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Rating Action:

Moody's assigns Aa2 rating to San Antonio (CPS Energy) TX Combined Utility Enterprise's junior lien revenue bonds and assigns P-1 rating to CPS Energy's Taxable commercial paper notes; outlook negative

16 Mar 2021

New York, March 16, 2021 -- Moody's Investors Service has assigned a Aa2 rating to City of San Antonio, TX Combined Utility Enterprise's (CPS Energy) proposed issuance of $367.4 million in Electric and Gas Systems Junior Lien Revenue Refunding Bonds, Series 2021A. Moody's has also assigned a P-1 short-term credit rating to CPS Energy's Electric and Gas Systems Commercial Paper (CP) Notes, Series A,B and C (Taxable). Concurrent with this rating action, Moody's affirms the P-1 rating on the outstanding Tax-Exempt CP Notes, Series A, B, and C. The outlook is negative.

On March 8, 2021, Moody's revised the outlook to negative from stable, while also affirming the Aa1 rating on outstanding senior lien debt obligations and the Aa2 rating on outstanding junior lien obligations for CPS Energy. Please visit https://www.moodys.com/research/--PR_907025381 for more detail on this rating action.

RATINGS RATIONALE

The Aa2 junior lien rating considers the subordinate pledge relative to the security on the senior lien obligations, currently rated at Aa1, and considers CPS Energy's various strengths including: the utility's broad and growing service area economy; supportive self-regulation on electric and gas rates and sound environmental policies; competitive retail rates despite a high General Fund transfer requirement; a competitive, reliable and diverse power supply; conservative financial record including strong liquidity; and the sound debt structure and risk management program.

The P-1 rating on the CP reflects CPS Energy's strong internal liquidity position, as demonstrated by 348 days of operating cash on hand as of January 31, 2020 and over 3.5x coverage of maximum expected CP outstanding with readily available funds. The P-1 rating also considers CPS Energy's disciplined financial management, the Aa1 rating for its long-term senior debt obligations, and the additional support provided by CPS's Energy's existing $700 million in credit facilities.

On March 8, 2021, Moody's revised the outlook on CPS Energy's senior and junior obligations to negative from stable due to the significant uncertainty surrounding the ultimate costs to be incurred by the utility as a result of the elevated natural gas costs for its distribution system and power costs incurred as a result of the winter storm and frigid temperatures in Texas during the week of February 14th. On March 13th, CPS Energy updated its estimated costs of natural gas and power costs to $670 million and $365 million respectively, still totaling just over $1 billion as previously estimated, which are above CPS Energy's annual fuel costs for a typical year. The natural gas costs which had been previously estimated to be in the range of $675-$850 million, were revised downwards to reflect the reconciliation of gas volumes not delivered. Purchased power costs were revised upward to $365 million from the previously estimated $175 million to $250 million range accounting for incurred and projected short payments from ERCOT. CPS Energy currently estimates it has been short paid $18 million by ERCOT. Please https://www.moodys.com/research/--PR_907025381 to learn more about the previous rating action and the impacts of the Texas weather event on CPS Energy. We consider the weather events in Texas as an environmental and social risk under our ESG framework, given customers throughout the state had intermittent, and in some cases, lost access to basic services such as electricity, water or heat during the winter storm.

CPS Energy has settled all of its payments with the Electric Reliability Council of Texas, Inc. (ERCOT, A1 negative) and has sufficient liquidity to meet all of its obligations associated with natural gas fuel purchases coming due on or about March 25, 2021. CPS Energy saw natural gas purchases trade above $100/MMBtu (which typically trades between $2-$4/MMBtu), and in some cases $500/MMBtu. In the event CPS Energy were to make such payments with available liquidity from cash on hand and CP issuance, it would significantly deplete its liquidity, a credit negative. CPS Energy is reviewing all costs related to the event to make sure they are fair and may also dispute and/or pursue legal action under its specific contractual arrangements for costs it deems to be unjustified. On March 12, 2021, CPS Energy filed a lawsuit against ERCOT seeking, among other things, a declaratory judgement to prevent ERCOT from wrongfully declaring a default by CPS Energy based on a force majeure event and due to ERCOT's prior material breach for the short payment of $18 million to CPS Energy. If the decision is positive for CPS Energy, it would also prevent ERCOT from requiring CPS Energy to pay for the default of others as a result of the excessive prices during the winter event.

The proposed transaction is one of the many steps CPS Energy is undertaking to bolster its liquidity profile in anticipation of potential costs related to the weather event. As of January 31, 2021, CPS Energy had approximately $892 million in unrestricted cash available, in addition to $280 million in borrowing capacity remaining under the $700 million CP program. The proposed transaction will replace the $420 million in outstanding CP notes with long-term junior lien obligations, restoring the full borrowing capacity of $700 million available under the CP program. This would increase the utility's adjusted days cash on hand, which includes amounts available under the credit facilities backing the CP program, to 375 days from 276 days if we consider 2021 unaudited operating expenses of $1.6 billion. CPS Energy has also received board approval to increase borrowing capacity by an additional $500 million. This borrowing increase also requires City Council approval, which is expected to be under consideration very soon. CPS Energy also fully drew upon its $100 million Flexible Rate Revolving Note (FRRN) program on February 26, 2021.

