Fitch rates Austin, Texas’ $404m electric system revenue refunding bonds

NEW YORK–(BUSINESS WIRE)–Fitch Ratings has assigned an ‘AA-‘ rating to the following Austin, TX (the city) revenue bonds:

–Approximately $290 million electric utility system revenue refunding bonds, series 2012A; –Approximately $114 million electric utility system revenue refunding bonds, taxable series 2012B.

The bonds are expected to be sold via negotiation the week of Dec. 3. Proceeds from the sale will be used to retire outstanding commercial paper and refund outstanding electric utility system revenue bonds for cost savings.

In addition, Fitch affirms the following ratings on outstanding debt of the city:

–$70.7 million combined utility systems (prior first lien) revenue bonds; –$168.3 million combined utility systems (prior subordinate lien) revenue bonds; –$1.3 billion electric utility system revenue bonds.

The Rating Outlook is Stable.

SECURITY

The series 2012A and 2012B bonds are secured by net revenues of the Austin Electric (AE), after provision for the prior first lien obligations. The series 2012A and 2012B bonds are issued on a parity basis with the prior subordinate lien obligations and outstanding AE revenue bonds.

The prior first- and subordinate-lien obligations are secured by a joint and several pledge of the Austin water utility (AWU) and AE net revenues. Provision for the subordinate-lien obligations is made after the prior first-lien obligations. The master ordinance adopted in 2000 prohibits the issuance of additional bonds secured by a joint and several pledge of net revenues from both systems, which effectively closes the prior lien.

KEY RATING DRIVERS

LARGE REGIONAL UTILITY SERVICE PROVIDER: The rating on the city’s electric utility system reflects its role as a retail electric service provider to a large and important service area that includes the state capital as well as portions of Travis and Williamson Counties.

STRONG SERVICE TERRITORY: AE’s growing service area includes a deep and diverse economy, exceptionally low unemployment, above average wealth levels and a diversified customer base.

WEAKENED FINANCIALS EXPECTED TO IMPROVE: Operating margins weakened in recent years resulting in financial metrics below Fitch’s ‘AA-‘ rating category medians. However, solid growth in sales increased debt service coverage to a more acceptable 1.9x in fiscal 2011 and the recent implementation of a 7% base rate increase is expected to return AE’s financial position to a level more in line with rating category medians.

AFFORDABLE BUT RESTRICTIVE RATES: AE’s autonomous rate setting authority and competitive rates provide flexibility to raise additional revenues if needed. However, city council’s prolonged trend of holding rates steady demonstrates a reluctance to increase rates and offsets somewhat the benefits typically associated with low rates.

DIVERSE POWER SUPPLY: AE maintains a diverse power supply portfolio with a strategy to continue increasing renewable energy sources. Owned and purchased power resources provide the city with a reliable power supply sufficient to meet future needs.

MODERATE DEBT PROFILE: Leverage ratios, including debt to funds available for debt service (FADS) of 4.3x and equity to capitalization at nearly 55% in fiscal 2011, are in line with rating category medians. However, additional debt plans needed to support AE’s sizeable capital program will increase system leverage going forward.

WHAT COULD TRIGGER A RATING ACTION

INSUFFICIENT RATE SUPPORT: Any meaningful reluctance on the part of AE and its governing bodies to promote and approve rate increases necessary to achieve the utility’s financial plan would result in downward pressure on the rating or Outlook.

CREDIT PROFILE

WEAKENED METRICS EXPECTED TO REBOUND AE’s financial position weakened in fiscal years 2009 and 2010 before returning to a more acceptable level in fiscal 2011. Declines in both energy sales and interest income prompted coverage of all AE obligations, including debt service on prior first and subordinate lien obligations, to fall from over 2.0x historically to a subpar 1.8x and 1.6x in fiscal years 2009 and 2010 (AE targets a 2.0x debt service coverage ratio for electric utility bonds).

