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2021-005 S&P Global RatingsDate: January 15, 2021 Report No. 2021-005       INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: S&P Global Ratings for Utility System Revenue Extendable Commercial Paper Notes. BACKGROUND: The purpose of this report is to inform the City Council of S&P’s rating for the newly adopted utility system revenue extendable commercial paper program. On December 18, 2020, staff participated in a rating conference call with S&P regarding the City’s extendable commercial paper program. DISCUSSION: On January 12, 2021, the City received the rating of A-1+ from S&P on our utility system revenue extendable commercial paper (UECP) rating. The rating of A-1+ is the highest rating offered by this agency on short-term issuer credit ratings. The UECP rating is based on the long-term creditworthiness of the city’s combined utility system, based on S&P’s “Methodology For Linking Long-Term Ratings” (April 2017). S&P also affirmed the long-term ‘AA-‘ rating on the system’s revenue secured debt. The outlook on the long-term rating is stable. The rating also reflects S&P’s opinion of the combined utilities very strong enterprise risk profile, including its:  Very strong operational management assessment, as evidence by the electric system’s recent transition to more renewable power supply and annual updates to its multiyear capital planning and financial forecasts;  Adequate market position. The electric system’s average rate revenue remains greater than the state average, although we positively view the presence of an energy cost adjustment (ECA) that management reviews quarterly; and  Very strong economic fundamentals, reflected by the combined utility’s residential customer base, lack of customer concentration, and Denton’s participation in the broad and deep Dallas- Fort Worth metropolitan statistical area. The rating also reflects the combined utility’s very strong financial risk profile including:  Fixed-cost coverage (FCC) that averaged a very strong 1.5x annually over fiscal years 2017- 2019; and  Extremely strong liquidity and reserves. For your review, staff has attached the Credit Opinion report from S&P. Only one rating was needed for the extendable commercial paper program, therefore, no other short-term ratings reports are expected. ATTACHMENT: S&P Credit Opinion Report S&P Ratings Chart Date: January 15, 2021 Report No. 2021-005       STAFF CONTACT: Cassey Ogden, Director of Finance (940)-349-7195 Cassandra.Ogden@cityofdenton.com   11511 Luna Road Suite 500 Farmers Branch, TX 75234 tel (214) 871-1400 reference no.: 1647179 January 12, 2021 City of Denton 215 E. McKinney Denton, TX 76201 Attention: Mr. David Gaines, Assistant City Manager/CFO Re:US$100,000,000 Denton, Texas, Utility System Revenue Extendable Commercial Paper Notes Program, Series A, dated: Date of delivery, due: January 12, 2031 Dear Mr. Gaines: Pursuant to your request for an S&P Global Ratings rating on the above-referenced obligations, S&P Global Ratings has assigned a rating of "A-1+" . S&P Global Ratings views the outlook for this rating as not meaningful. A copy of the rationale supporting the rating is enclosed. This letter constitutes S&P Global Ratings' permission for you to disseminate the above-assigned ratings to interested parties in accordance with applicable laws and regulations. However, permission for such dissemination (other than to professional advisors bound by appropriate confidentiality arrangements or to allow the Issuer to comply with its regulatory obligations) will become effective only after we have released the ratings on standardandpoors.com. 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PF Ratings U.S. (4/28/16)Page | 4 Summary: Denton, Texas; CP; Combined Utility Primary Credit Analyst: Theodore A Chapman, Farmers Branch + 1 (214) 871 1401; theodore.chapman@spglobal.com Secondary Contact: Timothy P Meernik, Centennial + 1 (303) 721 4786; timothy.meernik@spglobal.com Table Of Contents Rating Action Stable Outlook Credit Opinion Related Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 12, 2021 1 Summary: Denton, Texas; CP; Combined Utility Credit Profile US$100.0 mil util sys rev extendable cml pap nts prog ser A due 01/12/2031 Short Term Rating A-1+ New Denton comb util Long Term Rating AA-/Stable Affirmed Rating Action S&P Global Ratings assigned its 'A-1+' rating to the city of Denton, Texas' series A utility system revenue extendable commercial paper (ECP) program. The authorizing resolution permits the city to issue both tax-exempt and taxable notes, so long as the total amount outstanding does not exceed the authorized size of the program, currently $100 million. The ECP rating is based on the long-term general creditworthiness of the city's combined utility, based on our "Methodology For Linking Long-Term And Short-Term Ratings" (April 7, 2017). S&P Global Ratings also affirmed its long-term 'AA-' rating on the system's revenue-secured debt. The outlook on the long-term rating is stable. The CP notes are secured by a subordinate-lien pledge on the net revenues of the city's combined electric, water, and wastewater system. In the event that the city needs to extend CP note maturities to 270 day from 90 days--for which the city already has codified policies that speak to timing and who among staff is responsible for each particular task--the notes would revert to the maximum interest rate of 10% if they are tax-exempt, or 12% for taxable notes. Because the series A program is not supported by a revolving credit agreement or even a letter of credit, we do not expect nor are we assuming for rating purposes that the city maintains sufficient cash on hand to retire outstanding notes in the event they cannot be rolled over. Instead, we understand