In the event CPS Energy needs to absorb financial costs on the outer range of its current estimates, it could be required to potentially issue up to $1 billion of additional debt, while creating a regulatory asset which would enable it to recover costs from customers over an extended period of time (10-20 years). Establishment of the regulatory asset would require both Board and City Council approval. Moody's estimates that under such a scenario, the debt service coverage ratio (DSCR) could decline to the 1.4x range and the adjusted debt ratio could reach as high as 80% if the higher end of the debt issuance occurred, while liquidity levels would likely decline to levels below the over 300 days cash on hand that CPS Energy has typically carried. As of FY 2020, FOCC and the adjusted debt ratio were 1.75x and 68.7%, respectively.

CPS Energy and the City of San Antonio are collaborating and the City has allowed CPS Energy to delay its payments to the City while working through final resolution of the costs for the weather event. The payments due in February were accrued and are expected to resume and be paid in late March or early April as anticipated, following CPS Energy's completion of its current short-term financing plan. CPS Energy does not anticipate there to be a change in the calculation of future payments owed to the City as current payments are at the discretion of the City and in an amount that cannot exceed 14% of CPS Energy's annual gross revenue. The transfers to the City have historically consisted of 12%-14% of operating revenue, which we consider to be large and higher than industry norm.

CPS Energy is amending its revolving credit agreements and ancillary documents to allow for the issuance of taxable CP notes under the CP program, in addition to the existing ability to issue tax-exempt notes. This will allow CPS Energy to issue CP for additional purposes such as fuel costs that are not currently covered under the tax-exempt notes, which we view as credit neutral. The provider and the amount of liquidity support provided under the credit facilities is unchanged at $700 million. Following the amendment, the overall CP program will be supported by the same revolving lines of credit for Series A (Tax-Exempt & Taxable), ($400 million) provided by Bank of America, N.A. (Aa2/stable; P-1); for Series B (Tax-exempt &Taxable), ($200 million) from State Street Bank and Trust Company ); and for Series C (Tax-Exempt & Taxable) ($100 million) offered by Wells Fargo Bank, NA (Aa1/negative; P-1).

RATING OUTLOOK

The negative outlook reflects the uncertainty surrounding the ultimate financial impact from the sizable costs incurred to procure natural gas and power at significantly elevated prices during the recent Texas winter event, which could lead to significant additional leverage being incurred in order to shield customers from rate spikes over several years, as well as weaker liquidity and a narrowing of credit metrics going forward.

FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGS

CPS Energy's senior lien rating is among the highest rating assigned to any combined electric and gas utility in the US, so upward rating prospects are limited, especially in light of the negative outlook owing to the recent events associated with Texas' 2021 winter. The outlook could be stabilized however if the ultimate financial impact to be absorbed by CPS Energy is significantly below what the utility is currently estimating, driven in part to the utility's intention to dispute costs it deems as illegitimate.

FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGS

In the event the financial impact to be absorbed by CPS Energy is large, requiring the issuance of long-term debt and the creation of a regulatory asset, there would be negative pressure on the rating given the expectation of sustained weaker credit metrics and liquidity as a result.

Other factors that could exert pressure on the rating include:

- Adjusted debt service coverage that is expected to fall below 1.50 times over a three-year period

- Greater than anticipated impact from coronavirus related economic crisis that could lead to lower levels of liquidity and financial metrics beyond FY 2021

- Customer intolerance for any rate increase that would adversely impact financial metrics

- Extended forced outage at its nuclear facility

- Weakening in competitive position or change in business model that impacts fixed cost recovery

LEGAL SECURITY

Similar to outstanding junior lien obligations, the Series 2021A bonds are secured by the net revenue pledge of CPS Energy's electric and natural gas systems with a sum-sufficient rate covenant required which includes a deposit of 6% of gross revenues into the repair and replacement account, that effectively provides greater than the stated sum-sufficient debt service coverage. The junior lien pledge is subordinate and inferior to the pledge of net revenues securing the senior lien bonds, but prior and superior to the lien on, and pledge of, the net revenues securing the payment of the CP notes.

The junior lien bonds do not have a debt service reserve, however, the senior liens bonds do have a debt service reserve funded at average annual debt service and provided by a surety policy from Assured Guaranty Municipal Corp. (A2 stable). There is an additional bonds test of 1.50 times maximum annual debt service on senior lien bonds and 1.00 times on all senior and junior-lien debt obligations

USE OF PROCEEDS

The proceeds of the bonds will be used to refund the $420 million in notes currently outstanding under the CP program and to pay the expenses related to the issuance of the bonds. Following the transaction, all of the utility's obligations will consist of long-term debt (with the exception of the $100M drawn floating rate notes), with outstanding senior lien debt comprising approximately 68% of total debt outstanding and outstanding junior lien debt comprising the remaining 32%. Total debt outstanding post issuance will be around $5.8 billion.

PROFILE

CPS Energy is a combined utility owned by the City of San Antonio. CPS Energy provides near monopoly locally-owned electric service to a strong economic area that includes all of Bexar County (Aaa stable) and part of seven adjacent counties. There is no service area boundary for the CPS Energy gas system.

METHODOLOGY

The principal methodology used in the long-term rating was US Public Power Electric Utilities with Generation Ownership Exposure Methodology published in August 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1170209. The principal methodology used in the short-term ratings was Short-term Debt of US States, Municipalities and Nonprofits Methodology published in July 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1210749. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Jennifer Chang
Lead Analyst
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Angelo Sabatelle
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