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2019-050 S&P Surveillance Rating
Date: March 15, 2019 Report No. 2019-050 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: Surveillance Rating for Series 2017 Utility System Revenue Bonds by Standard & Poor’s Global Ratings (S&P). BACKGROUND: Over the last few weeks, staff has been working with S&P on a surveillance rating of the City’s Series 2017 Utility System Revenue Bonds. This specific series of revenue bonds are the only outstanding revenue bonds that the City currently has on its books and were issued on January 19, 2017 to fund the Denton Energy Center. As of March 15, 2019, the City has $330,704,750 in outstanding principal and interest remaining with final maturity being December 1, 2037. S&P has affirmed (maintained) the same “AA-” rating with Stable Outlook from the initial offering (Attachment 1). DISCUSSION S&P, as do other rating agencies, routinely conduct surveillance ratings on outstanding bonds they rate in conjunction with an initial offering. Formal surveillance ratings, like this one, are generally conducted every few years and result in a public release on the status of the rating. While the interest the City pays on outstanding bonds will not be impacted by the surveillance rating, it could have an impact in the trading of those bonds in the secondary market. Additionally, a changed rating could also impact the City if new bonds, of similar type, are issued in the future. There are currently no plans to issue additional revenue bonds since any debt issued for the City’s utilities (Electric, Water and Wastewater) have been issued as Certificates of Obligation (COs). This has been the City’s practice since 2010 in order to take advantage of interest savings from the COs higher rating of AA+ (Fitch and Standard & Poor’s). For your information, staff has also attached the Informal Staff Report (ISR) dated January 20, 2017 (Attachment 2) that includes details regarding the initial offering of the Series 2017 Utility System Revenue Bonds. The ISR includes the initial ratings reports from both Fitch and Standard & Poor’s. Please do not hesitate to contact me if you have any questions. ATTACHMENTS 1. S&P Surveillance Ratings Report 2. Informal Staff Report dated January 20, 2017 STAFF CONTACT: Antonio Puente, Jr. Chief Financial Officer (940)-349-7283 Antonio.Puente@cityofdenton.com Summary: Denton, Texas; Combined Utility Primary Credit Analyst: Scott W Sagen, New York (1) 212-438-0272; scott.sagen@spglobal.com Secondary Contact: Doug Snider, Centennial + 1 (303) 721 4709; doug.snider@spglobal.com Table Of Contents Rationale Outlook WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 14, 2019 1 Summary: Denton, Texas; Combined Utility Credit Profile Denton comb util Long Term Rating AA-/Stable Affirmed Rationale S&P Global Ratings affirmed its 'AA-' rating on Denton, Texas' utility system revenue debt. The outlook is stable. A first-lien pledge of net revenues of Denton's combined electric, water, and sewer systems secure the bonds. The electric system accounted for a significant 73% of total operating revenue in fiscal 2018, which is the focus of our analysis. The combined utility had $785 million in total debt outstanding at the end of fiscal 2018, including $544 million in general obligation (GO) and certificates of obligation debt. The rating reflects the application of our "U.S. Municipal Retail Electric And Gas Utilities: Methodology And Assumptions" criteria (published Sept. 27, 2018, on RatingsDirect). The rating also reflects our opinion of the system's very strong enterprise and financial risk profiles. The enterprise risk profile reflects our view of the system's: • Very strong service area economic fundamentals, reflecting its primarily residential and diverse customer base with extremely strong income levels that benefits from participating in the deep employment base of the Dallas-Fort Worth metropolitan area; • Extremely strong industry risk relative to other industries and sectors; • Adequate market position, based on our forward-looking view of the utility's weighted average electric system rate that will likely decline following rate decreases in 2018 and 2019 due to lower energy and fixed costs; and • Very strong operational and management assessment, as evidenced by the utility's transition to a lower-cost power supply based on wind and solar energy firmed up through owned gas-fired peaking generation and market purchases. Denton expects to add wind and solar purchased power agreements (PPAs) by the end of 2020, which will more than double its current renewable generation capacity. We consider the utility's financial management policies and practices very strong, including monthly review of its power cost adjustment factor based on changes in fuel and purchased power costs, and annually updating its formal multiyear capital planning and financial forecasts. The financial risk profile reflects our view of the system's: • Very strong coverage metrics, after annual transfers to the city, ranging from 1.3x to 1.8x over the last three fiscal years, though the utility projects metrics could equal at least 1.5x beginning in 2020 as purchased power and related fixed costs are expected to decline; WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 14, 2019 2 • Extremely strong liquidity and reserves, with $176 million in total available liquidity or about 360 days' cash for audited fiscal 2018 after including its $46 million rate mitigation fund that provides financial flexibility; and • Adequate debt and liabilities profile, reflecting our view of the utility's 53% debt-to-capitalization ratio considering that 30% of the utility's debt profile was issued to fund peaking generation capacity and 20% of its debt burden is water and sewer-related debt. Outlook The stable outlook reflects our view of Denton's transition to a lower-cost power supply, likely resulting in more competitive electric rates and maintenance of very strong fixed-charge coverage and extremely strong liquidity as it plans to cash fund more than half of its capital improvement plan (CIP). Upside scenario We do not expect to raise the rating over the next two years given Denton's additional debt needs that will likely prevent a material improvement in projected fixed-charge coverage metrics. Downside scenario We could lower the rating if the utility's market position does not improve as expected or if additional debt needs cause weaker-than-expected fixed-charge coverage no longer supportive of the current rating. Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 14, 2019 3 Summary: Denton, Texas; Combined Utility WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 14, 2019 4 STANDARD & POOR’S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor’s Financial Services LLC. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. 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Date: January 20, 2017 Report No. 2017-007 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: City’s sale of Utility System Revenue Bonds, Series 2017 BACKGROUND: The purpose of this report is to provide the City Council with details regarding the sale of the Utility System Revenue Bonds, Series 2017 (hereafter, the “Bonds”) authorized on June 21, 2016 (Ordinance No. 2016-187). The Bonds were authorized for a maximum principal amount of $265 million for the purpose of constructing the Denton Energy Center, a quick start peak power generation facility. The Bonds are secured and payable only from revenues of the City’s Utility System, which is comprised by the Electric, Water and Wastewater Funds. DISCUSSION: On January 19, 2017, the City along with their financial advisor, First Southwest Company, conducted a negotiated sale of the Bonds. The underwriting firms were: JP Morgan Securities LLC, Citigroup Global Markets Inc., and Robert W. Baird & Co. Inc. The delivery date of proceeds will be January 27, 2017. As approved by the City Council on June 21, 2016, the Bonds were authorized to be issued provided they met the following parameters: 1. The maximum principal amount of bonds shall not exceed $265,000,000; 2. The final stated maturity shall not 20 years from the date of issuance; 3. The Bonds shall bear interest at a fixed rate, and the net effective interest rate on the Bonds shall not exceed 4.000%; 4. The sale must occur on or prior to June 21, 2017; 5. The Bonds shall be rated by a Rating Agency for municipal securities in one of the four highest categories for long-term obligations. Staff is pleased to inform the Council that the above criteria were met. The amount of bond proceeds was $247,157,116 at an all-in true interest cost of 3.53%. In addition, these bonds have been rated as AA- by Standard and Poor’s and A+ by Fitch. Staff would note that these ratings are similar to ratings previously issued by Standard and Poor’s of AA- and Moodys of A1 for the City’s Utility System Revenue Bonds. Date: January 20, 2017 Report No. 2017-007 As a reconciliation of amounts originally estimated and communicated to the Council on June 14, 2016, the table below reflects a side-by-side comparison to final sale proceeds: Use Category Estimated Proceeds Actual Proceeds Project Cost $240,000,000 $225,000,000 Capitalized Interest $ 23,000,000 $ 20,598,306 Issuance Costs $ 2,000,000 $ 1,558,810 Grand Total $265,000,000 $247,157,116 Attached are the final debt schedules and ratings reports. Please do not hesitate to contact me if you have any further questions on the results of the City’s most recent bond sale. ATTACHMENTS: 1. Final Debt Schedule 2. Fitch Rating Report 3. Standard & Poor’s Rating Report STAFF CONTACT: Chuck Springer, Director of Finance (940)-349-8260 Charles.Springer@cityofdenton.com Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 1 SOURCES AND USES OF FUNDS City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Dated Date 01/27/2017 Delivery Date 01/27/2017 Sources: Bond Proceeds: Par Amount 214,890,000.00 Premium 32,267,116.00 247,157,116.00 Uses: Project Fund Deposits: Project Fund 225,000,000.00 Other Fund Deposits: Capitalized Interest Fund 20,598,305.56 Delivery Date Expenses: Cost of Issuance 565,992.47 Underwriter's Discount 992,817.97 1,558,810.44 247,157,116.00 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 2 BOND SUMMARY STATISTICS City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Dated Date 01/27/2017 Delivery Date 01/27/2017 First Coupon 06/01/2017 Last Maturity 12/01/2036 Arbitrage Yield 2.996065% True Interest Cost (TIC)3.503576% Net Interest Cost (NIC)3.831282% All-In TIC 3.527917% Average Coupon 4.980660% Average Life (years)12.662 Weighted Average Maturity (years)12.641 Duration of Issue (years)9.627 Par Amount 214,890,000.00 Bond Proceeds 247,157,116.00 Total Interest 135,522,638.89 Net Interest 104,248,340.86 Bond Years from Dated Date 2,720,977,666.67 Bond Years from Delivery Date 2,720,977,666.67 Total Debt Service 350,412,638.89 Maximum Annual Debt Service 18,077,750.00 Average Annual Debt Service 17,657,971.72 Underwriter's Fees (per $1000) Average Takedown 3.864477 Other Fee 0.755645 Total Underwriter's Discount 4.620122 Bid Price 114.553631 Par Average Average PV of 1 bp Bond Component Value Price Coupon Life change Serial Bond 214,890,000.00 115.016 4.981%12.662 177,080.95 214,890,000.00 12.662 177,080.95 All-In Arbitrage TIC TIC Yield Par Value 214,890,000.00 214,890,000.00 214,890,000.00 + Accrued Interest + Premium (Discount)32,267,116.00 32,267,116.00 32,267,116.00 - Underwriter's Discount -992,817.97 -992,817.97 - Cost of Issuance Expense -565,992.47 - Other Amounts Target Value 246,164,298.03 245,598,305.56 247,157,116.00 Target Date 01/27/2017 01/27/2017 01/27/2017 Yield 3.503576%3.527917%2.996065% Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 3 BOND SUMMARY STATISTICS City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 4 NET DEBT SERVICE City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Period Total Capitalized Net Ending Principal Coupon Interest Debt Service Interest Fund Debt Service 09/30/2017 3,680,388.89 3,680,388.89 3,680,388.89 09/30/2018 10,685,000.00 10,685,000.00 10,685,000.00 09/30/2019 10,685,000.00 10,685,000.00 6,232,916.67 4,452,083.33 09/30/2020 7,580,000 5.000%10,495,500.00 18,075,500.00 18,075,500.00 09/30/2021 7,970,000 5.000%10,106,750.00 18,076,750.00 18,076,750.00 09/30/2022 8,375,000 5.000%9,698,125.00 18,073,125.00 18,073,125.00 09/30/2023 8,805,000 5.000%9,268,625.00 18,073,625.00 18,073,625.00 09/30/2024 9,260,000 5.000%8,817,000.00 18,077,000.00 18,077,000.00 09/30/2025 9,735,000 5.000%8,342,125.00 18,077,125.00 18,077,125.00 09/30/2026 10,200,000 ** %7,873,500.00 18,073,500.00 18,073,500.00 09/30/2027 10,695,000 5.000%7,380,875.00 18,075,875.00 18,075,875.00 09/30/2028 11,245,000 5.000%6,832,375.00 18,077,375.00 18,077,375.00 09/30/2029 11,820,000 5.000%6,255,750.00 18,075,750.00 18,075,750.00 09/30/2030 12,425,000 5.000%5,649,625.00 18,074,625.00 18,074,625.00 09/30/2031 13,065,000 5.000%5,012,375.00 18,077,375.00 18,077,375.00 09/30/2032 13,735,000 5.000%4,342,375.00 18,077,375.00 18,077,375.00 09/30/2033 14,435,000 5.000%3,638,125.00 18,073,125.00 18,073,125.00 09/30/2034 15,180,000 5.000%2,897,750.00 