Fitch Affirms Buckeye Power, Inc. at 'A'; Outlook Revised To Negative

NEW YORK--()--Fitch Ratings has affirmed the rating on Buckeye Power, Inc.'s (Buckeye) senior secured bonds at 'A'. Outstanding senior secured bonds affirmed include:

--$17.7 million Ohio Air Quality Development Authority (Buckeye Power, Inc. Project) Series 2003;

--$11.4 million Ohio Water Development Authority, Series 2004;

--$75.0 million Ohio Air Quality Development Authority, Series 2010.

The Rating Outlook is has been revised to Negative from Stable.

SECURITY

The senior secured bonds are secured pursuant to Buckeye's existing mortgage and deed of trust that includes a lien on substantially all of the cooperative's assets.

SENSITIVITY/RATING DRIVERS

LONG COAL-FIRED CAPACITY: Buckeye has acquired a significant amount of surplus capacity in recent years. The cooperative has attempted to contract capacity to creditworthy counterparties, sell energy into the wholesale market and has raised rates to cover increased costs; but this aggressive strategy is being frustrated by slower energy growth, less costly natural gas-fired generation and low market power prices.

ENVIRONMENTALLY CLEAN, BUT UNCERTAINTY REMAINS: Buckeye has moved aggressively to upgrade environmental control systems on its coal-fired units to ensure their long-term operation, but at a heavy capital cost. Uncertainty over Environmental Protection Agency (EPA) policy makes it unclear if this decision will prove to be economically justified.

HISTORICALLY STRONG FINANCIALS HAVE DIMINISHED: Financial metrics have fallen in recent years from much higher historical levels, due largely to substantial costs associated with an extensive capital program. As a result, debt service coverage (DSC) remains close to 1.0x, based on Fitch calculations, well below the median level for the current rating.

SUFFICIENT LIQUIDITY: Although cash on hand is at a very low level, Fitch believes that credit facilities, totaling $275 million, provide adequate liquidity for major operating and capital needs.

LONG-TERM MEMBER CONTRACTS: Supporting Buckeye's creditworthiness are all-requirements contracts with its 25 member distribution systems, extending to 2057.

REASONABLE ELECTRIC RATES: Buckeye and its member systems' have increased rates significantly in recent periods, to cover costs associated with its major capital expenditure program. Following these adjustments, system-wide rates remain generally competitive with other power providers in the region; but some loss of rate flexibility is noted.

WHAT COULD TRIGGER A RATING ACTION

FAILURE TO IMPROVE FINANCIAL METRICS: Buckeye's failure to improve investment-strained metrics commensurate with the current rating level will likely result in a downgrade.

CREDIT PROFILE

Buckeye is a not-for-profit generation and transmission (G&T) cooperative that supplies wholesale electricity to approximately 390,000 customers, through its 25 electric distribution cooperative members within Ohio. Buckeye's retail customer base is heavily weighted toward residential customers.

Buckeye meets the energy needs of its membership through a combination of owned and purchased resources, with heavy reliance on its investment in the coal-fired Cardinal Station Units 2 & 3 (Cardinal 2 & 3), which has historically accounted for over 90% (including supplemental purchases) of the energy supplied to members. The remaining requirements are largely met through an 18% interest in Ohio Valley Electric Corporation (OVEC) assets, purchases from the New York Power Authority (NYPA) and renewable power. Buckeye is also an active participant in the wholesale power market, on both a long-term and short-term basis, as its current power supply capacity (2,365 MW) is well in excess of its recent member peak demand of 1,600 MW.

Buckeye is nearing the completion of a long-term capital investment program that began in FY 2001 that is expected to exceed $2 billion through FY 2015. The program has included major environmental upgrades, improvements to existing assets, and the acquisition of new generation; all of which will limit required investment over the longer term. However, the program has significantly increased leverage and outstanding debt.

ESCALATING ELECTRIC RATES

Buckeye's wholesale rate to members has risen steadily in recent years. For example, total cost per kWh to members equaled 4.65 cents in fiscal year 2008 and it steadily increased to 6.98 cents by fiscal 2012. On average, the cost of environmental upgrades has added about $20 per month to the bills of electric co-op members since 2007. The cumulative effect on the wholesale rate has been 1.5 cents per kWh. As of July 1, 2012, the costs of environmental upgrades are now fully embedded in rates.

Future forecasts anticipate average annual wholesale rate increases of about 1.6% per year over the next ten years. Even with these increases, system-wide rates remain generally competitive with other utilities in the Midwest region; but rate flexibility has been reduced. Buckeye members' average residential rate is about 12.5 cents per kWh.

FINANCIAL PERFORMANCE PRESSURED

Buckeye's financial position and performance metrics have experienced a steady decline in recent years in large part due to the cooperative's heavy capital program and increased borrowings. Buckeye's latest financial forecast projects that net margins and financial ratios will remain strained and somewhat lower for several years. Part of this is based on lower estimates for margins earned on excess power sales, startup costs associated with the recently scrubbed units and increased debt service requirements. Using Buckeye's financial forecast, Fitch calculated debt service coverage is likely to remain low, near 1.0x for some period.

Buckeye reported financials show FY 2012 DSC of 1.21x and a times interest earned ratio (TIER) of 1.45x. This compares with DSC and TIER of 1.22x and 0.89x, respectively, in FY 2009. Equity as a percentage of total assets stands at 17.13%, compared with 25.53% in FY 2008. Fitch calculated debt-service coverage declined from 1.5x in FY 2006 to less than 1.0x in FY 2012.

Buckeye's operating cash on hand, $15 million, is very low by any rating standard and remains a concern. In February 2011, Buckeye entered into a four-year $200 million unsecured revolving credit facility. CFC arranged the transaction with participation from five other banking institutions. The company utilized this facility for general corporate purposes. At June 30, 2012, $105 million was drawn under this facility. In addition, Buckeye has two short-term lines of credit totaling $75 million, with CoBank and CFC.

MEMBER SYSTEMS' RESULTS SATISFACTORY

The Buckeye members are reasonably well diversified and the local economy has shown signs of improving. Following a period of steady, solid growth, energy sales to members have declined in recent years largely due to unfavorable weather conditions, as well as the impact of the economic recession. Longer term, Buckeye and its members are preparing to operate in a much lower growth environment, with forecasted load growth of around 1% per annum. The Buckeye members exhibit reasonable financial profiles, with an aggregate TIER of 2.46x for FY 2011. This is much improved from an unusually low figure of 1.63x in 2009.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'U.S. Public Power Rating Criteria' (Dec. 18, 2012);

--'Revenue-Supported Rating Criteria' (June 12, 2012).

Applicable Criteria and Related Research:

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

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Contacts

Fitch Ratings
Primary Analyst
Alan Spen, +1-212-908-0594
Senior Director
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Alan Spen, +1-212-908-0594
Senior Director
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com