Fitch Places Paducah Power System, KY's Revs on Rating Watch Negative

NEW YORK--()--Fitch Ratings has placed the following Paducah Power System, KY (PPS) 'A-' rated revenue bonds on Rating Watch Negative:

--$153 million revenue bonds, series 2009A;

--$1 million refunding revenue bonds, series 2010.

The Negative Rating Watch reflects PPS's constrained financial position and charged operating environment that could limit the system's return to stability. An October 2014 rate freeze that remains in effect exacerbates PPS's financial challenges.

Fitch expects to resolve the Negative Rating Watch following a review of PPS's updated strategic plan and projected financial performance, as well as the delivery of PPS's fiscal 2014 audit.

SECURITY

The bonds are secured by a first lien on PPS's net revenues derived from electric system operations.

RATING SENSITIVITIES

INADEQUATE RATE RECOVERY: Inadequate rate recovery set against the system's sizable debt burden and long overall power supply could lead to negative rating action, absent material near-term financial improvements and a longer-term comprehensive strategy to establish stability.

CREDIT SUMMARY

INADEQUATE RATE RECOVERY LIMITS FINANCIAL CUSHION

Inadequate rate recovery has weakened PPS's financial position over the past five years, commensurate with its shift to owning and operating generation assets. Base rate increases from November 2012-April 2014 aligned with PPS's cost of service have not sufficiently supported system metrics at previously projected levels.

In addition, the PPS Board froze a quarterly power cost adjustment (PCA) in October 2014; PPS implemented the PCA this year. The action, which continued into November, caused a $472k (3.2% of fiscal 2013 funds available for debt service) revenue shortfall compared with what would have otherwise been collected that month.

This compounds lackluster unaudited fiscal 2014 results suggesting near 1.2x debt service coverage and 14 days cash on hand by Fitch's calculation. Fitch's comparable 'A-' rating category medians are 1.6x and 79 days, respectively.

Projected fiscal 2014 debt service coverage was 1.44x - reaching upwards of 1.7x in fiscal years 2015-2017 - during Fitch's August 2013 review of the system. PPS expected that the base rate increases and greater cost certainty from its participation in the Prairie State Energy Campus (PSEC) would build support.

LONG POWER SUPPLY ADDS COSTS

PPS's power supply (246MW) is long by approximately 50%, including all sources of capacity and a reserve margin. This is a concern in a soft power market where off-system sales are unlikely to generate substantial revenues. Moreover, it adds costs to a rate base evidencing below average wealth and employment indicators.

This appears to have limited PPS's practical revenue-raising flexibility, as evidenced by the October 2014 rate freeze. Above average rates equal to 141% of the state average, according to data provided by the Energy Information Administration, adds to Fitch's concern.

Sales growth has not materialized as envisioned during PPS's 2010 debt offering.

TRANSITION TO ASSET OWNER

PPS's PSEC capacity (104MW) pursuant to a take-or-pay contract with Kentucky Municipal Power Agency should ultimately meet about two-thirds of its energy requirements as the project ramps up. A 124MW peaking unit, which became operational in 2010, and a small portion of hydroelectric power from American Municipal Power constitute the majority of other long-term power sources.

PPS had been a distributor of purchased power supplied by the Tennessee Valley Authority (TVA; global power bonds rated 'AAA'/Outlook Stable by Fitch) until 2010. The system elected to track TVA's lower rates during the transition period rather than strengthening its financial profile in anticipation of the change. A one-notch rating downgrade by Fitch ensued in August 2011.

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

This rating action was informed by the sources of 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);

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

Applicable Criteria and Related Research:

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=919435

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Christopher Hessenthaler
Senior Director
+1-212-908-0773
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Ryan A. Greene
Director
+1-212-908-0593
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Christopher Hessenthaler
Senior Director
+1-212-908-0773
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com