DALLAS - Moody's Investors Service yesterday upgraded the San Antonio Electric & Gas system's debt to Aal on the eve of a $669.1 million refunding by the utility.

The one-notch upgrade makes San Antonio one of only three city utilities in the nation with a rating that high from Moody's, which has no triple-A-rated local utilities.

"It's the highest rating they've ever had," said Chris Evangel, vice president at Moody's. The old Aa on the utility's outstanding debt, which totals some $2.8 billion, had been awarded October 1975.

The rating comes as a syndicate led by First Boston Corp. and Merrill Lynch & Co. is scheduled to price today's negotiated deal. It will be the largest single transaction ever for a local issuer in Texas.

"We're real pleased with the upgrade," said Don Thomas, manager of financial services for the utility. "They have indicated to us that the reason is our low need for debt and our fiscal record."

Added Howard Freeman, assistant general manager for finance at the utility, "We made the pitch that we thought we were ready for an upgrade, that we have minimized a lot of concerns they had had in the past."

The system's outstanding debt is rated AA by Fitch Investors Service and Standard & Poor's Corp. Standard & Poor's has the rating under review.

Underwriters had originally planned the sale next week, but decided to price the transaction today ahead of next week's large Treasury auction.

An improving market also was a factor in timing the deal so soon after a large San Antonio general obligation refunding bond issue.

"When we saw the way the market was moving, we wanted to get in while the market was hot," Mr. Freeman said. "We'd expect to be under 6% on the long bond."

The size of the issue could grow if market conditions allow the utility to refund more of its debt with at least a 5% present-value savings, the standard the city uses.

In a statement, Moody's said the upgrade on the utility's debt was prompted by strong finances, a diversified energy mix, and modest borrowing needs.

Also, the agency said that "management's responsiveness to changing markets allows the system to optimize lower-cost energy and preserve a favorable utility rate structure, which will not necessitate any base rate adjustment over the next five years."

Further, Mr. Evangel said the utility has modest capital borrowing needs through the end of the decade. At present, the city plans to issue $150 million in long-term debt in 1997 to take out commercial paper that will be used for interim financing.

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