Fitch Rates Indiana Finance Auth. First and Second Lien Water Revs 'A' & 'A-'

CHICAGO--()--Fitch Ratings assigns the following ratings to the Indiana Finance Authority, Indiana (IFA) bonds on behalf of Citizens Energy Group (CEG):

--$26.6 million first lien water utility revenue bonds, series 2014A 'A';

--$43.99 million second lien water utility revenue refunding bonds, series 2014B 'A-'.

Fitch also affirms the following ratings on the outstanding Indianapolis Local Public Improvement Bond Bank (ILPIBB) bonds and IFA bonds:

--$909 million first lien water utility revenue bonds, series 2005F, 2006A, 2007B, 2007L, 2009A, and 2011E at 'A';

--$42.9 million second lien water utility revenue bonds, series 2011B at 'A-'.

The series 2014A and 2014B bonds are expected to sell via negotiation during the week of June 23. Bond proceeds of the series 2014A bonds will be used by CEG to fund capital improvements to the system. A portion of the proceeds will also be used to repay a draw made on a line of credit, to fund a debt service reserve and pay costs of issuance. The series 2014B bond proceeds will be used to refund the outstanding IFA second lien water utility revenue bonds, series 2011B and pay costs of issuance.

The Rating Outlook is Stable.

SECURITY

The IFA's series 2014A first-lien bonds are secured by payments to be made on CEG's simultaneously issued series 2014A bonds. The CEG bonds are payable from a senior lien on water system net revenues. The ILPIBB bonds are parity obligations with the IFA's first lien water bonds. The IFA's series 2014B bonds are secured by CEG's series 2014B second-lien bonds.

KEY RATING DRIVERS

WEAK FINANCIAL PERFORMANCE: The system's all-in debt service coverage remains below Fitch's median for 'A' rated category utilities.

STABLE REGULATORY ENVIRONMENT EXPECTED: The regulatory oversight by the Indiana Utility Regulatory Commission (IURC) creates a level of uncertainty for the CEG's financial profile. However, recent legislation and the allowance for certain interim filings for rate adjustments should bring stability to the regulatory environment.

HIGH DEBT BUT MANAGEABLE NEEDS: Moderate capital requirements are expected to limit further escalation of the system's elevated debt levels.

LIMITED RATE AFFORDABILITY: User charges for the system are approaching Fitch's affordability threshold of 1% of median household income (MHI). The combined water and wastewater system charges exceed affordability measures. However, user charges are currently comparable to other large systems in the region.

FAVORABLE SERVICE TERRITORY: The city of Indianapolis (the city) has a large and well- diversified economy. The consistent steady gains in employment bolster the system's ratepayer base.

RATING SENSITIVITIES

WEAKENED FINANCIAL RESULTS: Any deterioration in the system's financial profile would be viewed negatively. However, the Stable Outlook reflects Fitch's expectation that further declines are unlikely.

CONTINUED RATE RELIEF ESSENTIAL: Management's ability to achieve timely implementation of rate hikes that would sustain adequate financial margins and required capital funding is important to maintain the rating.

EMERGING DEBT NEEDS: Given the system's already elevated debt profile, any material increases to the current size and scope of the capital program would be viewed negatively.

CREDIT PROFILE

On Aug. 26, 2011, CEG acquired the system from the Indianapolis (the city) Department of Waterworks (DOW), assuming all assets and certain liabilities of the system. CEG is a not-for-profit public charitable trust, which has been in operation for over 100 years, providing gas and other utility services to the city and surrounding area. The system is a largely retail provider of water service to the vast majority of the Indianapolis metropolitan statistical area (MSA). The system has approximately 308,572 customer accounts, including three wholesale customers and three other large customers with volume purchasing contracts. The customer base has remained relatively stable with estimated annual average growth of less than 1% since 2009.