Financial metrics stabilized somewhat in fiscal 2011 as energy sales grew by a favorable 6% over the prior year. DSC improved to 1.9x as a result, although liquidity remained low with just 83 days cash on hand (DCOH). General fund transfers have averaged 8.4% of total operating revenues over the prior three years with little deviation. The transfers are limited to 12% of AE’s non-fuel revenue with a $105 million minimum transfer amount required each year.

Financial performance for fiscal 2012 is expected to remain relatively unchanged according to financial projections through the first nine months of the fiscal year. Fitch expects further improvement in AE’s financial position based on its financial forecast through fiscal 2017. Projections show DSC ramping back up to at least 2.0x by fiscal 2015 and DCOH growing to nearly 200 days by fiscal 2017. The forecast reflects the 7% rate increase adopted in fiscal 2013 and includes what Fitch believes are reasonable assumptions.

STRONG SERVICE TERRITORY AE serves a diverse customer base of approximately 424,300 customers in a service territory that includes the entire city as well as portions of surrounding Travis and Williamson Counties. Residential users compose nearly 90% of AE’s customer base but account for just 40% and 36% of total revenue and sales, respectively. Commercial and industrial customers together account for slightly more than half of total revenue and sales. No meaningful concentration exists among users as the top 15 customers accounted for a modest 19% of total system revenue in fiscal 2011.

The Austin economy continues to outperform that of many other large metro areas in the U.S. (Fitch rates the city’s general obligation bonds ‘AAA’ with a Stable Outlook). The city’s economy historically has been buffered by the large and stabilizing presence of state government as well as seven colleges and universities, including the University of Texas (the University of Texas System is rated ‘AAA’ by Fitch with a Stable Outlook), one of the largest public universities in the country.

The city’s population, estimated at roughly 811,000 for 2012, has increased more than 20% since 2000. Wealth indicators for the area are above average and the city’s September 2012 unemployment rate of 5% is exceptionally low relative to the state and national averages.

DIVERSE POWER SUPPLY AE’s power supply is well diversified, consisting primarily of two jointly owned coal units, a jointly owned nuclear facility, owned natural gas/oil units, and renewable projects (primarily wind) derived from purchased power contracts. Total resources are 3,148 megawatts (MW) versus fiscal 2011 peak demand of 2,710 MW. Owned generation provides the majority (78%) of AE’s total capacity.

Renewable purchased power contracts have increasingly been supplanting AE’s other sources of generation. The biggest contracts were signed in 2011 when the system entered into wind contracts for a combined 487 MW. Management expects the contracts to increase customer energy supply from renewable sources to 27% in fiscal 2013 from 10% in fiscal 2011. Longer term, Austin anticipates growing its renewable portfolio to ultimately achieve the utility’s goal of 35% of its total energy generation by 2020.

COMPETITIVE RATES TEMPERED BY POLITICAL RATE SETTING ENVIRONMENT In June 2012, city council approved a system average 7% rate increase effective Oct. 1, 2012 needed to address weakened operating margins. Fitch notes that while the rate hike will lead to a positive increase in annual revenue estimated at $71 million, the size of the rate increase was substantially scaled back compared to a previously anticipated 13%, or $126 million in additional revenue, considered by management over much of the prior year. Further, the increase in the base rates marked the first increase approved by city council since 1994.

Current rates, including an annual fuel adjustment, compare well to other large Texas cities and remain almost even with the statewide average. The average revenue/kWh was 9.70 cents in fiscal 2011, compared to the current statewide and national averages of 9.34 cents and 9.83 cents, respectively. Fitch believes the city council’s demonstrated reluctance to raise rates somewhat offsets the affordability of the system’s cost structure.

MANAGEABLE DEBT PROFILE AE’s debt levels are in line with rating category medians. Debt to FADS improved somewhat in fiscal 2011 to 4.3x and equity to capitalization has remained at nearly 55% over the last several years. AE’s capital program through fiscal 2017 totals $1.1 billion primarily for routine upgrades and general maintenance. Approximately 70% of the capital plan will be debt funded, which Fitch expects will lead to a sizeable but manageable increase in leverage. The current offering will restructure certain bond maturities coming due over the next several years in an effort to reduce debt service costs over the short term.