Fitch Affirms Memphis Light, Gas and Water Division, TN's Electric Revs at 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the 'AA+' rating on the following Memphis Light, Gas and Water Division's (MLGW) bonds:

--$691.7 million electric utility revenue bonds, series 2003A, 2008 and 2010.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a subordinate lien on net revenues of the electric system (the system). MLGW's senior lien indenture remains open, although no senior lien bonds are currently outstanding.

KEY RATING DRIVERS

LARGE DISTRIBUTION SYSTEM: MLGW operates a combined utility system providing electricity, gas and water services to customers within the City of Memphis and in portions of Shelby County, Tennessee. The electric system continues to generate sound financial metrics despite an ongoing trend of uneven sales and the relatively weak service area demographics.

RELIABLE SOURCE OF POWER: MLGW remains the largest all-requirements customer of the Tennessee Valley Authority (TVA; global power bonds rated 'AAA'/Rating Watch Negative) pursuant to a rolling five-year contract.

PREPAYMENT AGREEMENT: MLGW's prudent decision in 2003 to prepay for a sizeable portion of its capacity from TVA via a 15-year supplemental contract has resulted in a reliable long-term baseload supply and meaningful cost savings for MLGW. Fitch does not expect the expiration of the supplemental contract in 2018 to have a meaningful impact on the system's prospective financial performance.
STABLE FINANCIAL METRICS: Debt service coverage and liquidity are consistently low compared to median ratios for the given rating category. However, the fixed discount on purchased power pursuant to the supplemental contract fully offsets annual debt service payments on all existing debt, and MLGW's obligation to automatically pass through in full its wholesale costs (equal to nearly 80% of total expenses) ensures sufficient cash flow.

AFFORDABLE RATES: Low overall retail rates compared to other large cities provides flexibility; although TVA's sizeable capital needs could ultimately challenge the MLGW's rate competitiveness. Base rate changes are subject only to Memphis city council approval.

LOW DEBT: Existing debt obligations fully amortize by 2018, which should result in continued improvement in the system's already favorable leverage ratios, despite an additional $80 million borrowing planned for fiscal 2014.

WEAK SERVICE TERRITORY: The system's service area is relatively stable and diverse, but continues to exhibit high unemployment and low income levels. The resulting concern is mitigated, however, by MLGW's trend of strong collection rates, the obligation to automatically pass through power supply costs and affordable retail rates.

RATING SENSITIVITY

RATING STABILITY: Fitch expects MLGW's stable financial position, low debt levels and sound overall operating profile will continue for the foreseeable future.

CREDIT PROFILE

LIMITED RISK DISTRIBUTION PROVIDER

MLGW derives its power supply entirely from TVA pursuant to an all-requirements take-and-pay power contract (the contract). The system functions solely as a distribution utility and does not own generating assets.

The contract with TVA remains in effect, subject to automatic one-year extensions on the first of each year, unless either MLGW provides notice to terminate a minimum of five years in advance or TVA provides the required ten years advanced notice to terminate. TVA's supply obligation is absolute and unconditional, and MLGW is required pursuant to the contract to purchase all of its electric power from TVA.

PREPAY AGREEMENT

Of the total capacity provided annually by TVA, a fixed amount (equal to 928,671 kW for each hour of the year) was prepaid for in 2003 as part of a supplement to the power contract. In 2003 MLGW issued $1.5 billion in electric system revenue bonds (series 2003) and used the proceeds to prepay TVA for the fixed amount of capacity for a 15-year period ending in 2018.

The prepayment represented the full cost of the prepaid capacity at TVA's November 2003 wholesale rate. In return, MLGW receives a fixed discount on the power purchased annually from TVA equal to annual debt service on the prepayment bonds plus approximately $13 million per year.

Fitch continues to view the prepayment transaction favorably for both MLGW and TVA. Acquiring the prepaid capacity ensured a long-term baseload supply and meaningful cost savings for MLGW, whereas TVA secured its largest customer for approximately half its energy requirements for 15 years.

SOUND, STABLE FINANCIAL RESULTS

Fitch calculated debt service coverage has averaged 1.7x over the prior five years, slightly below the rating category median of 2.3x but still healthy relative to MLGW's operating profile. Liquidity is similarly low at 46 days cash, but is satisfactory when MLGW's rate flexibility and obligation to immediately pass through changes in power costs is considered. The system makes an annual transfer to the city after the payment of debt service that typically accounts for a modest 3% of total revenues.
Projected financial results through fiscal 2018 include a modest improvement in debt service coverage and maintenance of current cash reserve levels. A 5% planned rate hike in fiscal 2015 is projected to increase debt service coverage to about 2.0x while liquidity remains close to about 50 days through the forecast period.

The forecast assumes flat sales, zero growth in customer accounts and the issuance of $80 million in fiscal 2014 to fund capital needs. Fitch considers the assumptions reasonable and expects MLGW will achieve its stated financial targets.

WEAK SERVICE TERRITORY

Economic and demographic indicators are considered weak, but the city's role as the county seat and the presence of its largest employer, Federal Express Corp., provide a good degree of stability to the service area. The city's sizeable service sector and manufacturing, distribution and transportation industries were hit particularly hard during the recent economic recession, leading to a slow recovery and a persistently high unemployment rate. A modest decline in employment throughout much of 2013 was compounded by growth in the city's labor force, prompting the August 2013 unemployment rate to rise to 10.9% compared to 10.1% one year prior.

Wealth indicators are also below average; income measured on a per capita and median household basis is roughly 20% lower in comparison to state and national figures, largely due to a growing service sector that accounts for almost 30% of total wages and earnings. In addition, the city's poverty rate (27.3%) is almost twice the national average and well above the state figure. Nevertheless, MLGW reports strong collection rates with write-offs routinely below 1% of annual revenues.

The number of customer accounts served has declined some in recent years, although Fitch does not expect a meaningful decline going forward based on the relative stability of the service area. The system's customer base remains fairly diverse with no meaningful concentration among customers.

Additional information is available at www.fitchratings.com.

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 Peer Study -- June 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710397
U.S. Public Power Peer Study Addendum -- June 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710641
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=810581
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Contacts

Fitch Ratings
Primary Analyst:
Christopher Hessenthaler, +1-212-908-0773
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst:
Ryan Greene, +1-212-908-0593
Director
or
Committee Chairperson:
Alan Spen, +1-212-908-0594
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Christopher Hessenthaler, +1-212-908-0773
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst:
Ryan Greene, +1-212-908-0593
Director
or
Committee Chairperson:
Alan Spen, +1-212-908-0594
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com