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Rating Action:

Moody's revises outlook for San Antonio (CPS Energy) TX Combined Utility Enterprise's senior and junior lien revenue bonds to negative; affirms ratings

08 Mar 2021

New York, March 08, 2021 -- Moody's Investors Service has revised the outlook on the outstanding City of San Antonio, TX Combined Utility Enterprise's (CPS Energy) outstanding Senior Lien Electric and Gas System Revenue Bonds and Junior Lien Electric and Gas System Revenue Bonds to negative from stable. Concurrent with the rating action, Moody's affirmed the Aa1 rating on $3.9 billion of senior lien debt, the Aa2 rating on $1.5 million of junior lien debt, and the P-1 rating on outstanding commercial paper (CP) notes.

RATINGS RATIONALE

Today's rating action factors in 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. During the event, CPS Energy saw significant increases in demand well above historical levels during the month of February, while also seeing a decrease in natural gas supply as the cold weather caused disruption to natural gas-fired generation and natural gas distribution systems. CPS Energy estimates costs could range as high as $850 million to $1.1 billion for both natural gas and power costs during those days, which are above CPS Energy's annual fuel costs for a typical year. 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 estimates natural gas fuel purchase costs of approximately $675 million to $850 million. 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.

The Aa1 senior lien rating considers 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 Aa2 junior lien rating considers the subordinate pledge relative to the security on the senior lien obligations.

CPS Energy and ERCOT reached an agreement on the utility's purchased power costs as CPS Energy agreed to pay its net obligations of $87 million to ERCOT. In addition, CPS Energy paid $99 million to counterparties in collateral calls on additional power transactions. CPS Energy estimates power costs ranging from $175 million to $250 million. However, the settlement of $87 million could increase given several market players have not been able to fully cover their obligations to ERCOT, to the tune of $2.5 billion, with at least one bankruptcy already having been filed. In the event ERCOT socializes the shortfall, known as uplift payments and per existing protocols, ERCOT is limited to invoicing at the rate of $2.5 million per thirty days, which would lead to a long recovery period and not a significant impact on financial metrics. However, it is uncertain if such protocol might change and what the ultimate figure and recovery period would be in that event.

To mitigate the potential costs of the winter storm, CPS Energy is currently taking necessary actions to bolster its liquidity profile. 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. CPS Energy expects to refund the $420 million in debt outstanding under the program by late March, which would restore full borrowing availability 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 as soon as reasonably possible. CPS Energy also fully drew upon its $100 million Flexible Rate Revolving Note (FRRN) 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 $1.1 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 the high 70% range 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's power supply is well balanced with both conventional and renewable energy that continues to evolve towards lower carbon emissions, a key policy initiative. In March 2018, CPS Energy announced its Flexible Path, a strategic approach on how CPS Energy will prudently plan for, develop and / or install new energy sources to serve its community. CPS Energy continually evaluates its generation portfolio, and will leverage its existing community-owned generation assets to bridge to a future that enables more non-emitting resources such as wind, solar, energy storage and new technology. Currently, the utility is prioritizing the replacement of capacity from older units, as almost one-third of capacity comes from assets of forty years or older. While this objective represents a challenge, it appears to be a measured plan to balance clean energy and system reliability and customer growth. Coal-fired generation capacity is expected to decline to around 7% by 2040 under a possible Flexible Path scenario. Moreover, the diverse fuel mix that includes nuclear, coal, natural gas and renewable resources remains well managed and provides the utility with ample flexibility to remain cost competitive as it focuses on sustainability objectives. That said, CPS Energy faces a continuing challenge managing market and commodity risks given its participation in the ERCOT day ahead market as lower energy prices caused by low natural gas prices and abundant wind energy have made its coal fleet less competitive during regular years.

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.

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 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

The senior lien bonds are secured by the net revenue pledge of CPS Energy's electric and natural gas systems; there is 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. 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 and a debt service reserve on senior lien bonds funded at average annual debt service and provided by a surety policy from Assured Guaranty Municipal Corp. (A2 stable). There is no debt service reserve for the junior lien bonds. 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.

Outstanding senior lien debt comprises approximately 73% of total debt outstanding with outstanding junior lien debt comprising the remaining 27%.

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 ratings 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.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

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
Project Finance
Moody's Investors Service, Inc.
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New York 10007
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Angelo Sabatelle
Additional Contact
Project Finance
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
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JOURNALISTS: 1 212 553 0376
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