SAN FRANCISCO--(BUSINESS WIRE)-- Fitch Ratings downgrades the following ratings on Lower Colorado River Authority, TX's (LCRA) outstanding obligations:
--$1.6 billion revenue bonds to 'A' from 'A+';
--$175 million in authorized commercial paper notes, series A to 'F1' from 'F1+'.
The rating on LCRA's transmission revenue bonds is unaffected.
Fitch also has assigned an 'A' bank note rating to the LCRA's electric system revenue commercial paper notes, series B. The bank note rating reflects LCRA's parity repayment to the bank providing the liquidity facility, in the event of a draw on the facility to support the series B commercial paper notes.
The Rating Outlook on the long-term bonds is Stable.
Long-term bonds and commercial paper notes are secured by a gross revenue pledge of the LCRA system.
KEY RATING DRIVERS
DOWNGRADE REFLECTS REVENUE PRESSURE: The downgrade reflects near-term revenue pressure resulting from the decision by some customers to terminate their contracts early and cease purchasing power from LCRA as of Sept. 13, 2012 as well as longer-term changes to LCRA's overall customer profile.
MANAGEMENT TARGETS EXPENDITURE REDUCTIONS: Management expects to preserve financial margins through expenditure reductions and market energy sales. However the expenditure reductions needed are meaningful and come on top of cost reductions already implemented.
SHRINKING CUSTOMER BASE: LCRA's scheduled loss of ten of its wholesale generation customers in 2016 (nine of which are the subject of the contractual dispute noted above), and load release provisions in the 2041 contracts already had potential to place pressure on revenues. The unexpected loss of load in fiscal 2013 has accelerated the pressure.
ADEQUATE FINANCIAL MARGINS: Credit stability is supported by generation revenues that consistently provide 1.25x coverage of debt service, as permitted by the wholesale power agreements. Management expects this ratio to remain stable through cost reductions, recovery of some fixed costs through market energy sales, as well as potential rate increases, but maintaining stability could be a challenge.
GENERATION INVESTMENT INCREASING DEBT: LCRA is completing investments in two generation plants: its share of the Sandy Creek Energy Station and the Ferguson Replacement Project. Load loss described above will reduce LCRA's sales at a time when generating capacity and fixed costs are increasing, although some portion of costs can likely be recovered through market sales.
SHORT-TERM RATING: The 'F1' rating on LCRA's commercial paper program is based on LCRA's long-term rating and available liquid resources. Available resources include cash reserves and internal liquidity provided by a revolving credit agreement with JPMorgan Chase Bank that can only be used to repay the series A commercial paper notes.
The downgrade reflects the changes in LCRA's operating profile as a result of the contract terminations and the financial pressure associated with fewer billing units. Near-term pressures will result from the contract terminations, but longer-term pressures may arise from the load-release provisions in most of LCRA's remaining contracts.
While in time, LCRA may prevail in the legal cases with the seven customers that have terminated their contracts early, LCRA's energy sales going forward will undoubtedly be lower following the loss of approximately 37% of its load in 2016. Nearly half of this load (17%) has terminated early, and load release options for the remaining customers that may reduce purchases to 65% of their all requirements over the longer term.
Rating stability is expected to be provided by the 2041 wholesale power agreements that permit LCRA's full cost recovery and LCRA's efforts to reduce expenditures and maximize market sales, when economic, in order to offer competitive rates to its customers.
LOSS OF 17% OF GENERATION LOAD IN SEPTEMBER 2012
Seven customers ceased purchasing power from LCRA in mid-September 2012 despite LCRA's challenge of their right to do so. LCRA's request for a temporary restraining order was withdrawn, which would have prevented contract termination while the legal right of the customers to terminate was considered by the courts. The seven customers account for 17% of LCRA's general load, or $138.8 million in fuel and non-fuel revenues in fiscal 2012 (excluding GenTex 1). The contracts that were terminated early all have original termination dates of June 2016 and are court-validated. The seven customers include the City of Boerne, Central Texas Electric Cooperative, Fayette Electric Cooperative, the City of Georgetown, the City of Kerrville, San Bernard Electric Cooperative, and the City of Seguin.
