Fitch Affirms Southern Illinois Power Cooperative at 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the rating on Southern Illinois Power Cooperative's (SIPC) implied senior secured obligations and implied senior unsecured obligations at 'BBB'. The rating is on implied obligations because none of SIPC's $685 million of outstanding long-term debt and $65 million line of credit is publicly held.

The Rating Outlook is Stable.

SECURITY

Senior secured obligations have a security interest in substantially all of SIPC's tangible and certain of its intangible assets. Under the terms of the wholesale power contracts, SIPC is required to establish rates sufficient to meet all of its costs and obligations and the members are required to pay for power at the rates established by the SIPC board.

KEY RATING DRIVERS

MID-SIZED G&T COOPERATIVE: SIPC is a generation and transmission (G&T) cooperative supplying wholesale power to seven member distribution cooperatives and two wholesale customers located predominantly in rural territories in southern Illinois. Power is supplied to the seven member cooperatives pursuant to long-term, all-requirements wholesale power contracts that extend through 2043. The addition of Norris Electric Cooperative (Norris) as a new customer in 2013 is viewed constructively, but the short duration of the contract raises a level of uncertainty.

ABUNDANT GENERATION: With the recent completion of the Prairie State Energy Campus (PSEC), SIPC's power supply portfolio is sufficient to meet anticipated native load growth for an extended period. While this offsets the need for future significant capital additions, the power project has burdened the G&T and its members system with heavier fixed costs. Environmental costs seem manageable, despite a coal-dominated portfolio, given that PSEC is one of the cleanest coal burning plants in the nation and the Marion coal plants are equipped with pollution control equipment to meet current environmental rules.

CONSTRAINED RATE FLEXIBILITY: The addition of PSEC, while likely to provide long-term cost benefit, has significantly eroded near-term ratemaking flexibility. Wholesale rates averaged about 7.5 cents per kilowatt-hour (KWH) in 2013, 8 cents in 2012 and 6.3 cents in 2011. Member rates vary based on load factor, and are reasonably competitive with other area cooperatives, but above those of investor-owned utilities.

PSEC NOW OPERABLE, PERFORMANCE IMPROVING: The recent commercial operation of both PSEC units will reduce SIPC's reliance on purchased power and should provide long-term cost stability to its members, albeit at a high initial price. The plants' forced outage rate, which is elevated, has begun to show improvement.

MARGINAL FINANCIAL METRICS: SIPC's financial metrics are low compared to other G&Ts, with Fitch calculated debt service coverage (DSC) at 1.02x and equity-to-capitalization at 9.2% in 2013. Financial metrics are expected to remain weak for some time as the large amount of debt associated with PSEC begins to amortize. As a result, the board's commitment to maintaining satisfactory financial metrics, and its willingness to raise rates when needed, carry great weight.

RATING SENSITIVITIES

LOSS OF NORRIS AS A CUSTOMER: Should Norris choose not to become a long-term member after its five-year contract ends in 2017, SIPC will be required to make adjustments to its business plan to assure continued stable financial performance. SIPC believes the impact would be manageable.

NEW LEADERSHIP: SIPC hired a new chief executive officer (CEO) effective January 2014, who is in the early stages of working with the board to update and improve the cooperative's business and financial strategy.

CREDIT PROFILE

Member cooperatives provide electricity to over 100,000 end-use customers, and a total population of approximately 250,000 people. The service area is primarily residential and agricultural, although some members have experienced increased load growth from a resurgence in the area's coal industry, reflecting improved coal demand from local, scrubbed power plants and from oversea sales. System residential load growth is forecast at about 1.5% per year. Total load growth over the next few years is expected to exceed 10%, reflecting the anticipated addition of several large industrial loads.

The newest customer addition is Norris, a wholesale system that is purchasing all of its power requirements under a five-year contract that began on Jan. 1, 2013. Norris will be required to make a decision about becoming a SIPC member by Dec. 31, 2015.

