Fitch Ratings has assigned an 'AA-' rating to the city of Garland, TX's subordinate lien electric utility system revenue refunding bonds, new series 2015. Proceeds of the bonds, which are scheduled to price via competitive sale on Jan. 20, 2015, will be used to refund outstanding electric utility system revenue bonds, series 2006.
In addition, Fitch has affirmed the following Garland bonds at 'AA-':
--$67.2 million of outstanding senior (prior) lien electric utility system revenue bonds, various series;
--$85.3 million of subordinate lien electric utility system revenue refunding bonds, series 2014.
The Rating Outlook is Stable.
SECURITY
The new series 2015 bonds are secured by a subordinate lien on the net revenues of Garland, TX's electric utility system, known as Garland Power & Light (GP&L).
KEY RATING DRIVERS
TEXAS RETAIL UTILITY: GP&L serves approximately 69,000 retail customers in a solid service territory located just outside the city of Dallas. The utility owns and operates various generating units, but its principal power source is the Texas Municipal Power Agency (TMPA; 'A+'/Outlook Stable).
ROBUST LIQUIDITY: A sizable rate mitigation fund (RMF) will enable GP&L to offset increased obligations to TMPA in fiscal years 2013-2018 with fewer rate increases. The RMF balance exceeded previous expectations, reaching a peak of $194 million in fiscal 2012 before declining to $175 million in fiscal 2013. GP&L retained 327 days cash on hand at the end of fiscal 2013.
PLANNED USE OF RESERVES: Projected cash flow and liquidity metrics remain satisfactory, despite significant draws on the RMF through fiscal 2018. The planned use of available cash is expected to reduce Fitch-calculated debt service coverage to below 1.0x for several years through fiscal 2018. However, rating concerns regarding the low coverage levels are offset to some degree by liquidity levels that are expected to remain sound and GP&L's other solid credit characteristics.
GOOD POWER SUPPLY: GP&L's 47% entitlement (220MW) in TMPA's coal-fired Gibbons Creek Steam Electric Station (GCSES) provides a sound baseload power supply currently requiring minimal environmental modifications. The utility's typically high (two-thirds) proportion of energy from the facility poses some degree of single-site generation risk.
FINANCIALS OFFSET WEAK LEGAL PROVISIONS: GP&L's sound financial profile offsets concerns about the otherwise weak legal provisions on the bonds that allow for a sum sufficient rate covenant, including transfers from the RMF, and require a debt service reserve fund only under certain conditions.
RATING SENSITIVITIES
WHOLESALE BUSINESS ADDS RISK: An expansion of GP&L's wholesale business, absent the appropriate controls, could weigh on the rating. GP&L currently manages wholesale market and credit risk by entering into purchase arrangements with established counterparties.
POSSIBLE PRIOR LIEN UPLIFT: A decreasing proportion of prior, closed lien debt and improving lien-specific metrics, coupled with the successful realization of GP&L's overall financial strategy, could cause Fitch to upgrade the lien in the next several years.
CREDIT PROFILE
Prudent long-term planning, favorable weather conditions in recent years, and the addition of wholesale sales as part of GP&L's business strategy have bolstered the utility's financial profile while rates have remained stable. Management's efforts to significantly increase cash balances over the past few years were driven by a strategy to effectively prefund a large portion of GP&L's increased financial obligation to TMPA (through fiscal 2018).
STRONG LIQUIDITY
GP&L's RMF provides the liquidity and flexibility to manage financial obligations through fiscal 2018 without significant rate increases. The RMF grew to a peak of $194 million in fiscal 2012, considerably higher than expected based on projections from 2011, before declining to $175 million in fiscal 2013.
The RMF was not used to support operations in fiscal 2014. Favorable weather conditions helped drive GP&L's financial outperformance compared to budgetary estimates, allowing GP&L to forego an anticipated $8 million transfer from the RMF. The fiscal 2015 budget includes the use of approximately $29.7 million from the RMF, leaving the fund with a projected ending balance of approximately $145.3 million.
ROBUST FINANCIAL RESULTS
Fiscal 2013 financial metrics reflect the first year of GP&L's augmented cash flows with draws on its RMF. Debt service coverage moderated to a still healthy 2.33x. Cash on hand likewise fell to 336 days from 647 days in fiscal 2012, reflecting both the significant increase in operating costs due to increased obligations to TMPA and the reduced cash levels at GP&L.
