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TEXT-Fitch affirms Seguin, Texas utility A-plus revs
September 13, 2012 / 6:16 PM / 5 years ago

TEXT-Fitch affirms Seguin, Texas utility A-plus revs

Sept 13 - Fitch Ratings has affirmed the 'A+' rating on the city of Seguin, Texas' approximately $20 million of outstanding utility system revenue bonds. The Rating Outlook is Stable. SECURITY The bonds are secured by a first lien on the net revenues of the city's combined electric, water, and wastewater system. KEY RATING DRIVERS SMALL, COMBINED UTILITY SYSTEM: The city of Seguin owns and operates a combined electric distribution, water, and wastewater system serving approximately 8,200 customers in the growing San Antonio-New Braunfels region. Electric revenues compose about two-thirds of total operating revenues. LIMITED RISK PROFILE: Management terminated its wholesale power contract with the Lower Colorado River Authority (LCRA; revenue bonds rated 'A+', with a Stable Outlook by Fitch) on Sept. 13, 2012, nearly four years ahead of schedule. However, the utility will preserve its limited risk profile as a distribution-only electric provider; American Electric Power Company, Inc. (AEP) will replace LCRA as Seguin's wholesale provider for an interim period. STRONG FINANCIAL METRICS: Financial metrics are well above rating category medians. Debt service coverage has averaged more than 4.0x annually over the last five years, and coverage of full obligations has also been strong. Good cost recovery has helped build equity levels to over 70% of capitalization, and cash on hand has improved to 252 days in fiscal 2011. The utility does not make a transfer to the city's general fund. PASS-THROUGH RATES: A power cost recovery factor (PCRF) helps ensure the timely recapture of electric costs to preserve financial margins. The PCRF does not require city council approval. LIMITED CAPITAL NEEDS: Capital needs total a modest $40 million over the next five to 10 years, and water and wastewater treatment capacity is sufficient for the foreseeable future. Consequently, there are no plans to issue additional debt, which should benefit the utility's already strong balance sheet ratios. MIXED SERVICE TERRITORY: Electric sales have grown by a healthy average of 1.5% annually over 10 years, and unemployment rates remained within reasonable ranges during the recent economic recession. However, income levels are only about 80% of state averages, and the city's heavy manufacturing presence causes some customer concentration. The 10 largest electric customers represent an above average 28.1% of electric revenues. WHAT COULD TRIGGER A RATING ACTION LCRA CONTRACT DISPUTE: Unanticipated pressure resulting from the early termination of Seguin's wholesale power contract with LCRA could lead to negative rating action. However, the utility's strong financial position would provide some cushion against unexpected costs arising from the dispute. CREDIT PROFILE CONTRACT DISPUTE The city of Seguin's combined utility is a municipally owned, city council-governed system providing electric (62% of operating revenues), water (19%) and wastewater (12%) services to approximately 8,200 customers. The small system's all-requirements wholesale power contract with LCRA expires in June 2016. However, officials terminated the contract early on Sept. 13, 2012. Seguin contends that LCRA breached the contract by limiting its access to competitive wholesale power markets. The matter will likely be decided in court. Seguin has an interim, nine-month wholesale power contract in place with AEP (long-term Issuer Default Rating 'BBB', with a Stable Outlook by Fitch). A separate three-year contract will follow before the utility's new wholesale agreement with CPS Energy (revenue bonds rated 'AA+', with a Stable Outlook by Fitch) begins in June 2016 for a minimum of 7.5 years. The utility intends to remain as a low-risk, distribution electric provider by entering into a series of new all-requirements power contracts to replace LCRA. However, the consequences of terminating its LCRA contract early are unclear. While any resulting pressure would be a rating factor in Fitch's future reviews, Seguin's strong financial position would provide some cushion against unexpected costs arising from the dispute. STRONG FINANCIAL METRICS Seguin's financial metrics have been strong, with debt service coverage, equity, and liquidity ratios all exceeding rating category medians. Debt service coverage has averaged more than 4.0x annually over the past five fiscal years, including 5.4x in fiscal 2011. The distribution-only electric system's relatively modest capital and bonding needs have helped maintain strong coverage and equity levels. The ratio of equity to capitalization equaled a high 72.4% in fiscal 2011 versus the rating category median of 62.8%, and liquidity levels equaled nearly twice the rating category median of 139 days. The inclusion of off-balance sheet obligations for treated water supply from the Schertz-Seguin Local Government Corporation - a legally separate entity - has only minimally reduced Seguin's coverage of full obligations. The metric has remained above rating category medians at an average of 1.6x over the past five years. MIXED ECONOMIC INDICATORS Total system rates appear competitive with neighboring utilities, and unemployment rates remained within reasonable ranges during the recent economic recession. However, the city's income levels are only about 80% of state averages, which could ultimately limit management's practical ability to raise rates significantly. Seguin (general obligation bonds rated 'AA', with a Stable Outlook by Fitch) is located approximately 35 miles east of the city of San Antonio.

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