18,077,750.00 18,077,750.00 09/30/2035 15,955,000 5.000%2,119,375.00 18,074,375.00 18,074,375.00 09/30/2036 16,775,000 5.000%1,301,125.00 18,076,125.00 18,076,125.00 09/30/2037 17,635,000 5.000%440,875.00 18,075,875.00 18,075,875.00 214,890,000 135,522,638.89 350,412,638.89 20,598,305.56 329,814,333.33 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 5 NET DEBT SERVICE City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Total Capitalized Net Annual Date Principal Coupon Interest Debt Service Interest Fund Debt Service Net D/S 06/01/2017 3,680,388.89 3,680,388.89 3,680,388.89 09/30/2017 12/01/2017 5,342,500.00 5,342,500.00 5,342,500.00 06/01/2018 5,342,500.00 5,342,500.00 5,342,500.00 09/30/2018 12/01/2018 5,342,500.00 5,342,500.00 5,342,500.00 06/01/2019 5,342,500.00 5,342,500.00 890,416.67 4,452,083.33 09/30/2019 4,452,083.33 12/01/2019 7,580,000 5.000%5,342,500.00 12,922,500.00 12,922,500.00 06/01/2020 5,153,000.00 5,153,000.00 5,153,000.00 09/30/2020 18,075,500.00 12/01/2020 7,970,000 5.000%5,153,000.00 13,123,000.00 13,123,000.00 06/01/2021 4,953,750.00 4,953,750.00 4,953,750.00 09/30/2021 18,076,750.00 12/01/2021 8,375,000 5.000%4,953,750.00 13,328,750.00 13,328,750.00 06/01/2022 4,744,375.00 4,744,375.00 4,744,375.00 09/30/2022 18,073,125.00 12/01/2022 8,805,000 5.000%4,744,375.00 13,549,375.00 13,549,375.00 06/01/2023 4,524,250.00 4,524,250.00 4,524,250.00 09/30/2023 18,073,625.00 12/01/2023 9,260,000 5.000%4,524,250.00 13,784,250.00 13,784,250.00 06/01/2024 4,292,750.00 4,292,750.00 4,292,750.00 09/30/2024 18,077,000.00 12/01/2024 9,735,000 5.000%4,292,750.00 14,027,750.00 14,027,750.00 06/01/2025 4,049,375.00 4,049,375.00 4,049,375.00 09/30/2025 18,077,125.00 12/01/2025 10,200,000 ** %4,049,375.00 14,249,375.00 14,249,375.00 06/01/2026 3,824,125.00 3,824,125.00 3,824,125.00 09/30/2026 18,073,500.00 12/01/2026 10,695,000 5.000%3,824,125.00 14,519,125.00 14,519,125.00 06/01/2027 3,556,750.00 3,556,750.00 3,556,750.00 09/30/2027 18,075,875.00 12/01/2027 11,245,000 5.000%3,556,750.00 14,801,750.00 14,801,750.00 06/01/2028 3,275,625.00 3,275,625.00 3,275,625.00 09/30/2028 18,077,375.00 12/01/2028 11,820,000 5.000%3,275,625.00 15,095,625.00 15,095,625.00 06/01/2029 2,980,125.00 2,980,125.00 2,980,125.00 09/30/2029 18,075,750.00 12/01/2029 12,425,000 5.000%2,980,125.00 15,405,125.00 15,405,125.00 06/01/2030 2,669,500.00 2,669,500.00 2,669,500.00 09/30/2030 18,074,625.00 12/01/2030 13,065,000 5.000%2,669,500.00 15,734,500.00 15,734,500.00 06/01/2031 2,342,875.00 2,342,875.00 2,342,875.00 09/30/2031 18,077,375.00 12/01/2031 13,735,000 5.000%2,342,875.00 16,077,875.00 16,077,875.00 06/01/2032 1,999,500.00 1,999,500.00 1,999,500.00 09/30/2032 18,077,375.00 12/01/2032 14,435,000 5.000%1,999,500.00 16,434,500.00 16,434,500.00 06/01/2033 1,638,625.00 1,638,625.00 1,638,625.00 09/30/2033 18,073,125.00 12/01/2033 15,180,000 5.000%1,638,625.00 16,818,625.00 16,818,625.00 06/01/2034 1,259,125.00 1,259,125.00 1,259,125.00 09/30/2034 18,077,750.00 12/01/2034 15,955,000 5.000%1,259,125.00 17,214,125.00 17,214,125.00 06/01/2035 860,250.00 860,250.00 860,250.00 Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 6 NET DEBT SERVICE City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Total Capitalized Net Annual Date Principal Coupon Interest Debt Service Interest Fund Debt Service Net D/S 09/30/2035 18,074,375.00 12/01/2035 16,775,000 5.000%860,250.00 17,635,250.00 17,635,250.00 06/01/2036 440,875.00 440,875.00 440,875.00 09/30/2036 18,076,125.00 12/01/2036 17,635,000 5.000%440,875.00 18,075,875.00 18,075,875.00 09/30/2037 18,075,875.00 214,890,000 135,522,638.89 350,412,638.89 20,598,305.56 329,814,333.33 329,814,333.33 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 7 BOND PRICING City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Maturity Yield to Call Call Premium Bond Component Date Amount Rate Yield Price Maturity Date Price (-Discount)Principal Cost Takedown Serial Bond: 12/01/2019 7,580,000 5.000%1.480%109.767 740,338.60 8,320,338.60 2.500 12/01/2020 7,970,000 5.000%1.680%112.307 980,867.90 8,950,867.90 2.500 12/01/2021 8,375,000 5.000%1.880%114.379 1,204,241.25 9,579,241.25 2.500 12/01/2022 8,805,000 5.000%2.090%115.928 1,402,460.40 10,207,460.40 2.500 12/01/2023 9,260,000 5.000%2.270%117.212 1,593,831.20 10,853,831.20 3.750 12/01/2024 9,735,000 5.000%2.450%118.094 1,761,450.90 11,496,450.90 3.750 12/01/2025 3,400,000 3.250%2.630%104.861 165,274.00 3,565,274.00 3.750 12/01/2025 6,800,000 5.000%2.630%118.590 1,264,120.00 8,064,120.00 3.750 12/01/2026 10,695,000 5.000%2.760%119.190 2,052,370.50 12,747,370.50 3.750 12/01/2027 11,245,000 5.000%2.860%118.244 C 3.015% 12/01/2026 100.000 2,051,537.80 13,296,537.80 3.750 12/01/2028 11,820,000 5.000%2.970%117.214 C 3.238% 12/01/2026 100.000 2,034,694.80 13,854,694.80 4.250 12/01/2029 12,425,000 5.000%3.080%116.194 C 3.430% 12/01/2026 100.000 2,012,104.50 14,437,104.50 4.250 12/01/2030 13,065,000 5.000%3.130%115.734 C 3.551% 12/01/2026 100.000 2,055,647.10 15,120,647.10 4.250 12/01/2031 13,735,000 5.000%3.190%115.184 C 3.664% 12/01/2026 100.000 2,085,522.40 15,820,522.40 4.250 12/01/2032 14,435,000 5.000%3.250%114.638 C 3.765% 12/01/2026 100.000 2,112,995.30 16,547,995.30 4.250 12/01/2033 15,180,000 5.000%3.310%114.095 C 3.854% 12/01/2026 100.000 2,139,621.00 17,319,621.00 4.250 12/01/2034 15,955,000 5.000%3.370%113.555 C 3.935% 12/01/2026 100.000 2,162,700.25 18,117,700.25 4.250 12/01/2035 16,775,000 5.000%3.420%113.107 C 4.002% 12/01/2026 100.000 2,198,699.25 18,973,699.25 4.250 12/01/2036 17,635,000 5.000%3.460%112.751 C 4.058% 12/01/2026 100.000 2,248,638.85 19,883,638.85 4.250 214,890,000 32,267,116.00 247,157,116.00 Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 8 BOND PRICING City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Dated Date 01/27/2017 Delivery Date 01/27/2017 First Coupon 06/01/2017 Par Amount 214,890,000.00 Premium 32,267,116.00 Production 247,157,116.00 115.015643% Underwriter's Discount -992,817.97 -0.462012% Purchase Price 246,164,298.03 114.553631% Accrued Interest Net Proceeds 246,164,298.03 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 9 AVERAGE TAKEDOWN City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Dated Date 01/27/2017 Delivery Date 01/27/2017 Maturity Par Takedown Takedown Bond Component Date Amount $/Bond Amount Serial Bond: 12/01/2019 7,580,000 2.5000 18,950.00 12/01/2020 7,970,000 2.5000 19,925.00 12/01/2021 8,375,000 2.5000 20,937.50 12/01/2022 8,805,000 2.5000 22,012.50 12/01/2023 9,260,000 3.7500 34,725.00 12/01/2024 9,735,000 3.7500 36,506.25 12/01/2025 3,400,000 3.7500 12,750.00 12/01/2025 