TEXT-Fitch rates CoServ Electric, Texas notes 'AA-'
July 31 - Fitch Ratings assigns an initial rating of 'AA-' to the following Denton County Electric Cooperative, Inc., Texas (d/b/a CoServ Electric) notes: --Approximately $475 million first mortgage notes, series 2012B. Proceeds of the private placement, which are expected to price in mid-August 2012, will be used to refinance all of the cooperative's existing debt with the National Rural Utilities Cooperative Finance Corporation. The Rating Outlook is Stable. SECURITY The notes are secured by a first priority lien on substantially all of CoServ's 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, which supplies substantially all of the cooperative's power needs pursuant to a long-term wholesale power contract through 2045. STRONG SERVICE TERRITORY: The cooperative's largely residential service territory exhibits sound economic indicators that contribute to its relative operating stability. In addition, minimal bad debts improved in each of the past three years to a negligible 0.17% of 2011 total operating revenues, reflecting a resiliency of the area economy to the recent economic recession. CONSISTENT FINANCIAL OPERTAIONS: Cash flow metrics are sound and in line with management's targets, despite being slightly below Fitch's 'AA-' rating category medians. Debt service coverage and operating margins averaged 2.1x and 11.6%, respectively, over the last four years with little deviation. MODEST, IMPROVING BALANCE SHEET: Balance sheet metrics are below average but trending stronger. Cash on hand has averaged 39 days since 2008, but improved to 57 days in 2011; the ratio of equity to capitalization was 35.6%. Rating category medians were 128 days and 54.9%, respectively. COMPETITIVE RETAIL RATES: 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 about one-third of the total enhances the cooperative's revenue predictability. LIMITED COMPETITIVE PRESSURE: Customers can choose their retail electric provider in about 40% of CoServ's service territory that is multi-certified. However, existing customers rarely switch providers, and the cooperative has been successful in gaining about three-quarters of new residential customers in these areas since 2006. This provides good evidence for the reliability of the cooperative's electric service. CREDIT PROFILE CoServ provides low-risk electric distribution service to approximately 164,000 meters in a growing, six-county area of the northern Dallas-Fort Worth Metroplex. Financial metrics are solid, if not slightly below Fitch's 'AA-' rating category medians. However, the service territory's strong economic indicators allow for relative operating stability that provides comfort at the 'AA-' rating level. STABLE CASH FLOW METRICS CoServ's cash flow metrics are steady and healthy. Debt service coverage remained in a tight range of 2.1x-2.3x from 2008-2011, evidencing the stability of CoServ's financial operations that benefit from a strong service territory and the timely pass through of costs. Management has traditionally targeted a debt service coverage ratio of 2.0x. However, coverage is forecasted at about 2.5x annually through the cooperative's 2022 planning period. MODEST, IMPROVING BALANCE SHEET Liquidity metrics are below rating category medians, but improved. Cash on hand averaged 39 days in the four years to 2011, when it reached 57 days. The cooperative added to its electric and gas facilities an above-average 190% of annual depreciation during the period, principally through cash funding; this limited the growth of cash balances. The rating category median for capex/depreciation is 139.5%. Equity levels grew by three quarters from 2008 to $222 million in 2011, as the cooperative continued to expand and mature from its legacy bankruptcy filing over 10 years ago. Limited debt-financing plans are expected to help the cooperative reach a goal of 50% equity to capitalization by 2019. STRONG SERVICE TERRITORY CoServ operates largely in Denton County (65% of revenues) and Collin County (33% of revenues). The service territory exhibits strong economic characteristics, including well above-average wealth and employment levels that contribute to the cooperative's stable overall financial position. In addition, CoServ serves a largely residential base representing a high 69% of kWh sales that further enhances revenue predictability. Meter growth has slowed from the early 2000s, but remains healthy at an average of about 3.5% annually. A strong area economy left bad debts largely immaterial through the recent recession. The cooperative's bad debt expense has declined in each year since 2008 to 0.17% in 2011. SOLID POWER SUPPLIER CoServ is the largest of Brazos Electric Power Cooperative's 16 distribution cooperative members, representing nearly one third of its total megawatt hour sales. Brazos' implied senior secured rating is 'A', with a Stable Outlook. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. This action was informed by information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria. Applicable Criteria and Related Research: --'Brazos Electric Power Cooperative, Texas' (June 15, 2012); --'Revenue-Supported Rating Criteria' (June 12, 2012); --'U.S. Public Power Rating Criteria' (Jan. 11, 2012). Applicable Criteria and Related Research: Brazos Electric Power Cooperative, Texas Revenue-Supported Rating Criteria U.S. Public Power Rating Criteria