that the city council will adopt a parameters resolution each year that delegates the staff the authority to issue revenue bonds to convert outstanding notes to long-term debt. With the six-month window afforded by the ability to extend note maturities plus the authorization to issue revenue bonds to retire the notes, it is our view that any risks outlined in our "Contingent Liquidity Risk" criteria (March 5, 2012) are sufficiently remote. A first-lien pledge of net revenues of Denton's combined electric, water, and wastewater systems secures the approximately $680 million in long-term debt outstanding as of fiscal year-end 2020. Most of the allocable debt--more than $450 million--are general obligation bonds and other tax-secured debt that was issued on behalf of the utility and is self-supported by surplus net revenues. In fiscal 2019, the electric system alone accounted for just over half of net revenues available for debt service, making it the focus of our analysis. Credit overview Denton's combined utility provides electric (about 54,500 accounts), water (37,000), and wastewater (35,000) service WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 12, 2021 2 to a primarily residential customer base 35 miles north of Dallas in Denton County. The electric system derives its power primarily from renewable purchased power agreements, which accounted for more than 60% of energy in fiscal 2019. The renewable portfolio is backed by market purchases and 12 city-owned quick-start combustion gas engines that provide 225 megawatts (MW) in peaking capacity. Our analysis incorporates the financial contribution of each utility system to the combined utility's capacity to meet its financial obligations. We applied our retail electric and gas utilities criteria in performing the analysis because the electric system's net revenue represents a preponderance of net revenue available to service the debt. In fiscal 2019, the electric system provided about 55% of net revenue, the water system 28%, and the wastewater system 17%. The rating reflects our opinion of the combined utility's very strong enterprise risk profile, including its: • Very strong operational management assessment, as evidenced by the electric system's recent transition to a more renewable power supply and annual updates to its multiyear capital planning and financial forecasts; • Adequate market position. The electric system's average rate revenue remains greater than the state average, although we positively view the presence of an energy cost adjustment (ECA) that management reviews quarterly; and • Very strong economic fundamentals, reflected by the combined utility's residential customer base, lack of customer concentration, and Denton's participation in the broad and deep Dallas-Fort Worth metropolitan statistical area. The rating also reflects our view of the combined utility's very strong financial risk profile, including its: • Fixed-cost coverage (FCC) that averaged a very strong 1.5x annually over fiscal years 2017-2019; • Extremely strong liquidity and reserves; and • A sizable capital plan that is likely to include substantial additional debt. The stable outlook reflects our view of the combined utility's mainly residential customer base, as well as the electric system's diverse power supply both as to supplier and fuel mix. The combined utility's unrestricted reserves provide financial flexibility to meet near-term challenges, including the economic effects of the pandemic on utility sales. A large, growth-driven capital plan that includes additional borrowing, however, could pressure the long-term financial profile. Environmental, social, and governance factors The combined utility has taken steps in recent years to reduce its carbon footprint and meet potential greenhouse gas emission regulations, given that its power supply centers on renewables and natural gas-fired peaking generation and has shifted away from coal. In February 2018, the city council adopted the Denton Renewable Resource Plan, which set a goal to generate 100% of the city's annual electricity from renewables by 2020. While the electric system still uses natural gas-fired generation and market purchases (which are generally gas-fired) to meet demand during peak periods, renewable sources provided more than 60% of energy requirements in fiscal 2019. The electric system executed PPAs for additional solar power in fiscal 2020. Through the early months of the pandemic, the city suspended shutoffs and disconnections of customers for health WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 12, 2021 3 Summary: Denton, Texas; CP; Combined Utility and safety purposes. Although shutoffs resumed in August 2020, management will not assess penalty fees at least through March 2021, and the city continues to work with third-party non-profits for customer bill-pay assistance. The city used federal relief money plus some of its own reserves to further bolster the programs. We view governance-related characteristics as in line with those of comparable municipal utility systems. The city council is the final approver for base-rate adjustments, the annual budget, and the issuance of debt. The city has a long history of timely audits and continuing disclosure that we view as typical for the public finance universe. Stable Outlook Downside scenario If the impacts of the additional debt were to outstrip the currently ample financial capacity and weaken FCC over time to a level that is consistently below 1.4x, we could lower the rating. Upside scenario If, as S&P Global Economics projects, credit conditions for all governments and their related utilities face headwinds such as elevated unemployment for the next several years because of a potentially uneven and prolonged recovery, this could increase the likelihood of