Fitch Rates Citizens Thermal Energy System, IN's Revs 'A'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A' rating to the following city of Indianapolis, IN (the city) thermal energy system bonds:

--$36 million first lien revenue refunding bonds, series 2014A.

Fitch has affirmed the 'A' rating on the following outstanding thermal energy system bonds:

--$50.1 million first lien multi-mode revenue refunding bonds, series 2008.

In addition, Fitch has assigned an 'A' rating to the following outstanding thermal energy system bonds:

--$68.5 million first lien revenue refunding bonds, series 2010A and series 2010B;

--$8.6 million first lien revenue bonds, series 2013A.

Fitch neither rates nor will assign a rating to the outstanding series 2013B bonds that are expected to be refinanced with proceeds of the current offering.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a first lien on Citizens Thermal Energy System's (Citizens Thermal, or the system) net revenues, which include its regulated Steam System and unregulated Chilled Water System, and certain other pledged funds under Citizens Thermal's master indenture.

KEY RATING DRIVERS

Central Service Provider: Citizens Thermal is an established provider of steam and chilled water services to customers in the Indianapolis metropolitan area. The system is an operating division of Citizens Energy Group (CEG).

Stable Customer Base: The system's cost advantage over in-house services provides for customer stability that helps mitigate considerable revenue concentration among largest payers and limited customer contract terms relative to the system's outstanding debt. The Chilled Water System has renewed all but three contracts since 1991.

Steam System Rate Relief: The June 2013 rate case resulting in 95.5% ($7.6 million) of the final requested amount positions the Steam System to begin producing positive net margins in fiscal 2014, thereby establishing better balance between the two systems. This follows five consecutive years of negative margins for the Steam System that became a credit concern.

Stable Consolidated Metrics: Consolidated cash flow metrics show stability, despite the segment imbalances. Debt service coverage has averaged 1.65x since fiscal 2010, including 1.72x in fiscal 2013. Cash on hand is forecast to rebound beginning in fiscal 2014, after sizable drawdowns for capital spending since fiscal 2011.

System Growth: Ongoing expansions of large, long-standing customers such as Indiana University-Purdue University at Indianapolis and Indiana University Health Partners, as well as the addition of the new Eskenazi Hospital in December 2013, should buttress system growth and ultimately cash flows.

RATING SENSITIVITIES

Balanced Operations: Positive financial margins at the Steam System will remain a principal rating factor, given the recent segment imbalances. A material deviation from forecast results could result in negative rating action.

Competitive Rate Position: Competitive rates contributing to strong customer retention are critical to the system's long-term credit quality. Fitch views the recent sale of the Indianapolis Campus Energy (ICE) Plant to Eli Lilly as an anomaly that nevertheless eliminates a customer and productive asset. Additional customer migrations could cause negative rating action.

CREDIT PROFILE

STEAM AND CHILLED WATER SERVICES

Citizens Thermal provides regulated steam and unregulated chilled water services for heating and cooling, respectively, to businesses and residents in the city and surrounding areas. The system operates as a distinct unit of CEG, which is an executive department of the city.

System assets appear reliable and have a long history of operations. CEG has provided various utility services in Marion County since 1887. Management believes both systems have ample capacity and redundancies. In addition, a Steam System boiler conversion project (to natural gas from coal) should ultimately lower long-term capital costs and related costs of emissions.

Citizens Thermal's new Chiller Boiler Plant serves Eskenazi Hospital, which recently opened in 2013.

CUSTOMER CONCENTRATION

The system's largest commercial and industrial customers represent the overwhelming majority of revenues, and customer contract terms typically expire prior to the outstanding bonds. However, the system's competitive rates, the high cost of switching to in-house services, and the long-standing presence in the city of many of the largest customers help mitigate these concerns.

Eli Lilly exercised its option to purchase the ICE plant from Citizens Thermal on Dec. 12, 2013. As a result of the transaction, Citizens Thermal increased its cash position by $12 million and recorded a $2.5 million non-cash loss related to the write-off of the remaining contract value. The contract had been recorded as an intangible asset.

While the payment from Eli Lilly approximates five years of EBITDA, the Chilled Water System loses a productive asset. Nevertheless, forecast Chilled Water System margins remain fairly robust, and management notes that there are no similar contract arrangements that risk the sale of additional assets.

STABLE BUT UNEVEN SEGMENT CONTRIBUTIONS

Citizens Thermal's consolidated financial metrics have been steady since fiscal 2010, but the underlying segment imbalances have been a credit concern for Fitch. Insufficient revenues for the larger, regulated Steam System have contributed to negative margins for that segment in each year since fiscal 2009. The Chilled Water System has contributed all of the combined positive net income during the period.

Fiscal 2013 debt service coverage (1.72x) was in line with the system's four-year average of 1.65x. Net income between the systems has averaged $6.8 million and -$3.9 million, respectively, since fiscal 2009.

FORECAST IMPROVEMENT

Forecast results demonstrate better balance between the segments, a precedent that is important to maintaining the 'A' rating. Fiscal 2014 midyear results show improved Steam System operations, and recent rate relief netting a favorable 95.5% of the requested amount ($7.6 million) should contribute positively to full year results. Fiscal 2014 forecast net income ($8.7 million) is split evenly between the segments.

Forecast Steam System and Chilled Water System net income averages $3.8 million and $7.3 million, respectively, through fiscal 2018. While Chilled Water System margins for fiscal years 2014-2017 are down an average of $3.7 million annually from the prior forecast, combined operations support the current rating: debt service coverage improves to 1.97x in fiscal 2014 and averages 1.82x annually through fiscal 2018. The ICE plant sale to Eli Lilly in December 2013 compresses Chilled Water System forecast margins.

The plant sale boosts Citizens Thermal's forecast cash position to $23.7 million (92 days cash on hand) in fiscal 2014. This is up from $11.8 million (50 days) in fiscal 2013. More limited capex totaling $30 million through fiscal 2018 with the near completion of the Steam System boiler conversion project and new Chiller Boiler Plant, versus $59 million during the prior five-year period through fiscal 2013, contributes handily to the system's forecast cash balances. Forecast cash on hand steadily improves to 210 days by fiscal 2018.

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

This rating action was informed by information identified in Fitch's U.S. Public Power Rating Criteria.

Applicable Criteria and Related Research:

--'U.S. Public Power Peer Study -- June 2014' (June 13, 2014);

--'U.S. Public Power Peer Study Addendum - June 2014' (June 13, 2014);

--'Fitch Rates Indiana Finance Auth. First and Second Lien Water Revs 'A' & 'A-'' (June 10, 2014);

--'Fitch Rates Indiana Finance Authority's First-Lien Wastewater Revs 'A'' (June 3, 2014);

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

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

--'Indianapolis Local Public Improvement Bond Bank, Indiana' (June 21, 2013).

Applicable Criteria and Related Research:

Indianapolis Local Public Improvement Bond Bank, Indiana

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696492

U.S. Public Power Peer Study -- June 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749789

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

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750283

U.S. Public Power Rating Criteria

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

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=837908

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Contacts

Fitch Ratings
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Alan Spen
Senior Director
+1-212-908-0594
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Alan Spen
Senior Director
+1-212-908-0594
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com