6,800,000 3.7500 25,500.00 12/01/2026 10,695,000 3.7500 40,106.25 12/01/2027 11,245,000 3.7500 42,168.75 12/01/2028 11,820,000 4.2500 50,235.00 12/01/2029 12,425,000 4.2500 52,806.25 12/01/2030 13,065,000 4.2500 55,526.25 12/01/2031 13,735,000 4.2500 58,373.75 12/01/2032 14,435,000 4.2500 61,348.75 12/01/2033 15,180,000 4.2500 64,515.00 12/01/2034 15,955,000 4.2500 67,808.75 12/01/2035 16,775,000 4.2500 71,293.75 12/01/2036 17,635,000 4.2500 74,948.75 214,890,000 3.8645 830,437.50 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 10 UNDERWRITER'S DISCOUNT City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Underwriter's Discount $/1000 Amount Average Takedown 3.86448 830,437.50 Underwriters' Counsel 0.40000 85,956.00 Management Fee 0.25000 53,722.50 CUSIP 0.00398 855.50 DALCOMP (Bookrunner & Wire Fees)0.06930 14,892.36 Day Loan 0.02864 6,154.11 DTC 0.00372 800.00 4.62012 992,817.97 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 11 COST OF ISSUANCE City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Cost of Issuance $/1000 Amount Financial Advisor Fee 0.89542 192,417.50 Bond Counsel Fee 0.94188 202,401.00 Paying Agent Acceptance Fee 0.00163 350.00 Offical Statement Printing & Distribution 0.02792 6,000.00 Fitch Rating Fee 0.39555 85,000.00 S&P Rating Fee 0.31900 68,550.00 Attorney General Fee 0.04421 9,500.00 Other 0.00826 1,773.97 2.63387 565,992.47 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 12 FORM 8038 STATISTICS City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Dated Date 01/27/2017 Delivery Date 01/27/2017 Redemption Bond Component Date Principal Coupon Price Issue Price at Maturity Serial Bond: 12/01/2019 7,580,000.00 5.000%109.767 8,320,338.60 7,580,000.00 12/01/2020 7,970,000.00 5.000%112.307 8,950,867.90 7,970,000.00 12/01/2021 8,375,000.00 5.000%114.379 9,579,241.25 8,375,000.00 12/01/2022 8,805,000.00 5.000%115.928 10,207,460.40 8,805,000.00 12/01/2023 9,260,000.00 5.000%117.212 10,853,831.20 9,260,000.00 12/01/2024 9,735,000.00 5.000%118.094 11,496,450.90 9,735,000.00 12/01/2025 3,400,000.00 3.250%104.861 3,565,274.00 3,400,000.00 12/01/2025 6,800,000.00 5.000%118.590 8,064,120.00 6,800,000.00 12/01/2026 10,695,000.00 5.000%119.190 12,747,370.50 10,695,000.00 12/01/2027 11,245,000.00 5.000%118.244 13,296,537.80 11,245,000.00 12/01/2028 11,820,000.00 5.000%117.214 13,854,694.80 11,820,000.00 12/01/2029 12,425,000.00 5.000%116.194 14,437,104.50 12,425,000.00 12/01/2030 13,065,000.00 5.000%115.734 15,120,647.10 13,065,000.00 12/01/2031 13,735,000.00 5.000%115.184 15,820,522.40 13,735,000.00 12/01/2032 14,435,000.00 5.000%114.638 16,547,995.30 14,435,000.00 12/01/2033 15,180,000.00 5.000%114.095 17,319,621.00 15,180,000.00 12/01/2034 15,955,000.00 5.000%113.555 18,117,700.25 15,955,000.00 12/01/2035 16,775,000.00 5.000%113.107 18,973,699.25 16,775,000.00 12/01/2036 17,635,000.00 5.000%112.751 19,883,638.85 17,635,000.00 214,890,000.00 247,157,116.00 214,890,000.00 Stated Weighted Maturity Interest Issue Redemption Average Date Rate Price at Maturity Maturity Yield Final Maturity 12/01/2036 5.000%19,883,638.85 17,635,000.00 Entire Issue 247,157,116.00 214,890,000.00 12.6407 2.9961% Proceeds used for accrued interest 0.00 Proceeds used for bond issuance costs (including underwriters' discount)1,558,810.44 Proceeds used for credit enhancement 0.00 Proceeds allocated to reasonably required reserve or replacement fund 0.00 Note: Final Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 13 PROOF OF ARBITRAGE YIELD City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Present Value to 01/27/2017 Date Debt Service @ 2.9960649979% 06/01/2017 3,680,388.89 3,642,882.18 12/01/2017 5,342,500.00 5,210,007.18 06/01/2018 5,342,500.00 5,133,111.50 12/01/2018 5,342,500.00 5,057,350.75 06/01/2019 5,342,500.00 4,982,708.16 12/01/2019 12,922,500.00 11,874,349.77 06/01/2020 5,153,000.00 4,665,152.18 12/01/2020 13,123,000.00 11,705,263.04 06/01/2021 4,953,750.00 4,353,359.28 12/01/2021 13,328,750.00 11,540,436.18 06/01/2022 4,744,375.00 4,047,195.53 12/01/2022 13,549,375.00 11,387,720.96 06/01/2023 4,524,250.00 3,746,334.27 12/01/2023 13,784,250.00 11,245,672.92 06/01/2024 4,292,750.00 3,450,486.08 12/01/2024 14,027,750.00 11,109,002.81 06/01/2025 4,049,375.00 3,159,493.26 12/01/2025 14,249,375.00 10,953,871.15 06/01/2026 3,824,125.00 2,896,318.16 12/01/2026 156,789,125.00 116,996,400.64 308,366,138.89 247,157,116.00 Proceeds Summary Delivery date 01/27/2017 Par Value 214,890,000.00 Premium (Discount)32,267,116.00 Target for yield calculation 247,157,116.00 Jan 19, 2017 1:27 pm Prepared by FirstSouthwest (aml)(Finance 7.017 DENTON:2017_ELC-2017_REV) Page 14 PROOF OF ARBITRAGE YIELD City of Denton, Texas $214,890,000 Utility System Revenue Bonds, Series 2017 (Electric Supported: $225 mm) Tax-Exempt Rates As of 01/19/2017 (AA- / A1) *** Amortized over 20 Years / Cap-I Until Dec. 31, 2018 / 10 Year Call *** *** Final Numbers *** Assumed Call/Computation Dates for Premium Bonds Bond Maturity Call Call Yield To Component Date Rate Yield Date Price Call/Maturity SERIAL 12/01/2027 5.000%2.860% 12/01/2026 100.000 2.8608749% SERIAL 12/01/2028 5.000%2.970% 12/01/2026 100.000 2.9708499% SERIAL 12/01/2029 5.000%3.080% 12/01/2026 100.000 3.0808988% SERIAL 12/01/2030 5.000%3.130% 12/01/2026 100.000 3.1309065% SERIAL 12/01/2031 5.000%3.190% 12/01/2026 100.000 3.1910106% SERIAL 12/01/2032 5.000%3.250% 12/01/2026 100.000 3.2510176% SERIAL 12/01/2033 5.000%3.310% 12/01/2026 100.000 3.3110346% SERIAL 12/01/2034 5.000%3.370% 12/01/2026 100.000 3.3710595% SERIAL 12/01/2035 5.000%3.420% 12/01/2026 100.000 3.4211176% SERIAL 12/01/2036 5.000%3.460% 12/01/2026 100.000 3.4610653% Rejected Call/Computation Dates for Premium Bonds Bond Maturity Call Call Yield To Increase Component Date Rate Yield Date Price Call/Maturity to Yield SERIAL 12/01/2027 5.000%2.860%3.0155152%0.1546404% SERIAL 12/01/2028 5.000%2.970%3.2389444%0.2680945% SERIAL 12/01/2029 5.000%3.080%3.4309080%0.3500092% SERIAL 12/01/2030 5.000%3.130%3.5518488%0.4209423% SERIAL 12/01/2031 5.000%3.190%3.6650704%0.4740598% SERIAL 12/01/2032 5.000%3.250%3.7653164%0.5142988% SERIAL 12/01/2033 5.000%3.310%3.8549928%0.5439583% SERIAL 12/01/2034 5.000%3.370%3.9359030%0.5648436% SERIAL 12/01/2035 5.000%3.420%4.0032138%0.5820963% SERIAL 12/01/2036 5.000%3.460%4.0585666%0.5975013% Note: Final Public Finance www.fitchratings.com January 3, 2017 Public Power / U.S.A. Denton, Texas Utility System Revenue Bonds New Issue Report New Issue Details Sale Information: $224,050,000 Utility System Revenue Bonds, Series 2017. Security: Payable from the net revenues of the combined utility