Fitch Rates Lower Colorado River Authority, TX's Rev Bonds 'A'; Outlook Stable

Fitch Ratings affirms the following rating on the Lower Colorado River Authority, TX's (LCRA) bonds:

--$1.72 billion revenue and refunding revenue bonds, and bank note rating on the commercial paper notes, series B at 'A'.

The Rating Outlook is Stable.

SECURITY

Bonds are secured by a gross revenue pledge of LCRA's system. Pledged revenues do not include LCRA Transmission Services Corporation (LCRA TSC) business activity but do include the raw water business line.

KEY RATING DRIVERS

REGIONAL WHOLESALE SUPPLIER: LCRA supplies energy to over 1 million people in central Texas through 34 wholesale power agreements that extend through 2041. LCRA's debt matures in 2040. The wholesale power agreements are in place through the life of the outstanding debt.

RESOLUTION OF CUSTOMER DISPUTES: LCRA reached settlements with seven of the eight customers that ceased purchasing a cumulative 25% of load in fiscal 2013. While the customer loss resulted in cash flow pressure, the resolution of litigation now provides greater financial certainty.

CASH FLOW PRESSURE MANAGEABLE: LCRA managed lower revenues resulting from the customer loss through expenditure reductions, realignments, the spend-down of reserves and the increased use of debt funding of capital. The cash flow pressure began in mid-fiscal 2013 and is expected to persist through fiscal 2016, the date of the original contract terminations for the lost customers, at which time debt service payments decrease.

LIMITED CAPITAL NEEDS: Debt levels are moderate and the majority of LCRA's consolidated $1.15 billion five-year capital plan is projected to fund transmission projects (separately financed and secured by LCRA TSC, rated 'A+' by Fitch). LCRA's debt declines over the remaining life of the debt through 2040.

LOAD RELEASE PROVISIONS: LCRA's 2041 wholesale power agreements have load release provisions that allow customers to reduce purchases from LCRA over time by up to 35% of their total load. The load release provisions introduce variation over time in the load served.

LONG GENERATION CAPACITY: Costs associated with capacity in excess of wholesale customer loads are offset by energy sales into the ERCOT market. Stronger market revenues as a result of capacity constraints and load growth across ERCOT, would improve the full recovery of LCRA's existing fixed costs.

RATING SENSITIVITIES

FURTHER DECLINE IN RESERVES: Further declines in generation operating reserves are possible but not projected by management in fiscals 2015 and 2016. Declines in generation operating reserves below the LCRA board's minimum policy levels of two months operations could result in negative rating pressure.

CREDIT PROFILE

LCRA is a conservation and reclamation district created by the Texas Legislature in 1934. It is the largest public power wholesale provider in Texas, serving five electric cooperatives, 29 cities, and one investor-owned utility. The system also manages and distributes water supply and controls flooding along the lower Colorado River in Texas.

LCRA's consolidated revenues consist primarily of wholesale electric revenues, which provided 63% of total combined revenues in fiscal 2014. Transmission revenues provided 31% of revenues, although they are not pledged to these bondholders, and water and irrigation services provided the remaining revenues.

Wholesale power is sold via 34 long-term wholesale power agreements that extend to 2041. LCRA also had nine wholesale power agreements that extended to 2016, eight of which have been the subject of recent litigation. Seven of those agreements were terminated in the past year based on settlements between LCRA and the respective customers, one (Kerrville Public Utility Board) is the subject of ongoing litigation and one (Guadalupe Valley Electric Cooperative) remains effective through 2016.

NEW MANAGEMENT TEAM

Phil Wilson took over as General Manager in February 2014. Mr. Wilson's background includes state government and experience in the Texas electric industry. Additional senior management changes have occurred that include participants with backgrounds in the competitive electric industry. Given the customer departures and LCRA's need to successfully participate in the ERCOT generation marketplace, the additions should bolster expertise in this area.

