NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns its 'A+' rating to the following outstanding Southern Minnesota Municipal Power Agency (SMMPA or agency) bonds:
--$68 million power supply system revenue bonds, series 2010A;
--$7 million power supply system revenue bonds, series 2010B.
The Rating Outlook is Stable.
SECURITY
The outstanding bonds are secured by net revenues derived by SMMPA from the operation of the power system, after payment of operating expenses. Net revenues are derived primarily from payments under power sales contracts (PSCs) with 18 participating municipal electric systems.
KEY RATING DRIVERS
MATURE AND STABLE JOINT ACTION AGENCY: SMMPA is a joint action agency that has provided wholesale power supply to its 18 member cities since 1977. Power and energy is principally supplied pursuant to take and pay PSCs that were recently extended through April 1, 2050 by 15 members representing 42% of 2013 system load. The remaining contracts, including the PSC with Rochester, MN ('AA-'/Outlook Stable) expire on April 1, 2030.
CONCENTRATION WITH THE LARGEST MEMBERS: The largest members are Rochester, MN, Owatonna MN, and Austin MN which account for a sizeable 69% of the Agency's energy sales. Each exhibits healthy overall credit characteristics and has experienced relatively stable retail electric sales in recent years. Rochester and Austin's decision not to extend their PSCs beyond 2030 present longer-term challenges to the agency.
COMPETITIVE AND STABLE ELECTRIC RATES: The agency maintains wholesale power rates (7.1 cents/KWh in 2013) that are below neighboring investor-owned utility, municipal, and cooperative utilities. Management's focus on long-term planning, cost efficiency, and building financial reserves has moderated the need for large rate increases in recent years, but produced below average debt service coverage metrics.
ROBUST SERVICE AREAD ECONOMICS: The city of Rochester, MN and the surrounding metropolitan areas (including Owatonna and Austin) weathered the last recession better than other regions across the nation. Unemployment rates for each of the three largest members were lower than national and state averages as of April 2014.
SINGLE UNIT GENERATION RISK: Sherbourne County Generating Unit No. 3 (Sherco 3) is SMMPA's principal generating asset. Although the unit experienced a nearly two year outage, the financial effects were largely mitigated by ample low-cost replacement power. Since returning to service in late 2013, the operating performance of Sherco 3 has been sound.
BELOW AVERAGE COVERAGE METRICS: Management's focus on maintaining low and stable wholesale rates has produced debt service coverage metrics that are somewhat weak relative to the proposed rating category. At the same time, the buildup of significant cash reserves, and above average liquidity, help mitigate the related risk.
RATING SENSITIVITIES
ASSET CONCENTRATION RISK: SMMPA's dependence on Sherco No. 3 for nearly two-thirds of its installed capacity exposes the agency to single unit risk. An extended outage of this plant, particularly in a volatile wholesale market environment, could pressure the financials of both SMMPA and its members.
REDUCED FINANCIAL RESERVES: SMMPA's robust cash reserves are a key factor supporting the recommended 'A+' rating. Changes in financial and/or rate setting policies leading to deterioration of current liquidity metrics would be viewed negatively by Fitch.
CHANGE IN FINANCIAL POLICIES: The implementation of financial and rate-setting policies that produce more robust coverage metrics could provide support for a positive Outlook.
CREDIT PROFILE
SMMPA provides wholesale power supply to 18 participating cities, all of which own and operate municipal electric systems. SMMPA's load center is concentrated in the southern portion of the state, including the city of Rochester, MN, the agency's largest member representing 44% of 2013 energy sales. Collectively, the participating systems serve approximately 112,000 largely residential and commercial customers and a total population of approximately 243,000.
Power is supplied to the members primarily through a mix of agency and member-owned resources with limited reliance on purchase power agreements (PPAs). SMMPA's core generating asset is its 41% interest in Sherco 3, a 910 MW coal-fired steam unit majority owned and operated by an affiliate of Xcel Energy Inc. (XEL; 'BBB+'/Outlook Stable). The remaining power and energy requirements of the participants are supplied through agency-owned and controlled natural gas-fired capacity, renewable facilities, and PPAs with third parties.
Take-and-Pay Contracts with Members
SMMPA supplies the power requirements of the participating municipal systems through separate, but substantially similar long-term PSCs. Each of the contracts expire on April 1, 2050, with the exception of PSC's with Rochester, MN, Austin, MN, and Waseca, MN which end on April 1, 2030. Although the PSCs terminating in 2030 represent 56.4% of 2013 energy sales, Fitch does not view the shorter tenor of these PSCs as a significant concern. Specifically, given the low level of projected annual debt service post-2030, the residual effect on SMMPA's remaining members would be very manageable from a cost standpoint in the event the PSCs are not extended.
Stable Agency Financial Performance
Operating performance at the agency has been stable over the last five years with funds available for debt service (FADS) averaging $67.5 million per annum over the period 2009-2013. Fitch notes the absence of volatility in earnings and cash flow during an extended outage of Sherco 3 which persisted throughout fiscal 2012 and the majority of fiscal 2013. In particular, a benign market for wholesale replacement power enabled SMMPA to replace the lost Sherco baseload capacity at a minimal incremental cost to the agency and its members.
Fitch-calculated debt service coverage (DSC) of 1.05x for fiscal 2013 is weak relative to the 'A+' category median. The bond resolution requires a coverage ratio of 1.10x, a level which SMMPA targets primarily through ongoing transfers into and out of its rate stabilization fund. Excluding RSF transfers, Fitch calculated DSC for fiscal 2013 is 1.18x.
Mitigating the sub-median DSC ratios are the agency's abundant cash reserves and strong liquidity metrics. SMMPA ended 2013 with 247 days cash on hand outperforming the category median for similarly rated wholesale systems. The agency also benefits from a $68 million commercial paper program which is supported by a U.S. Bank liquidity facility and revolving credit agreement. As of December 2013, $23 million was available under the program, strengthening liquidity to 294 days.
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:
--'U.S. Public Power Rating Criteria' (March 18, 2014);
--'U.S. Public Power Peer Study' (June 13, 2014).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841
U.S. Public Power Peer Study Addendum - June 2014
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750283
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=905794
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