system, including the water, wastewater and electric light and power systems. Purpose: Bond proceeds will be used to finance the development of new peak power generation facilities, fund capitalized interest and pay the costs of issuance. Final Maturity: Dec. 1, 2036. Key Rating Drivers Combined Utility System: The city of Denton, TX owns and operates a combined utility system, providing retail electric, water and wastewater services to the city and surrounding areas. The service area is characterized by manageable population growth, low unemployment rates and income levels modestly below the state average. Transitioning Power Supply: The electric system is transitioning toward a greater reliance on renewable energy and away from coal and market purchased energy. The strategy will be supported by the construction and operation of the 220-MW natural gas-fired Denton Energy Center (DEC). The increased operational risk is mitigated by reduced exposure to market pricing and volatility. Elevated Debt Levels: The system’s projected ratio of debt to funds available for debt service is to rise considerably to 11.3x in fiscal 2017, driven in part by planned debt issuance related to the development of the DEC. However, the rating reflects Fitch Ratings’ expectation that anticipated rate increases, improvement in financial margins and the relatively rapid amortization of the revenue bonds will all contribute to reduced leverage beginning in fiscal 2019. Strong Liquidity Metrics: Liquidity levels are healthy, with approximately 275 days cash on hand at the end of fiscal 2015, and should remain robust, offsetting to some degree the combined system’s increased debt burden. Demonstrated Rate Flexibility: The diversity of revenue from essential electric, water and wastewater services is a credit strength, although the electric system is the largest contributor to overall financial performance. Utility rates can be modified at the discretion of the city council, which has regularly increased rates over the past several years. Rating Sensitivities Reduction in Leverage: The current rating reflects Fitch’s expectation that the utility system will increase funds available for debt service and reduce overall leverage as projected through consistent rate increases, higher electric sales and improved operating margins. Failure to achieve the projected reduction in leverage would likely pressure the rating. Ratings New Issue $224,050,000 Utility System Revenue Bonds, Series 2017 A+ Rating Outlook Stable Key Utility Statistics Fiscal Year Ended 9/30/15 System Type Combined Utility NERC Region ERCOT Annual Revenues ($ Mil.) 229.6 Debt Service Coverage (x) 1.65 Days Operating Cash 275 Equity/Capitalization (%) 50.7 Related Criteria U.S. Public Power Rating Criteria (May 2015) Revenue-Supported Rating Criteria (June 2014) Related Research Fitch Rates Denton, TX’s Utility System Rev Bonds ‘A+’; Outlook Stable (December 2016) U.S. Public Power (Peer Study) (June 2016) Analysts Matthew Reilly, CFA +1 415 732-7572 matthew.reilly@fitchratings.com Rebecca Meyer +1 512 215-3733 rebecca.meyer@fitchratings.com Public Finance Denton, Texas 2 January 3, 2017 Credit Profile The city of Denton is located approximately 35 miles north of the cities of Dallas and Fort Worth and serves as a quickly growing suburb to the greater metropolitan area. Denton provides electric, water and wastewater services through city-owned utilities. The electric system is the largest of the combined utilities and accounts for the majority of the revenues, followed by the water and wastewater systems. Governance and Management Strategy The utility system is governed by the city council, consisting of six elected council members and the city’s mayor. The city council receives and acts upon recommendations and advice provided by the seven-member Public Utilities Board (the board). The board serves as an advisor to the city council and is responsible for reviewing annual budgets, capital improvement plans, system rates and the issuance of debt. The city council has approved all of the board’s rate recommendations to date. Strategically, the three utilities — electric, water, and wastewater — are budgeted for and operated on a self-supporting and stand-alone basis. Each of the separate utilities has board- and council-approved financial policies, including liquidity and debt service coverage targets. A brief presentation of the targets by utility is presented in the table below. Texas Municipal Power Agency Denton, along with the cities of Garland, Bryan and Greenville, created the Texas Municipal Power Agency (TMPA) in 1975. Through TMPA, the cities developed the Gibbons Creek Steam Electric Station (GCSES), located in Grimes County, TX. The single-unit, coal-fired plant has a net capacity of 470 MW and burns Powder River Basin coal. TMPA owns the coal plant and provides power to its four members under identical court- validated, take-or-pay power sales contracts (PSCs) that expire in September 2018. The PSCs financially obligate the members to pay certain expenses to TMPA, including its debt service costs, regardless of actual plant operations. The four members recently approved a joint operating agreement (JOA), effective September 2016. The JOA establishes the framework for how TMPA and its assets and liabilities are to be managed, regardless of whether the PSCs are extended beyond September 2018. TMPA’s assets and operations are divided into three business lines under the JOA: generation, transmission and mining. Denton, Garland and Bryan agreed to continue as TMPA members along all three business lines after Rating History Rating Action Outlook/ Watch Date A+ Assigned Stable 12/29/16 Liquidity and Debt Service Coverage Targets Electric Water Wastewater Liquidity Reserve Target (Days) 60–75a 120–180 100–140 Debt Service Coverage (x) 1.25 1.25 1.25 aTexas Municipal Power Agency debt payments are not included in the city’s liquidity reserve calculation. Source: Denton (TX). TMPA Participation Shares City Share (%) Garland 47.0 Denton 21.3 Bryan 21.7 Greenville 10.0 Source: Denton (TX). Public Finance Denton, Texas 3 January 3, 2017 September 2018. Greenville chose to continue as a transmission and mining member, but opted not to continue as a generation member. The JOA allocates costs, ownership interests, decommissioning and remediation responsibilities to members based on their participation share. Denton’s participation share is 21.3%. Customer Profile and Service Area The utilities serve an area characterized by strong employment gains, a low unemployment rate, a growing workforce and