Fitch Rates Paducah Power System's Electric Revs 'A'; Outlook to Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'A' rating to the following City of Paducah, Kentucky Electric Plant Board (Paducah Power System, or PPS) revenue bonds:

--$3 million refunding revenue bonds, series 2010.

The bonds are expected to sell competitively on Sept. 8, 2010, with proceeds refunding PPS's outstanding series 2001 revenue bonds.

In addition, Fitch affirms the following ratings:

--$170.6 million electric plant board revenue bonds at 'A'.

Also, Fitch withdraws the system's implied 'F1' rating, as the system has not issued any short-term debt.

The Rating Outlook has been revised to Negative from Stable.

RATING RATIONALE:

--The Negative Outlook reflects Paducah Power System's thin liquidity levels, which are expected to remain below-average both for the rating category and as an owner and operator of generating resources.

--The Negative Outlook also reflects weaker than projected demand in the area set against the system's excess capacity and relatively more expensive power supply.

--Liquidity levels have improved but remain slim, as evidenced by the system's 18 days cash on hand in fiscal 2009, which was well below the rating category median of 102 days.

--Leverage has grown considerably as part of PPS's transition to owning (through the Kentucky Municipal Power Agency, or KMPA) and operating generation resources from distributing power purchased from the Tennessee Valley Authority (TVA). When including off-balance sheet obligations, debt per customer is nearly $28,000.

--Coverage of debt service has averaged an adequate 1.3 times (x) over the past three years by Fitch's calculation (including power purchases as part of debt service), which is slightly better than the rating category median of 1.1x in fiscal 2009.

--A primarily residential customer base adds stability to the local service area. However, wealth indicators are below state and national averages.

KEY RATING DRIVERS:

--Increases in liquidity to levels more consistent with entities assuming power supply risk.

--Ability to service its high level of debt and successfully manage the transition to owning and operating generation from being a power purchaser.

--Maintenance of rate-setting flexibility, despite a relatively expensive power supply and below-average wealth indicators in the area.

--Successful and timely integration of power supply from the Prairie State Energy Campus Project (PSECP).

SECURITY:

The series 2010 bonds are secured by a lien on net revenues derived by PPS from the operation of its electric system. The series 2010 bonds are subordinate to the outstanding series 1998 bonds that fully mature in January 2011. The senior-lien bond indenture has been closed, and after the 1998 bonds are retired the series 2010 bonds will be secured by a first lien on net revenues of the electric system.

CREDIT SUMMARY:

Paducah Power System's financial performance is adequate for the rating category, but the transition to owning and generating power raises certain credit concerns, namely: the system's stark increase in leverage and thin liquidity levels. Including off-balance sheet obligations, leverage has increased to nearly $28,000 per customer, which is a function of owning generating resources (theoretically offset by eliminating power purchases). High leverage will be a credit concern for some time.

Regarding system liquidity, the system's 18 days cash on hand in fiscal 2009 was an improvement over prior years but still well below the rating category median of 102 days. (Being a TVA distributor, PPS has historically not operated with a great deal of liquidity.) A newly implemented cash reserve policy aims to increase liquidity over the next five years. However, the $8.5 million minimum goal would produce just 56 days cash using fiscal 2009 expenses, which would still be low for the rating category. Retaining ample liquidity levels to offset any unforeseen cost escalations is an important rating consideration for systems with generating units. Negative rating action could occur if cash levels remain consistently below average.

Paducah Power System's strategy is to transition from a distributor of purchased power to an electric utility that will own and operate generation resources sufficient to meet its power needs. PPS purchased its total power requirements from TVA until December 2009. However, the rising costs of wholesale power compelled management to form a joint-action agency, KMPA, with the Electric Plant Board of the City of Princeton, Kentucky to acquire base load power from the PSECP. The capacity from PSECP will ultimately meet three-quarters (104 megawatts [MW]) of PPS's demand requirements under a take-or-pay power sales agreement with KMPA when it comes online in phases over the next two years. PPS's own 110 MW peaking unit, which became operational earlier this year, and a small portion of hydroelectric power (8 MW) from American Municipal Power of Ohio expected in 2014 will provide additional capacity. Power is currently supplied by bridge contracts with KMPA.

The system's combined capacity of up to 222 MW is well in excess of its fiscal 2009 peak demand (150 MW). This creates a credit concern in a soft power market where off-system sales are unlikely to generate significant revenues. In addition, projections of energy requirements at the time of the system's 2009 financing showed increased usage from fiscal years 2008 to 2009 and 1.5% annual growth thereafter. However, actual energy requirements in fiscal 2009 declined by 7.8% from the prior year. Projected power costs have also increased.

PPS provides electric service to its 22,500 primarily residential customers located throughout the city limits and in portions of McCracken County. PPS sets its own retail rates, as the system is no longer under the jurisdiction of TVA or any regulatory entity. Self-regulation, coupled with PPS's defined service territory that is not subject to competition, provides the system a considerable advantage. As such, the timeliness and appropriateness of rate increases will be a consideration when evaluating the system's financial position in future years.

Additional information is available at 'www.fitchratings.com'

In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and R.W. Beck.

Related Research:

'Revenue-Supported Rating Criteria', dated 16 Aug 2010.

'Public Power Rating Guidelines', dated 11 Jun 2009.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Related Research:

Public Power Rating Guidelines

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=447150

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548606

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