Fitch Affirms CoServ Electric (TX) at 'AA-'; Outlook Stable

Fitch Ratings has affirmed the 'AA-' rating on the following Denton County Electric Cooperative, Inc. (dba CoServ Electric) notes:

--$537 million first mortgage notes, series 2012A.

The Rating Outlook is Stable.

SECURITY

The notes are secured by a first lien on substantially all of CoServ Electric's (CoServ) tangible and certain intangible electric assets, including its electric distribution facilities and interest in its wholesale power contract.

KEY RATING DRIVERS

LOW-RISK DISTRIBUTION SYSTEM: CoServ is a low-risk electric distribution provider in the growing northern Dallas-Fort Worth Metroplex. It is the largest member of Brazos Electric Power Cooperative (Brazos; implied senior secured obligations rated 'A'/Outlook Stable), which supplies substantially all of its power needs pursuant to a long-term wholesale power contract through 2045.

STRONG SERVICE TERRITORY: The cooperative's largely residential service territory exhibiting strong economic indicators contributes to its operating stability. Minimal bad debts have averaged a low 0.19% of operating revenues since 2009.

CONSISTENT FINANCIAL OPERATIONS: Sound cash flow metrics slightly exceed management's targets and approximate Fitch's 'AA-' rating category medians. Debt service coverage and operating margins have averaged 2.2x and 12.3%, respectively, over the past five years with little deviation.

MODEST, IMPROVING BALANCE SHEET: Balance sheet metrics are below the medians but have trended stronger. Cash on hand improved to 67 days in 2013 from 18 days in 2008, and the ratio of equity to capitalization grew slightly to 40.6%. Rating category medians are 180 days and 48.5%, respectively.

COMPETITIVE RETAIL RATES: Retail rates are competitive with area providers and allow for the timely pass through of all wholesale power costs. A fixed monthly component of CoServ's distribution charges representing approximately one-third of the total enhances the cooperative's revenue predictability.

LIMITED COMPETITIVE PRESSURE: Success in gaining approximately three-quarters of new residential customers in multi-certified areas since 2006 provides good evidence for the cost and reliability of the cooperative's electric service. Moreover, existing customers rarely switch providers. Customers can choose their electric distribution provider in approximately 40% of CoServ's service territory.

RATING SENSITIVITIES

CONTINUED BALANCE SHEET IMPROVEMENT: Outpaced improvement in CoServ's financial metrics - particularly its balance sheet - relative to its multiyear forecast through 2023 could ultimately lead to positive rating action. Growing capital and debt financing needs compared to prior forecasts temper CoServ's overall financial gains.

CREDIT PROFILE

CoServ provides low-risk electric distribution service to approximately 176,000 customers in a fast growing, six-county area of the northern Dallas-Fort Worth Metroplex. The cooperative's financial metrics are solid on balance, if not slightly below Fitch's 'AA-' rating category medians. However, a strong service territory provides comfort at the 'AA-' rating level.

STRONG SERVICE TERRITORY

CoServ's service territory characteristics include well above-average wealth and employment levels that contribute to the stability of its financial position. In addition, a largely residential customer base representing approximately two-thirds of kWh sales enhances revenue predictability. Meter growth rates have returned to pre-recessionary levels of over 5%, and forecast growth is a high 5.5% annually over the next several years.

Meter growth and kWh sales continue to come principally from CoServ's single-certified areas (80% and 59%, respectively), as the dual-certified areas of its service territory become built out. Nevertheless, CoServ has captured three-quarters of new residential customers in the multi-certified areas over the past eight years.

STABLE CASH FLOW METRICS

CoServ's cash flow metrics are stable and healthy. Debt service coverage has remained in a tight range of 2.1x-2.3x since 2009, evidencing the steadiness of the cooperative's financial operations that benefit from a strong service territory and the timely pass through of costs. Management has traditionally targeted a 2.0x coverage ratio. However, coverage is forecast at about 2.3x annually through the 2023 planning period, which is in line with Fitch's 'AA-' rating category median.

SLOWLY IMPROVING BALANCE SHEET

Liquidity metrics are below rating category medians but have improved. The cooperative has added to its electric and gas facilities at an above-average rate of 200% of annual depreciation since 2009, in large part through cash funding; this has limited the growth of cash balances.

Cash on hand grew to 67 days in 2013 from 24 days in 2009. The ratio of equity to capitalization likewise improved slightly to 40.6%. Rating category medians for cash on hand and equity to capitalization are 180 days and 48.5%, respectively. The median ratio for capex to depreciation is 139%.

ADDITIONAL DEBT FINANCING PLANS

Growing capital and debt financing needs relative to prior forecasts temper the pace and extent of improvement in CoServ's financial metrics, as noted. However, forecast ratios remain generally in line with rating category medians. Positive variations from the current 10-year forecast that cause sustained improvement in financial metrics could ultimately lead to upward rating action.

Long-term debt grows to $710 million by the final year of the 2023 forecast, compared with $488 million by 2022 in the prior 10-year plan. Consequently, outyear equity ratios are forecast at 50.8% (2023) compared with 56.7% (2022) in the prior plan, and outyear debt service coverage is nearer 2.3x compared with 2.6x-2.7x.

SOLID POWER SUPPLIER

Brazos' preponderance of natural gas-fired generation (77%), coupled with market purchases for up to 30% of power needs, by design, have kept CoServ's retail rates competitive with other Texas providers.

CoServ is the largest of Brazos' 16 distribution cooperative members, representing nearly one third of its total sales.

Additional information is available at 'www.fitchratings.com'.

This action was informed by the sources of information identified in Fitch's U.S. Public Power Rating Criteria.

Applicable Criteria and Related Research:

--'U.S. Public Power Peer Study -- June 2014' (June 13, 2014);

--'U.S. Public Power Peer Study Addendum - June 2014' (June 13, 2014);

--'Fitch Affirms Brazos Electric Cooperative at 'A'; Outlook Stable' (June 5, 2014);

--'U.S. Public Power Rating Criteria' (March 18, 2014);

--'Denton County Electric Cooperative, Inc. (dba CoServ Electric)(Mortgage Notes)' (Aug. 21, 2012).

Applicable Criteria and Related Research:

U.S. Public Power Peer Study -- June 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749789

U.S. Public Power Peer Study Addendum - June 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750283

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=840735

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