THREE CREDIT AGENCIES AFFIRM CPS ENERGY’S BOND RATINGS; S&P AND MOODY’S REFLECT STABLE OUTLOOK; FITCH CHANGES OUTLOOK FROM STABLE TO NEGATIVE
SAN ANTONIO, Texas – (October 16, 2020) – CPS Energy has recently received strong bond credit ratings from Moody’s, S&P, and Fitch. Each affirmed CPS Energy’s existing high industry credit ratings, which will support two refunding debt transactions that are planned for next week. Moody’s and S&P have reaffirmed their current ratings of CPS Energy at Aa1 and AA, respectively, both with a Stable Outlook. Fitch has also reaffirmed its current rating of the utility at AA+; however, it has changed its Outlook from Stable to Negative.
The Fitch rating still reflects the strong credit of CPS Energy; however, the change in their outlook is attributed to their concerns for the following:
- Emergent challenges in receiving required rate increases from the City Council that are necessary to maintain CPS Energy’s historically strong financial position.
- A heightened risk, driven by the broader economic stress caused by the pandemic, which could also impact the City Council’s willingness to approve, without delay, the full amount of a rate request.
- A new local petition that is interested in converting CPS Energy’s current governance structure to one that would cause the utility to be more susceptible to political pressures.
“CPS Energy remains focused on helping its customers through these challenging times and is absolutely committed to performing at the highest levels. This is despite this year’s challenges associated with COVID-19 and lower wholesale market sales,” said Paula Gold-Williams, President & CEO of CPS Energy. “We know the credit ratings agencies are watching all significant activities in San Antonio closely. Part of their close focus is because, historically, we have performed extremely well. While we received a Negative Outlook from one agency, every day we are focused on operating efficiently and are working diligently to return the outlook to “Stable,” across the board.”
A Negative Outlook is not always followed by a downgrade. CPS Energy faced similar issues in 2010 when it worked to pursue new nuclear generation. CPS Energy was ultimately moved back to a Stable Outlook after reaching a settlement with a counterparty that limited financial exposure and after completing a successful rate case.
It has been six (6) years since CPS Energy has needed a rate increase and it has only needed one (1) in nine years. Each year, it has considered the need for an increase and has been able to deploy other measures that have kept its financial ratios strong. This has included the consistent pursuit of:
- Cost savings,
- Investments in technologies that increase efficiencies,
- Managed growth, and
- Optimization of its extensive generation capacity in the wholesale and retail markets.
Again, due to the implications of the pandemic, recent declines in wholesale sales, and new activities from special interest groups to use political avenues to affect the company’s proven governance structure, it appears CPS Energy may need an increase by the fall of next year. While CPS Energy’s management team is cautiously optimistic about fiscal year 2022, which ends January 31, 2022, it remains committed to having future rate case discussions with its community and the San Antonio City Council, as the need evolves. While subject to change, current average total bill estimates could increase by 5%-to-8%.
The following includes excerpts that highlight strengths and risks from the Bond Ratings Agency Reports:
CREDIT RATING STRENGTHS
The ‘AA+’ rating continues to reflect CPS Energy’s strong revenue defensibility, supported by the favorable demographic trends of its service area, including very strong customer growth, competitive rates, and the utility’s independent rate-setting ability. Operating costs are expected to remain very low, even as the utility shifts its power supply toward lower carbon-emitting resources. Financial margins for bondholders remain dependable and strong with very little fluctuation from either volume sales or fuel prices. Fitch-calculated coverage of full obligations (COFO) exceeded 1.6x in the past five years despite the utility’s large transfer (14% of gross operating revenues) made annually to the city’s general fund.
The Negative Outlook reflects Fitch’s concern that rate increases required to maintain a financial profile consistent with the current rating may not materialize. The risk is somewhat heightened by the broader economic stress caused by the pandemic, which could impact city council’s willingness to approve, without delay, the full amount of a rate request. The lack of recent base rate increases, with the last adjustment occurring in February 2014, may add to customer rate sensitivity. A prolonged weakening of CPS Energy’s operating cash flow without a timely base rate increase, would likely pressure the current rating.
Petition to Revise Governance and Management Structure
A recent petition was proposed by a local coalition of citizens that would revise the governance and management structure of the utility, as well as institute certain carbon reduction and rate policies. The petition would effectively replace the current board with a board comprised of city council members, and replace the President and CEO with a director appointed by the newly comprised board. The petition also mandates the shutdown of the Spruce coal facility by 2030.
Fitch views the proposed governance change as a potential asymmetric additive risk consideration as it would likely result in additional political pressure on the utility, and could constrain the utility’s rate-setting ability or operational decisions.
CREDIT RATING STRENGTHS:
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’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. The Flexible Path is a fresh 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.
Separately, a petition was started by a community environmental group in early September 2020, which if they gain enough signatures to place on a ballot where it is affirmatively voted upon, would (1) replace the Board with a board comprised of City Council members, (2) replace the President & CEO with a director to be selected by the newly comprised board, (3) proscribe the powers and duties of the director, (4) establish an advisory commission, and (5) mandate certain energy and rate-related policies. The earliest possible voting may be held is May 1, 2021. In the event CPS Energy should lose its self-regulated rate making ability, it would be viewed as a credit negative.
CREDIT RATING STRENGTHS:
The enterprise risk profile reflects our view of the systems’:
- Very strong service area economic fundamentals, reflecting a broad and diverse service area economy that remains one of the most robust in the state and its very diverse and steadily growing customer base that promotes revenue predictability;
- Extremely strong industry risk relative to other industries and sectors.
- Strong market position, due to its automatic monthly purchased power cost-adjustment (PCA) mechanism that dynamically passes along changes in commodity prices, and its weighted average electric system rate that was 6.6% above the state average in 2018; and
- Very strong operational and management assessments, highlighted by a generation fleet that is diverse in both fuel and shaft risk, complies with environmental regulations, and incorporates an integrated resources plan that has significant renewable energy goals, along with its robust management policies and practices.
Environmental, social, and governance factors
We consider the utility’s governance factors, including its credit supportive rate-setting practices and robust financial practices, to be in line with those of other rated utilities. However, we understand an environmental group is seeking necessary signatures to put a charter amendment on the ballot in May 2021, which, if successful, could change CPS
Energy’s governance structure. The proposed charter amendment–if approved–would replace the board with oversight by the city council, and require CPS Energy to decarbonize its generation fleet at a faster pace. We will continue to monitor whether this potential charter amendment is successful and assess its effect on the utility’s operational and financial profiles.