NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded to 'BBB+' from 'BBB' the rating on the following East Kentucky Power Cooperative (EKPC) revenue bonds:
--$12.7 million Mason County, KY pollution control revenue bonds series 1984B;
--$6.0 million Pulaski County, KY solid waste disposal revenue bonds series 1993B.
Fitch has also upgraded to 'BBB+' from 'BBB' the rating on EKPC's implied senior unsecured obligations. The rating takes into account $293.5 million of unsecured debt at Dec. 31, 2012, but is assigned to implied obligations, since none of the outstanding unsecured debt is publicly held.
The Rating Outlook is Stable.
The senior secured obligations are secured by a mortgage interest in substantially all of EKPC's tangible and certain of its intangible assets.
KEY RATING DRIVERS
GENERATION AND TRANSMISSION COOPERATIVE: East Kentucky Power Cooperative (EKPC), a generation and transmission cooperative (G&T),supplies wholesale power to its 16 member-owner distribution cooperatives who serve predominantly rural territories in 87 counties in central and eastern Kentucky. The cooperative's generation fleet is geographically diverse; however, the majority of power comes from coal-fired units.
IMPROVING FINANCIAL PROFILE: The rating upgrade reflects EKPC's markedly improved financial profile and the execution of its long-term strategic plan. Fitch-calculated financial metrics for 2012 result in adjusted debt service coverage (DSC) of 1.25x and equity to capitalization of 11.6%. Total debt to funds available for debt service (FADS) of 10.8x is weak, but Fitch expects EKPC's high leverage to moderate as equity increases pursuant to the cooperative's strategic plan.
SUFFICIENT POWER SUPPLY RESOURCES: EKPC's current portfolio of power supply resources should be generally sufficient to meet anticipated demand through at least 2020; obviating the need for major new construction and additional major borrowings. The environmental compliance risks related to the coal-dominated portfolio are lessened by the presence of emissions control equipment at EKPC's most significant units.
REASONABLE MEMBER FUNDAMENTALS: EKPC supplies wholesale power to its distribution members pursuant to long-term, take-or-pay contracts, extending through Jan. 1, 2051, requiring members to purchase nearly all of their power requirements from EKPC to meet distribution system needs. This contractual relationship, together with the diversity and adequate financial performance of the member distribution cooperatives, supports the rating.
SUBJECT TO RATE REGULATION: EKPC's electric rates and those of its members are regulated by the Kentucky Public Service Commission (PSC). While the PSC has been supportive of the cooperative, state rate jurisdiction creates a greater level of uncertainty than self-regulated systems.
CONTINUATION OF STRATEGIC PLAN: The current rating reflects Fitch's expectation that EKPC will continue to achieve financial objectives incorporated in the strategic plan and that distribution members will maintain financial ratios at satisfactory levels.
RESTRICTIVE RATE REGULATION: Future regulatory decisions that prevent the cooperative from adequately recovering costs would likely result in downward pressure on the rating or Outlook.
IMPLEMENTING STRATEGIC PLAN
In 2009, the PSC ordered a comprehensive management audit of EKPC and publicly questioned the cooperative's commitment to "reversing its previous weakening financial condition." The management audit was to specifically examine the involvement of EKPC's Board of Directors in the strategic planning, decision-making and management of EKPC, with particular concern for EKPC's financial integrity.
EKPC's current long-range strategic planning initiatives are largely borne of the management audit, which noted that the cooperative did not engage in a regular, structured, and consistent strategic planning process. The EKPC board pledged its commitment to the PSC in May 2010, to actively engage in the development of a strategic plan. It began initiating the process with the help of an outside consultant in September 2010 with the strategic plan coming to fruition in early 2011. The plan is designed to achieve an equity ratio of 15% by 2015 and maintain a DSC ratio of around 1.20x.
MAXIMIZING GENERATING EFFICIENCY
EKPC boasts a geographically diverse generating fleet, but coal accounts for over 75% of electric production. Plants have historically performed well from a cost and availability standpoint when compared to national averages. EKPC's current forecast predicts that the existing portfolio of assets and related capacity, supplemented by modest amounts of purchased power, will be sufficient to cover peak demand requirements for the forseeable future.
EKPC filed its integrated resource plan (IRP) with the PSC in April 2012, which identified a potential need for up to 300 MW of energy to replace power plants that may be shut down as a result of federal regulations taking effect in 2015. The IRP places greater emphasis upon demand-side management and energy efficiency programs. EKPC subsequently issued a request for proposals (RFP) and received a number of responses. The capacity was planned to replace 200 MW of capacity from the Dale station as the unit approaches the end of its useful life prior to 2016, and to possibly replace 100 MW of capacity from the Cooper unit 1. Given its current power supply options, EKPC has said that it does not feel pressure to make a decision on new resources at this time.
ENVIRONMENTAL COMPLIANCE ACHIEVED
EKPC's preparedness for the pending regulations stems, in part, from a consent decree executed with the Department of Justice in 2007. EKPC management believes that the cooperative is now well positioned to meet the increasingly stringent emissions requirements proposed by the Environmental Protection Agency (EPA). An investment of $1.75 billion in emissions-control and clean-coal technologies has been made thus far. Emissions from the cooperative's largest generating station, Spurlock, have already been reduced significantly.