below-average income levels. The city is known for its institutions of higher education and regionally prominent medical sector. Denton is home to the University of North Texas and Texas Woman’s University, with combined enrollment exceeding 48,500. The city’s growing heath care facilities serve north Texas and southern Oklahoma. These institutions include Columbia Medical Center Denton, Texas Health Presbyterian Hospital and The Heart Hospital Baylor Denton. Electric System Denton’s electric system serves an approximately 60-square-mile, single certified area within the city of Denton’s city limits and an additional 53-square-mile area that is multiple certified outside the city’s boundaries. The city has not opted in to retail competition, so its customers in the single certified area are generally unable to change electric providers. However, the system does face competition with respect to new customers who move into the multiple certified area. Approximately 5.5% of Denton’s electric customers reside in the multiple-certified area. The electric system served approximately 51,085 customers in fiscal 2016. The customer base is largely residential, comprising approximately 88% of total customers. However, commercial and industrial customers drive the majority of total MWh sales, accounting for approximately 64% of total MWh sold in fiscal 2016. All system sales are retail, with no exposure to wholesale markets. Customer concentration is moderate, with the top 10 ratepayers providing approximately 18% of electric revenues and 28% of total MWh sales in fiscal 2016. The largest customer accounted for 9% of MWh sales and 4.6% of electric revenues. The diversity of the pledged revenues from the combined utility systems further mitigates concentration risks. Annual MWh sales tend to fluctuate with weather conditions, particularly in response to summertime temperatures when the system experiences its peak demand. The graph below shows the annual variation in MWh sales during 2011–2016. (4.0) (2.0) 0.0 2.0 4.0 1,320,000 1,360,000 1,400,000 1,440,000 1,480,000 2012 2013 2014 2015 2016 (MWh) MWh Sales Trends —2012–2016 Total Retail Sales YoY Change in Retail Sales Source: Denton (TX), Fitch. (%) Public Finance Denton, Texas 4 January 3, 2017 Water System The water system provides retail water service to a growing customer base within the city and sells raw and treated water wholesale to the Upper Trinity Regional Water District (UTRWD) for resale to two of its customer cities. Wholesale sales comprised less than 2% of total gallons sold in fiscal 2015. The water system’s top 10 customers reflect relatively stable entities, including the University of North Texas, the local school district and local health centers and hospitals. In fiscal 2016, the top 10 customers comprised approximately 10% of water revenues. Wastewater System The wastewater system provides retail wastewater collection and treatment service to a growing customer base within the city and to four wholesale customers. The four wholesale customers — the cities of Corinth, Krum, Argyle and the Lake City Municipal Authority — made up less than 1% of the wastewater system average volume in fiscal 2015. Assets and Operations Electric System Denton’s electric system is undergoing a significant change in its power supply and operational profile. The system has historically relied on GCSES and market purchases to provide the bulk of the system’s power supply. However, under the city’s Renewable Denton Plan (RDP), renewable energy is expected to increase to approximately 70% of the system’s power supply, supported by the DEC, a newly built, directly owned 220-MW natural gas-fired peaking plant. Fitch views the transition as presenting some additional operational risks, as the system has historically not owned or operated generation resources. However, these risks are offset to some degree by the contracting of renewable energy resources at generally fixed rates for the bulk of the system’s power supply, decreasing the system’s exposure to potentially volatile market pricing. Public Finance Denton, Texas 5 January 3, 2017 Gibbons Creek Steam Electric Station Denton’s primary source of power over the past decade has been TMPA’s 470-MW GCSES. While the plant’s operational availability remains sound, its competitive position has eroded over the past few years as low natural gas prices and a significant increase in wind generation in ERCOT have combined to reduce market power prices. TMPA’s decision in fiscal 2016 to place GCSES in reserve shutdown for a little over a month following a scheduled outage reflected the change in market dynamics. TMPA members have authorized a potential sale of GCSES, and an agreement has been reached with two potential buyers. The buyers are currently completing their due diligence, with a signing of the sales agreement expected in early 2017. The purchase price under the two sales agreements is $57.5 million for GCSES. The purchaser for GCSES has also agreed to post $35 million towards an environmental escrow and a letter of credit for $25 million for environmental purposes. A related transaction to a separate buyer includes the sale of approximately 25% of TMPA’s transmission assets for the price of $71.5 million. Fitch views the potential sale as a credit positive, but insufficient on its own to materially affect the current rating. Benefits from the potential transaction include the use of the proceeds to pay down a portion of TMPA’s outstanding debt, reducing Denton’s obligations by a modest amount. More significantly, the sale of GCSES would eliminate Denton’s and other member cities’ exposure to decommissioning and other environmental liabilities, allowing for potentially significant future savings. Failure to complete the sale would be unlikely to affect the current rating, as TMPA would retain the option to pursue other sales opportunities while continuing to run the plant at the reduced levels of the past few years. Renewable Denton Plan and Denton Energy Center The city’s RDP calls for increasing renewables as a percentage of the city’s power supply to 70% by 2019. The plan outlines the renewable resource balance as 52% from wind, 17% from solar and 1% from locally owned landfill gas. Wind and solar resources are expected to be secured under long-term power purchase agreements at generally fixed prices. Wind energy supplied approximately 10% of system needs in fiscal 2016. Negotiations for additional resources are ongoing, with the expectation that most of the needed resources will be secured under contract by the end of 2017. The RDP also calls for