HEAVILY COAL WEIGHTED

SIPC'S power supply is predominantly fueled by coal (70%) and consists of 558 megawatts (MW) of owned generation assets, including the Marion units and newly constructed PSEC, and 38 MW in power purchase agreements with Southeastern Power Administration and Pioneer Trail Wind Farm. SIPC's 7.9% undivided ownership interest in the PSEC project (125 MW) will reduce its reliance on purchased power and provide long-term cost stability, and a reliable and affordable base-load power supply, given the plant's ultra-efficient design and sufficient coal resources from an adjacent coal mine. Fitch expects PSEC to operate at a reasonable and healthy level of availability and capacity over time, although normal startup issues have been experienced.

HIGH ELECTRIC RATES

SIPC's rates have historically been competitive with both Midwest ISO (MISO) and neighboring investor-owned utilities. Prior to 2012, base rates had not been raised since 2008, but a 22% increase to 8 cents/KWH took effect in 2012, which was designed to capture the higher debt service and operating costs associated with the PSEC project. For 2013, the wholesale rate moderated by about 6% helped by better customer efficiency due to the addition of Norris, but on Jan. 1, 2014 rates were increased by 2%. Wholesale rates for 2014 are forecast at around 7.5 cents/KWH. No further increases are currently planned. SIPC also uses a fuel and cost tracker with its members.

Members continue to face some rate pressure, but the gap between members' rates and neighboring utilities is closing. Members' rates to customers are fairly competitive when compared with the universe of cooperatives in and around the state of Illinois. The members' average residential rate was approximately 12.60 cents/KWH in 2013.

FINANCIAL METRICS TIGHT

SIPC's historical metrics have tracked at the lower end of most Fitch-rated G&T cooperatives. SIPC's financial performance is expected to remain constrained for some time following the commercial operation of PSEC. The equity-to-capitalization ratio stood at 9.2% in 2013.

The long-term goal is to achieve a 15% equity ratio by 2017, with a TIER/MFI ratio around 1.40x, which would be more in line with other rated G&Ts. While there is no formal target for DSC, it is expected to remain close to minimal levels over the next few years.

Regarding the balance sheet, liquidity over the last five-year period was weak, averaging 25 days cash on hand. SIPC has set a financial policy of holding a minimum of $5 million of liquid assets, plus the $65 million credit facility.

SIPC member cooperatives have maintained adequate financial metrics historically. For 2013, on a consolidated basis, the members reported operating revenues of $280.4 million and net margins of $9.9 million. This compares with operating revenues of $244.9 million and net margins of $1.7 million the year before. The 2013 aggregate TIER and DSC were 2.88x and 1.26x, respectively, compared with 1.84x and 1.85x in 2012. The reduction in DSC reflects the full inclusion of principal and interest related to PSEC in financial calculations. The equity-to-capitalization ratio equaled 57.6% in 2013.

MANAGEABLE CAPITAL EXPENDITURES

SIPC's future capital spending will be substantially reduced, and used mostly to fund a turbine overhaul at Marion, before capital expenditures further moderate to about $7 million per year. SIPC expects to use about $30 million of its credit facility to pay for the turbine overhaul. SIPC's strategy has been to write off these costs over a six-year period.

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

Applicable Criteria and Related Research:

--'U.S. Public Power Rating Criteria' (March 18, 2014);

--'U.S. Public Power Peer Study Addendum - February 2014' (Feb. 7, 2014);

--'2014 Outlook: U.S. Public Power and Electric Cooperative Sector' (Dec. 12, 2013);

--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013).

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

2014 Outlook: U.S. Public Power and Electric Cooperative Sector (Calm Under Pressure)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=725447

U.S. Public Power Peer Study Addendum -- February 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735601

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826513

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Contacts

Fitch Ratings
Primary Analyst
Alan Spen, +1-212-908-0594
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Hugh Welton, +1-212-908-0742
Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +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 Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Hugh Welton, +1-212-908-0742
Director
or
Committee Chairperson
Chris Hessenthaler, +1-212-908-0773
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com