GP&L's average debt service coverage ratio over the past five years (3.9x) was nearly double Fitch's 'AA-' median (2.2x).
FORECAST METRICS REFLECT FINANCIAL STRATEGY
Fitch calculated financial metrics are projected to decline through fiscal 2018 but remain satisfactory for the rating given the utility's overall financial position and business strategy. Operating margins are expected to compress notably given the increased financial obligations and limited planned rate increases. Fitch calculated debt service coverage, which is not adjusted for transfers from the RMF, is expected to drop below 1.0x in fiscal 2015 and remain at similar levels through fiscal 2018. Draws from the RMF will offset weaker financial operations, reducing cash balances, as intended, over the next several years.
The projected decline in operating expenses in fiscal 2019 is expected to provide some financial relief and result in improved financial metrics. Fitch calculated debt service coverage averages 1.41x through fiscal 2023, with coverage levels increasing to more satisfactory levels post-fiscal 2018. These ratios include the next proposed issuance of debt in fiscal 2017 ($60 million).
RATING REFLECTS GP&L's ABILITY TO SERVICE DEBT
A large portion of the utility's outstanding debt carries a pledge of ad valorem revenues. However, in practice, debt related to the electric system is serviced by electric revenues. Consequently, Fitch measures the entity's ability to service the entirety of its financial obligations from the electric system's net revenues.
MAINTAINING STABLE ELECTRIC RATES
GP&L's existing retail rates are above the Texas average (114%). However, Fitch expects rates to become more competitive over time as rates are held relatively stable through 2023 and RMF balances are used to absorb the temporary increase in expenses related to TMPA.
GP&L's 10-year financial forecast calls for 1 cent/kWh, 0.8 cent/kWh, and 0.15 cent/kWh rate increases in fiscal years 2016, 2022, and 2023, respectively. Better than expected cash flows, principally from wholesale operations, have pushed out a fiscal 2018 rate increase that had been planned during Fitch's 2013 review of the utility.
WHOLESALE BENEFITS AND RISKS
GP&L's extensive wholesale sales should provide additional financial benefits, but present risks for the utility. Fiscal 2013 wholesale sales of nearly 1,800,000MWh rivaled GP&L's native load. Accordingly, its overall enterprise risk is now higher than for a comparable retail utility serving a retail base. Any measurable expansion of this business without commensurate controls could ultimately lead to negative rating pressure.
As a qualified scheduling entity within the ERCOT market, GP&L measurably increased its wholesale sales in fiscal 2013. The additional margins have enabled GP&L to limit planned draws from its RMF and maintain retail rate stability. Nevertheless, these wholesale operations require active management of counterparty credit risk and market risk.
GP&L provides contracted full- or partial-requirements service to seven municipal and distribution cooperatives for various terms through December 2021. Each customer contract has its own heat rate or fixed rate price, depending on the nature and term of the provided services. GP&L principally enters into bilateral contracts with highly rated suppliers marketers under industry standard master agreements, including EEIs and ISDAs, to cover its customers' requirements. In addition, its wholesale purchasers enjoy full rate-setting authority.
LARGE BASELOAD RESOURCE
GP&L's primary source of power is TMPA's 470MW GCSES, which typically supplies about two-thirds of its energy requirements. The utility rounds out its power supply with purchase power contracts and other owned, peaking facilities.
GCSES' historical operating metrics are in line with industry averages, and the facility has been a low cost resource for GP&L. Declining natural gas prices resulted in a 49% decrease in the unit's fiscal 2012 net generation. However, output rebounded in fiscal 2013 with a rise in natural gas prices. Moreover, GP&L estimates a healthy 80%-85% capacity factor going forward.
Additional information is available at 'www.fitchratings.com'.
This rating action was informed by information identified in Fitch's U.S. Public Power Rating Criteria and Revenue-Supported Rating Criteria.
Applicable Criteria and Related Research:
--'U.S. Public Power Rating Criteria' (March 18, 2014);
--'Fitch Affirms Texas Muni Power Agency Revs at 'A+'; Outlook Stable' (Sept. 27, 2013).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=964815
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