EKPC previously filed a request seeking PSC's approval to integrate its system into the PJM Interconnection. The analysis indicates membership in PJM Interconnection, LLC (PJM) will provide a significant benefit to EKPC, enabling more efficient and economical operation, while providing affordable access to an established power market. On Dec. 20, 2012, the PSC approved, with certain conditions, the cooperative's request to transfer functional control of certain transmission facilities to the PJM. Integration into PJM became effective June 1, 2013.
STABLE ELECTRIC RATES
The EKPC board is required to review its wholesale rate at least annually, and to seek revisions as necessary to ensure covenant compliance, subject to the approval of the PSC. Given the anticipated time frame for PSC approval and implementation of rate increases (approximately seven months), the cooperative seeks to anticipate the need for rate relief well in advance of any projected revenue shortfall to maintain minimum annual TIER and DSC metrics.
Wholesale rates averaged $68.41/MWh for 2012, largely unchanged from the previous year, but remain higher than wholesale rates charged by other utilities to their members. Wholesale costs are projected at $69.70/MWH in 2013, consisting of a: i) base rate ($61.08), ii) fuel charge (credit $0.79) and iii) environmental surcharge ($9.41). For 2014, wholesale rates should moderate slightly and then are expected to grow moderately by the end of the decade. The utility is permitted to pass fuel and purchased power costs on to its members through the fuel adjustment clause approved by the PSC.
G&T FINANCIALS TRENDING HIGHER
Fiscal 2012 financials continued the cooperative's improving financial trend. Helped by rate increases granted by the PSC in recent years, net margins were a solid $52.8 million, with DSC equaling 1.25x. Leverage continued its downward trend, consistent with management's strategic plan. EKPC does not anticipate major capital expenditure or incremental debt issuances in the near term.
While equity to capitalization is historically low compared to other Fitch rated G&T co-ops, the ratio continues to improve towards EKPC's goal of equity to assets of 15% by 2015. Fiscal 2012 saw Fitch's calculation of EKPC's equity ratio grow to 11.6% from 10.4% in 2011. Fitch expects that the cooperative's low capitalization will be addressed as total debt levels decline pursuant to the strategic plan.
Fitch notes EKPC's improved liquidity, bolstered by a combination of higher earnings and healthier working capital. Day's cash on hand doubled, reaching 97 days in 2012, up from 47 days in 2010. Cash and cash equivalents totaled $157.2 million at year end 2012, compared with $129.7 million in 2011. This excludes restricted deposits with RUS.
EKPC has a $500 million unsecured credit facility that extends to October 2018 to be used for general operating expenses and capital construction projects. Borrowings as of Sept. 30, 2013 totaled $275 million. EKPC is contemplating a $200 million private placement before year end 2013 to help pay down outstanding borrowings under this facility. Future plans anticipate drawdowns from the credit facility of at least $50 million a year, with long-term cleanup financings occurring possibly every two years.
2013 INTERIM RESULTS
Net margins for the nine months ended Sept. 30, 2013 were $55.7 million, significantly ahead of budget, reflecting better sales and more favorable pricing for off-system sales into the PJM. For calendar year 2013, net margins are estimated at $58 million-$60 million, resulting in an estimated TIER of 1.51x, DSC of 1.30x and equity to assets ratio of 12.5%. No cash return of capital to the members is anticipated, due to the need to bolster the G&T's equity level. As of June 30, 2013, cash and cash equivalents amounted to $139.4 million, and deposits with RUS (cushion of credit) totaled $100.8 million.
DIVERSIFIED CUSTOMER BASE
EKPC's member distribution cooperatives provide retail electric service to 522,523 energy meters throughout territories that are reasonably diverse. Member territories are confined to central and eastern Kentucky. However, they include mountainous coal mining areas (Cumberland Valley Electric), rolling farmlands (Farmers Rural Electric Cooperative Corporation), and the more suburban areas surrounding the state's largest cities.
Energy sales among the members are reasonably well balanced and exhibit only modest concentration with respect to EKPC's largest member, Owen Electric Cooperative, Inc. Remaining energy sales are well spread over the other 15 members. In aggregate, 66% of total member revenues were derived from residential customers in 2012, with the remainder equally divided between small commercial and industrial. EKPC's members expect customer energy growth to average 1.3% annually over the next several years.
The consolidated financial profile of the EKPC membership has been satisfactory. Operating revenue and patronage capital for 2012 totaled $1.10 billion and net margins equaled $63.85 million (including G&T capital credits of $53.1 million). The members reported consolidated TIER of 2.70x and 1.28x (excluding G&T capital credits). Equity to capitalization ratio totaled 43.3% and a current ratio was 1.34x. Performance trailed 2011 results of a consolidated TIER of 3.01x (1.61x excluding G&T capital credits) and equity to capitalization of 41.5%. Several member systems are in the process of requesting rate adjustments from the PSC.
Additional information is available at 'www.fitchratings.com'.
The rating action was informed by information from Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013);
--'U.S. Public Power Peer Study Addendum -- June 2013' (June 13, 2013);
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
U.S. Public Power Peer Study Addendum -- June 2013
U.S. Public Power Peer Study -- June 2013