitations on price increases, a fuel cost factor which adjusts annually and an energy-only rate with no demand charge. The fuel rate charged by CPS to FELPs is a fleet-wide fuel rate based on CPS's diverse generation mix of coal-fired, nuclear, natural gas and renewable generation assets. CPS is well positioned to meet federal regulatory requirements regarding the Clean Air and Clean Water Acts.

IMPROVED UTILITY PRACTICES

Management has reviewed a number of its internal policies and practices over the past two years. Actions include completion of a cost of service study (last done in 1987), compensation review, pole attachment survey, enforcement of shut-offs for nonpayment, divestiture of the internet business line and the implementation of a fleet management program. Management is in the process of reviewing its financial policies. Fitch views these achievements as management best practices and the periodic review of policies and procedures is a positive credit factor.

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

Applicable Criteria and Related Research:

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

--'Revenue-Supported Rating Criteria'(June 12, 2013).

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:

U.S. Public Power Rating Criteria

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

Revenue-Supported Rating Criteria-Effective June 12, 2012 to June 3, 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=887974

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Contacts

Fitch Ratings
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Ryan Greene
Director
+1-212-908-0593
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Kathy Masterson
Senior Director
+1-512-215-3730
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Ryan Greene
Director
+1-212-908-0593
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com