the development and operation of the DEC, a 220-MW natural gas-fired electric generation facility consisting of 12 separate reciprocating internal combustion engines. The DEC is designed to economically supply power to firm up intermittent wind and solar resources. In addition, the DEC will act as a physical hedge against high market prices, with the DEC utilized when cheaper than purchasing power from the market and vice versa, effectively hedging against the risk of high peak power prices. Management estimates that the DEC will supply approximately 13% of the system’s power needs. The RDP projects that short-term purchased power will contribute approximately 17% of the system’s energy needs. Management will continue to hedge the system’s exposure to potentially volatile market prices by securing needed supply three to six months ahead of time and layering contracts. Gibbons Creek Operating Statistics (%) Fiscal Year Availability Capacity Factor 2015 79.9 55.3 2016 84.5 38.8 Source: TMPA. Public Finance Denton, Texas 6 January 3, 2017 Water System The city’s water system consists of two water treatment plants, 618 miles of water mains, 14 million gallons of ground storage, and 11 million gallons of elevated storage. The system provides water to all customers within the city of Denton and to the UTRWD for resale to the cities of Sanger (population 7,601) and Krum (population 4,919). Denton’s water system has sufficient water supply to meet projected needs. The city has a combined 24.62 million gallons per day (MGD) of available surface water from the Ray Roberts Reservoir and the Lewisville Reservoir, which is adequate to meet the city’s retail and wholesale treated water volume of approximately 17.26 MGD (fiscal 2016). Likewise, the systems treatment capacity is viewed as adequate to meet demand. The system’s two treatment plants provide 48.75 MGD of treatment and pumping capacity, providing a significant cushion relative to the maximum volume pumped to date of 37.52 MGD in 2011. Wastewater System The city’s wastewater system provides retail wastewater collection and treatment to all customers within the city and to four wholesale customers. The system consists of 521 miles of gravity wastewater lines, 25 miles of force mains and 27 lift stations. The system’s total permitted treatment capacity is 21 MGD, which is sufficient to meet the average demand of 16.74 MGD (2016). The four wholesale customers accounted for approximately 0.89 MGD of treatment volume in 2016. Cost and Rate Structure The city council has the authority to establish and modify rates for each of the utility systems without state or federal oversight. Regular rate increases over the past several years have demonstrated the council’s willingness to increase rates as necessary. A brief history of recent base rate increases by utility is provided in the table below. Please note that the electric system rate changes based on the energy cost adjustor are not reflected in the table. Electric Rate Structure The electric system’s rate structure is viewed as a credit positive, as it provides the utility with the flexibility to recapture potentially volatile energy costs in a timely manner. The structure includes a fixed charge, a volumetric charge, an Energy Cost Adjustment Factor (ECA) and a Transmission Cost Recovery Factor (TCR). The ECA is designed to capture and pass through to customers the utility’s fuel and purchased power costs. The ECA is adjusted on a quarterly basis to stay within a $5 million range. The Average Retail Rate Increase by Utility System (%) Fiscal Year Electric Water Wastewater 2017E 4.5 5.0 2.0 2016 4.5 5.0 2.0 2015 4.7 3.0 6.0 2014 2.5 — 9.0 2013 — — 9.0 E – Expected. Source: Denton (TX). Public Finance Denton, Texas 7 January 3, 2017 general manager of the electric system recommends adjustments to the board on a quarterly basis, when the $5 million threshold is projected to be breached. The electric utility also has a TCR that is designed to capture and pass through to customers the utility’s net transmission costs. This has provided another valuable means for capturing increasing fixed costs following ERCOT’s build-out of its transmission system. Financial Performance and Legal Provisions The financial performance of the combined utility system is largely driven by the electric system, which accounted for an average of 48.7% of the combined system’s net operating revenues during fiscal 2011–2016. The water system and the wastewater system contributed approximately 30.6% and 20.8%, respectively. A breakdown of the combined system’s net operating revenues by utility is provided in the chart below. As shown in the chart, the electric system’s financial performance was noticeably weaker in fiscals 2013 and 2014. This was largely driven by the ongoing but temporary period of increased TMPA obligations, including TMPA debt service costs, that runs through fiscal 2018. Denton’s payment of its respective share of TMPA’s O&M and debt service costs is recorded as a purchased power expense. Once the final payment on TMPA’s generation debt is made in fiscal 2018, Denton expects purchased power costs will decline by approximately $33 million. However, DEC operations are expected to increase operation expenses by $7 million– $9 million, offsetting some of the expected savings. The financial performance of the combined utility system will become increasingly dependent on the electric system after 2018. With the reduction in TMPA obligations that begins in fiscal 2019, Denton’s electric system will contribute approximately 75% of the projected net operating revenues for the combined utility system. Recent Financial Metrics The financial metrics of the combined utility system are relatively low but adequate for the rating. Fiscal 2015 debt service coverage and coverage of full obligations was 1.65x and 1.14x, respectively. Preliminary and unaudited financial reports for fiscal 2016 reflect Fitch-calculated coverage metrics of approximately 1.70x and 1.10x, respectively. Liquidity levels for the combined utility system are healthy, with approximately $119.8 million in unrestricted cash and investments, or 275 days cash on hand, at the end of fiscal 2015. Liquidity levels are expected to increase in fiscal 2016 to approximately $158.6 million 0 20 40 60 80 100 2011 2012 2013 2014 2015 2016 Average(2011–2016) (%) Combined Utility System Net Operating Revenue by Utility Electric Water Wastewater Source: Denton (TX). Public Finance Denton, Texas 8 January 3, 2017 (unaudited), due in part to the release of certain bond funds following recent refundings. A portion