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City’s financial advisors warn against delay on raising electric rates

Thursday, January 19, 2012 by Bill McCann

While the Austin City Council is mulling over what to do about electric rates, the city’s outside financial advisors have sent a strong warning that without a rate increase Austin Energy faces a possible downgrade of its bond ratings.


A downgrade would mean the city-owned electric utility would have to pay more to borrow money for major construction projects – with ratepayers footing the added costs, according to the financial experts.


The warning came in a memorandum to Austin Energy General Manager Larry Weis from two officials of Public Financial Management, Inc. (PFM), the financial advisor to both the city and Austin Energy. 


“PFM cannot overestimate the importance of AE moving forward in a timely manner with its rate case,” Dennis Waley and Bill Newman said in the memo, dated Dec. 13. Council received a copy of the memo yesterday as an attachment to a letter from Philip Schmandt, chair of the seven-member Electric Utility Commission (EUC).


In Wednesday’s letter, Schmandt pointed to the warning memo from the financial advisors and echoed their concerns.


Two successive years of budget deficits and a depletion of key reserves to zero, as well as the warning from the financial advisors, “demonstrates the urgent need, in my mind, to take decisive action (to) avert a serious and structural financial crisis in your utility,” Schmandt said. He said he believed the urgent need to act was the reason for the many broad consensus votes for the rate package by the EUC.


The December memo included documentation from the three national bond-rating services – Standard & Poor’s, Fitch Ratings and Moody’s Investor Service – about Austin Energy’s financial condition — to support the advisors’ warning. The memo did not mention a recommended timetable for approval or an amount of increase but it was sent to Weis the day before he made a rate presentation to Council.


In their memo, Waley and Newman pointed out that Austin Energy’s two key financial indicators – debt service coverage and system equity – have declined significantly.


“Our concern is that this decline in financial margins may well lend itself to a reduction in AE’s bond ratings unless positive, near-term action (in the form of a rate increase) is taken to remedy the problem,” they wrote.   


Impacts of a downgrade include significantly higher costs of borrowing, potential loss of buyers who formerly bid on Austin Energy bond sales, and declines in the value of the portfolio of existing bondholders, Waley and Newman said. 


In addition, electric ratepayers would see added costs to their bills, and it could take the utility many years to regain its bond ratings, they said, adding that a 1 percent increase in borrowing rates would increase the cost of a $100 million bond sale by $1 million annually.


The Council, which has the final say on rates, has held one lengthy public hearing and two work sessions so far on the rate package proposed by Austin Energy. The utility submitted its proposal to the Council at a work session on Dec. 14 following months of discussions and hearings at meetings of the advisory EUC last summer and fall. The rate package includes a major rate restructuring, and a rate increase that averages about 12 percent systemwide. For residential users, the increase would average about 20 percent.  


Austin Energy officials have argued that the rate increase is needed in part to get the utility back on firm financial footing. The utility has been operating at a deficit the past few years, digging heavily into reserves to break even.


The rate package has drawn widespread opposition from consumer and other groups, and from Mayor Lee Leffingwell, who announced on Sunday his opposition to the package, as proposed. The Council is planning to hold at least one more public hearing on Feb. 2. But there is no indication as yet when the Council might take a final vote.


At the same time, a newly formed group of residential ratepayers living outside the city is waiting in the wings to take the case to the Public Utility Commission if any rate plan approved by the Council does not address the group’s list of concerns. (See In Fact Daily, Jan. 17, 2012.)


Also, a loose coalition of consumer advocates came out this week with an “electric rate change action plan” in which they recommend that the Council put off new rates until 2015 when special contracts with industrial ratepayers expire.


Austin Energy spokesman Ed Clark said Wednesday the utility is working on options to address concerns expressed by Council members and hopes to deliver those options to the Council by late January to be available in advance of the Feb. 2 hearing. These will include options related to the size and timing of a rate increase, Clark said. 


“But waiting three years or even one year to begin addressing our financial needs would put the financial integrity of the electric utility at serious risk,” Clark added.


Schmandt’s letter was a follow-up to a Tuesday Council work session at which Schmandt and other EUC members were invited to discuss rates. Schmandt told the Council that the rate package would not only help stabilize the utility financially but would put it in position to meet the ambitious goals – such as the 800-megawatt energy demand savings  by 2020 – that the Council has set.


Warning that Austin Energy faces a possible revenue shortfall of $2 million a week in 2012, the EUC, at its December meeting recommended, on a 4-3 vote, that the Council move quickly to set new electric rates.

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