DEBT SERVICE COVERAGE REMAINS LIGHT

The system's all-in debt service coverage (DSC) for fiscal 2013 equaled a modest 1.19x, short of the projected 1.3x and slightly below 1.2x coverage in fiscal 2012 after a $6.9 million transfer to the rate stabilization fund. The decline in coverage from projections was due to CEG's most recent rate increase (8.98%) that was lower than originally anticipated (14%). In addition, the system had lower billings due to a milder summer with less demand. For fiscal 2014, management projects 1.36x coverage. Fitch believes that this projection is reasonable as the system's operating revenues for the first six months of fiscal 2014 have outpaced prior year results, by 3.5%, during the same period.

For fiscal 2013, cash on hand of 202 days of operations was slightly lower than Fitch's median for 'A' rated category utilities. The days cash number included a $30 million line of credit from BMO Harris for working capital. The line of credit is scheduled to expire on April 24, 2015 but will likely be extended. Free cash to depreciation was a low 35% compared to the median for the 'A' category of 102%.

IMPROVED IURC ENVIRONMENT

The IURC maintains jurisdiction over the approval of rates and charges of the system. The IURC's oversight has hindered timely rate relief in the past, due to a prolonged, two year period between previous petitions for a permanent rate increase and the IURC's final rate order. During this time, and prior to the acquisition by CEG (fiscal years 2008 and 2009), the system's annual debt service (ADS) coverage remained below 1.0x and reserves were exhausted.

However, in 2013, the Indiana Legislature passed Senate Bill 560, which helps to mitigate the effects of regulatory lag by requiring that rate cases take no longer than 300 days. Failure to act within the 300-day time frame will result in 50% of the rate request becoming effective immediately, subject to refund if the final order authorizes less than the 50%. In addition, the system is authorized, by law, to petition the IURC for adjustments of basic rates for certain capital costs including water system replacements and upgrades.

MODERATE CAPITAL NEEDS; DEBT LOAD REMAINS HIGH

The current five-year CIP covers fiscal 2014 - 2018 and totals approximately $290 million, a 1.5% increase over the prior capital plan. The system's capital needs are manageable at $189 per customer each year. The focus of the CIP is on system reliability with more than two-thirds of the ongoing capital program dedicated to treatment plant and distribution system improvements. The balance of capital expenditures will be for system upgrades and maintaining regulatory compliance.

The system's current debt profile is elevated, with debt per customer at $3,130 and debt per capita at $1,040, well above the averages for 'A' category utilities. Even with CEG's plans to increase the amount of equity funding for capital projects the debt is expected to remain above comparably rated credits, as principal amortization of debt is weak; only 68% of outstanding principal matures within 20 years.

COMBINED RATES LIMIT AFFORDABILITY

Water user charges, based on approximately 7,500 gallons (Fitch's assumption for U.S. average household consumption), are 1.1% of MHI. This measure is above Fitch's affordability threshold of 1%. On a combined basis, water and wastewater user charges are over 2% of MHI. Current user charges, based on actual average consumption of approximately 5,200 gallons, are somewhat more affordable at $29.98 per month or 0.8% of MHI. On a combined basis, rates reflecting average water and wastewater usage total $65.8 and are 1.8% of MHI, approaching Fitch's affordability threshold of 2%. CEG maintains that its rates are in line with other systems in the region.

LARGE AND DIVERSE SERVICE AREA

Fitch rates the city's general obligations (GO) bonds 'AAA' with a Stable Outlook, reflecting a well-diversified economy that serves as the economic engine for the surrounding area. The city has a large retail sector as well as a significant manufacturing presence, which includes pharmaceuticals and automotives. The city's economy also includes health services, life and sciences companies and other business and professional service companies.

The city's unemployment rate of 6.2% in March 2014 was down from the March 2013 rate of 8.3% and is comparable to the unemployment rate of the state (6.2%) and the nation (6.8%). MHI levels in the county are 11% and 18% lower than state and national levels, respectively.

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2013);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2014 Water and Sewer Medians' (Dec. 2013);

--'2014 Outlook: Water and Sewer' (Dec. 5, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=833944

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Contacts

Fitch Ratings
Primary Analyst
Adrienne M. Booker
Senior Director
+1-312-368-5471
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Doug Scott
Managing Director
+1-512-215-3725
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Adrienne M. Booker
Senior Director
+1-312-368-5471
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Doug Scott
Managing Director
+1-512-215-3725
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com