unfavorable variances to budget. Attainment of a higher rating would therefore be predicated mainly on the utility system's financial results far outstripping the forecast and at a level we would view as sustainable. Credit Opinion Enterprise risk profile The electric system's power supply has transitioned away from coal and now centers on contracted PPAs of renewable energy, natural gas-fired peaking capacity, and market purchases when doing so is economic. The electric system's Denton Energy Center, consisting of 12 quick-start combustion turbines with a capacity of 225 MW, began operations in July 2018. In fiscal 2019, the electric system derived 63% of its power supply from several PPAs (largely wind and solar), 22% from spot or day-ahead market purchases (which in Texas' market are usually gas-fired), and 15% from owned generation (natural gas). We view positively the number of projects from which the electric system gets power, reducing supply risk. The electric system is compliant with all environmental regulations. The combined utility's management annually updates its multiyear capital planning and financial forecasts. We view the planning and forecasts as credit positive because they can provide direction, identify problems, and require a forward-looking view. The electric system's weighted-average revenue per kilowatt-hour as a percentage of the state average was 117%, according to 2019 data from the U.S. Energy Information Administration. We believe that the electric system's rate-raising flexibility is limited given the rates are above the state average. The city did not implement a base-rate adjustment for any system in fiscal 2021 nor has it had to do so over the past five years, and in fact reduced water rates by 2% in 2020. Nor is the city planning to adjust base rates in the upcoming five years. The electric system has an ECA to recover changes in power costs. In our view, the ECA is a credit positive because it allows the electric system WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 12, 2021 4 Summary: Denton, Texas; CP; Combined Utility to adjust rates when costs for purchasing power (or fuel) change. For the water and wastewater systems, the combined bill for a residential customer consuming 6,000 gallons per month is $74.70, or about 1.9% of median household effective buying income. In our view, the water and wastewater rates are affordable. In fiscal 2019 for the electric system, residential customers made up about 88% of customer accounts, 39% of kilowatt-hour sales, and 44% of revenue. We believe that residential customers provide stability, as residential sales are less volatile than commercial and industrial sales. Customer concentration is limited for the combined utility. In fiscal 2019, the top customer accounted for about 4% of the combined utility's revenue, while the top 10 customers accounted for 14%. The city's median household effective buying income is 91% of the national rate, skewed somewhat by the large number of college students living in Denton, chiefly the University of North Texas and Texas Woman's University, both of which had a mix of in-person and virtual enrollment in fall 2020. In November 2020, the unemployment rate in Denton was 6.4%, half of what it was in April 2020 and in line with the region's and nation's levels. Financial risk profile The combined utility's FCC was 1.43x in fiscal 2019, 1.8x in fiscal 2018, and 1.27x in fiscal 2017, all generally strong, in our view. FCC is S&P Global Ratings' adjusted debt service coverage metric that incorporates all use of utility operating revenues regardless of lien or accounting treatment, and also treats certain mandatory minimum costs as if they were debt service payments of the city even if they are in actuality operating expenses. We make these adjustments to inform our view of true financial capacity as well as to improve comparability between peer utilities. The city has represented that despite the macroeconomic conditions, COVID-19 has not had a material impact on cash flow. Still, management also implemented a number of cost-saving measures in fiscal 2020 to avoid any unfavorable variance to budget. Furthermore, management is projecting declining purchased power expenses over the next five years, while also assuming that revenue from the Denton Energy Center declines as renewable generation increases throughout the Electric Reliability Council of Texas market. The combined utility's unrestricted reserves totaled $181 million, equivalent to about nine months of operating expenses, at the end of fiscal 2019. In its long-term financial forecast for each of the three utility divisions, management considers beginning-of-the-year reserves to be available for appropriation, although the forecast also indicates operating reserves will be well above the respective targets of: • Electric: equivalent to 60-75 days of operating expenses; • Water: 120-180 days; and • Wastewater: 100-140 days. We believe that this amount of liquidity provides sufficient cushion to any lingering effects of the pandemic on the economy and customer accounts receivable. The extremely strong available reserves also provide the city the discretion if it chooses to strategically deploy cash toward the capital plan, which is substantial. The plan contains $501 million in capital commitments through fiscal 2025, about $385 million of which will be financed with additional debt. Currently, the only cash slated to be used to fund capital projects will be impact fees. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JANUARY 12, 2021 5 Summary: Denton, Texas; CP; Combined Utility Related Research • Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020 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. 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