of the increased reserves are expected to be spent on capital projects in fiscal 2017. The combined system’s cash balances have declined moderately over the past several years as funds have been used for capital needs and to meet increased TMPA obligations. Additional draws are expected, including a planned $17 million use of reserves in fiscal 2017, although cash balances are projected to stabilize at still-sound levels thereafter. Financial Outlook Projected financial metrics are adequate for the rating and relatively consistent with recent performance. Fitch-calculated all-in debt service coverage ratios are projected to remain in the 1.60x–1.90x range through fiscal 2021, with the notable exception of fiscal 2018 when coverage is expected to decline to a low of 1.19x. Fiscal 2018 is the final year of elevated TMPA costs for the electric system as the outstanding generation debt is repaid. Increasing debt service costs through 2021 will keep coverage levels relatively low over the period despite improving financial margins driven by lower electric system costs after 2018. Management’s financial projections are based on several assumptions, including 2.5% annual electric load growth, 4.5% annual electric rate increases in fiscals 2017–2019 and the realization of approximately $25 million in non-contracted wholesale electric revenue beginning in fiscal 2019. An inability to achieve these assumptions could result in weaker-than-expected financial performance. General Fund Transfers Each of the utility systems pays three separate transfer amounts to the city’s general fund. The transfers include an indirect cost allocation, a “rate of return” to the city authorized in the city charter and a payment in lieu of franchise taxes. While the indirect cost allocation transfer is considered an operating expense by the utilities, the rate of return and payment in lieu of franchise taxes transfers are subordinate to debt service per the city ordinance authorizing the revenue bonds. The transfer amounts have been relatively stable over the past several years. The indirect cost allocation amount is established by an independent consultant. The rate of return and payment in lieu of franchise taxes are set at 3.5% and 5%, respectively, of each utility system’s revenues. Debt Profile The senior lien revenue bonds are expected to comprise approximately 25% of the combined utility system’s total outstanding debt in 2017. The majority of the debt is in the form of general obligation (GO) bonds and certificates of obligation (CO) that are issued and secured by the general government, but actually paid from the underlying utility systems. All of the outstanding debt is fixed-rate. Fitch’s coverage and debt calculations include the GO and CO bonds and the respective debt service paid by the utility systems. The combined utility system’s debt metrics are elevated, projected at 11.3x debt/FADS in fiscal 2017. The rating incorporates the combined utility system’s plans for around $343 million in additional GO bonds and a potential issuance of $40 million in revenue bonds over the next five years. The relatively high debt load reflects the systems’ significant investment in additional generation, transmission and other investments. The relatively quick repayment period, including the 20-year amortization rate on the revenue bonds, together with improved operating Public Finance Denton, Texas 9 January 3, 2017 earnings is expected to reduce the elevated debt/FADS ratio beginning in 2019 and restore future debt capacity, if needed. Legal Provisions The bond’s legal provisions are viewed as permissive but adequate for the rating. The bonds are payable from a first lien on the net revenues of the combined utility system. Operating costs are defined in the ordinance to include transfers of indirect costs, but exclude return on investment and payment in lieu of franchise tax transfers. The bonds feature a sum-sufficient rate covenant and do not have a debt service reserve fund. Public Finance Denton, Texas 10 January 3, 2017 Financial Summary — Denton (TX) ($000, Audited Years Ended Sept. 30) 2011 2012 2013 2014 2015 Debt Service Coverage (x) Debt Service Coverage 4.6 1.9 1.3 1.3 1.7 Adjusted DSC (Including Purchased Power Adjustment as D/S) 2.3 1.5 1.2 1.1 1.4 Adjusted DSC (Including Transfer/PILOT/Dividend as O&M Expense) 3.5 1.5 0.9 0.8 1.3 Coverage of Full Obligations (PP as D/S and Transfer/PILOT/Dividend as O&M Expense) 2.0 1.3 0.9 0.9 1.1 Liquidity Metrics Days Cash and Investments on Hand 415.1 451.3 337.9 283.5 275.4 Days Liquidity on Hand 415.1 451.3 337.9 283.5 275.4 Leverage Metrics Debt/FADS (x) 5.7 5.8 8.4 9.4 7.1 Adjusted Debt (Including PP Adj.)/Adjusted FADS (Including PP Adj.) (x) 6.3 6.4 8.3 8.8 7.4 Debt/Total Retail Customers 3,443.5 3,520.5 3,621.2 4,097.8 4,466.5 Net Debt/Net Capital Assets (%) 43.7 41.1 44.0 51.3 53.5 Equity/Capitalization (%) 54.9 55.5 54.9 52.2 50.7 Debt/Capitalization (%) 45.1 44.5 45.1 47.8 49.3 Adjusted Debt/Capitalization (%) 55.5 54.7 57.0 59.1 59.1 Other Financial & Operating Metrics Operating Margin (%) 25.2 24.5 14.9 14.3 21.7 Retail Electric Revenue/kWh (Cents/kWh) 9.1 9.5 9.7 10.4 11.3 Transfer and PILOT and Tax/Total Operating Revenue 0.3 0.4 0.4 0.5 0.7 Capex/Depreciation and Amortization (%) 215.7 242.7 314.6 389.7 411.2 Debt Service/Cash Operating Expenses (%) 10.4 21.6 19.8 19.9 21.6 Income Statement Total Operating Revenue 186,359 189,645 197,126 208,666 229,583 Total Operating Expense 139,416 143,145 167,855 178,900 179,740 Operating Income 46,943 46,500 29,272 29,766 49,844 Adjustment to Operating Income for Deferred Revenue 18,286 19,236 18,733 19,784 22,478 Funds Available for Debt Service 65,229 65,736 48,004 49,550 72,322 Total Annual Debt Service 14,271 34,484 37,143 39,756 43,722 Balance Sheet Unrestricted Funds (Cash and Liquid Investments) 139,272 155,025 138,938 124,553 119,781 Restricted Funds 95,370 98,204 107,779 129,929 142,112 Total Net Assets/Member's Equity 447,800 476,564 492,549 505,466 526,301 Total Debt 368,396 382,703 403,996 463,410 512,604 Cash Flow Statement FCF (FADS – Transfer and PILOT – Total Annual Debt Service) 36,014 16,094 (4,572) (6,516) 10,742 Capex 36,556 43,101 55,831 72,319 86,200 FCF Less Capex (543) (27,007) (60,402) (78,836) (75,458) DSC – Debt service coverage. D/S – Debt service. PP – Purchased power. FADS – Funds available for debt service. PILOT – Payment in lieu of taxes. Source: Denton (TX), Fitch. Public Finance Denton, Texas 11 January 3, 2017 ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. 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