LOSS OF CUSTOMERS RESULTED IN FINANCIAL PRESSURE

The rating downgrade in October 2012 reflected anticipated declines in LCRA's revenues as a result of the unexpected early wholesale power agreement terminations with the eight customers that ceased purchasing power in mid fiscal 2013. Although the customers had valid wholesale power agreements through fiscal 2016, they claimed LCRA was in breach of the contract terms and ceased purchasing power from LCRA as a result. At no time was the validity of the agreements challenged.

LCRA stopped purchasing energy in the ERCOT market on behalf of the eight customers mentioned above but continued to bill customers for remaining fixed costs due under their wholesale power agreements. LCRA has used a number of tools to manage the revenue impacts, including expenditure reductions, increased use of debt and the economic dispatch of available energy into the ERCOT market.

DEBT SERVICE COVERAGE DROPPED IN FISCAL 2014; IMPROVEMENT EXPECTED IN 2015

LCRA took a $59.5 million write-off in fiscal 2014 for its uncollected electric revenues to date. As a result, Fitch-calculated consolidated debt service coverage declined to 1.19x, although LCRA's calculation remained above the board policy target of 1.25x. Fitch-calculated debt service coverage without the activity of LCRA TSC was below 1.0x, reflecting the planned use of reserves. Management expects consolidated debt service coverage to recover to above 1.25x in fiscal 2015 and 2016 when cash balances set aside to offset the negative cash flow impacts of lower sales are included.

CASH LEVELS ADEQUATE FOR GENERATION; STRONG AT CONSOLIDATED LEVEL

Cash levels for the generation business line declined in fiscals 2013 and 2014 to replace lost revenues. However, unrestricted generation operating reserves remained acceptable and in line with management's target of three months of operations, given the accompanying decline in fuel and power expenses. Generation operating cash reserves were around $185 million at the end of fiscal 2013 and declined to $108 million at the end of fiscal 2014. The three-month operations target for cash is around $105-$110 million, which management expects to exceed in the next two years. Board policy requires rate action if LCRA consolidated reserves fall below two months operations.

In addition to operating cash reserves, the generation business line has management restricted reserves to fund potential litigation costs and to supplement lower revenues in fiscals 2015-2016. Consolidated unrestricted LCRA cash is healthy with $300.7 million, or 189 days funds on hand.

WHOLESALE POWER AGREEMENTS AND RATE SETTING

LCRA charges a uniform rate to all of its customers. The statutory rate covenant in the LCRA Act requires LCRA to set rates sufficient to cover all of its expenses, including debt service, and maintain reserves. LCRA's board-adopted financial policies require rates to be set to recover 1.25x debt service coverage on a consolidated basis. The bond resolution only requires rates sufficient to cover all obligations and no remedy is required if the threshold is not met.

LCRA's uniform rate consists of fuel rate and nonfuel rate components. LCRA's actual fuel costs, generation market revenues, and costs related to market energy purchases are passed along to customers through the fuel rate component. The nonfuel rate component includes LCRA's fixed costs, such as labor costs that are not related to fuel procurement, operation and maintenance costs, debt service, and generation system contributions to the public service fund. The rate is typically established annually during the budget process, but the non-fuel rate can be changed according to terms of the wholesale power agreements with 180 day notice to customers (the 2041 contracts have a shorter 60 day notification). The fuel rate component can be changed at any time.

LCRA's goal is to maintain its non-fuel rate component level through fiscal 2016. Even with the debt funding plan and the use of reserves to mitigate the early loss of eight customers, LCRA may still need a rate increase prior to fiscal 2017. The Stable Outlook reflects Fitch's assumption that LCRA will exercise its rate authority, if needed.

For more information see Fitch's report 'Lower Colorado River Authority', dated Oct. 14, 2013.

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

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 3, 2014);

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

--'Lower Colorado River Authority' (Oct. 14, 2013)

--'Fitch Downgrades Lower Colorado River Authority's Revs to 'A', Outlook Stable' (Oct. 2, 2012);

--'U.S. Public Power Peer Study' (June 12, 2014).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Public Power Rating Criteria

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

Lower Colorado River Authority, TX

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=703895

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

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=958776

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