The fundamental issue in question appears to be rate equity and whether LCRA's decision to offer a provision that allows customers to purchase a portion of their load from a provider other than LCRA to customers that have signed amended and restated wholesale power agreements through 2041 constitutes a breach of contract by LCRA. The terminating customers allege that it does, and that LCRA's breach of contract allows them to terminate the contracts early. LCRA does not believe it is in breach of contract. Four of the seven utilities rated by Fitch began purchasing power from other providers following the termination on September 13, 2012.
In addition to the seven, two other customers (Guadalupe Valley Electric Cooperative and the City of New Braunfels) have legal cases pending or have alleged breach of contract regarding the same issues and collectively account for another 19% of load. These customers have not provided notice to terminate to date although Guadalupe Valley has notified LCRA of its intent to do so if the issues are not resolved.
There are multiple lawsuits pending between LCRA and the customers noted above. Timing for resolution is uncertain given multiple venues and time involved in potential appeals.
LCRA TARGETS EXPENDITURE REDUCTIONS
LCRA has stopped purchasing energy on behalf of the seven customers that have provided notice of termination but continues to bill these customers for contract costs. LCRA plans to mitigate the net revenue loss from the early contract termination through further expenditure reductions and does not anticipate increasing its non-fuel rate to remaining generation customers. LCRA had committed in its 2013 - 2017 business plan, released prior to the contract terminations, to hold the non-fuel component of rates flat through fiscal 2017. Nevertheless, LCRA has the ability in its wholesale power agreements to increase rates with notice to customers and pass through costs, if necessary.
The fuel component of rates is adjusted as needed, with actual fuel costs. However, the expenditure reductions needed would come on top of those already implemented or targeted by the 2013 - 2017 business plan to reduce budgeted generation nonfuel O&M to $102.5 million in fiscal 2013 from $138.7 million in fiscal 2012. Some portion of the revenue loss will likely be recovered through market sales, depending on real-time market prices, or through potential rate increases to the remaining generation customers.
LOAD RELEASE PROVISIONS ARE RISK TO FUTURE REVENUES
One of the notable provisions in the 2041 contracts is the load release provision that allows customers to gradually adjust downward or upward the amount of load purchased from LCRA through annual stepped adjustments. A customer may notify LCRA of its intent to reduce load once every 12 months but the load reduction is not effective until 2 years after the notice. Any one-year decline in requirements cannot exceed 10% initially and then 5% per year thereafter to a minimum of 65% of that wholesale customer's full requirements. .
Multiple customers have already provided LCRA with an initial notification to release 10% of their load in the initial year and some for additional percentages in subsequent years. As these options are exercised by a number of customers, it could escalate the rate pressure associated from recovering fixed costs on fewer sales.
ADDITIONAL GENERATION INVESTMENT
LCRA has a mix of generation resources that provide 3,045 MW of net dependable capacity, with the largest resource being the Fayette Power project (a 1,035 MW coal-fired generation resource). Historically, the resource portfolio was supplemented with market purchases during brief periods of peak demand to meet overall load. Market purchases may be used less following the load loss.
Current generation investment includes 200 MW of new coal-fired capacity at the Sandy Creek plant and replacement of an older simple cycle natural gas unit, the Ferguson plant, with a new 540 MW combined cycle plant. The investments are being funded, in part, with debt issuance, which will increase LCRA's fixed costs over time.
SHORT-TERM RATING 'F1'
The commercial paper, series A notes were previously supported by a $250 million revolving credit facility provided by JPMorgan Chase Bank (rated 'A+/F1' and the rating is on Rating Watch Negative by Fitch). The revolving credit agreement is a dedicated facility that may only be used by LCRA to cover the payments on the notes if the notes are unable to be remarketed. The revolving credit agreement expires on May 19, 2014. However, in connection with LCRA's creation of its commercial paper, series B note program (supported by a direct-pay line of credit from State Street Bank), LCRA will reduce the amount of the revolving credit facility from JPMorgan Chase Bank to $175 million from $250 million. In addition to the revolving credit facility, LCRA had reserves of approximately $285 million in the revenue fund as of Aug. 31, 2012 that could be used to support the CP programs, if needed.
Additional information is available at www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria' (June 12, 2012);
--'U.S. Public Power Rating Criteria' (Jan. 11, 2012);
--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity' (June 15, 2012).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria
Criteria for Assigning Short-Term Ratings Based on Internal Liquidity
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Elizabeth Fogerty, +1 212-908-0526
Source: Fitch Ratings