NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns initial 'A-' ratings to Heartland Consumers Power District's (Heartland, or the district) implied first and second lien revenue obligations.
The rating Outlook is Stable.
The ratings take into account approximately $16 million of privately placed second-lien debt obligations (not rated), but are assigned to implied obligations as none of the district's outstanding debt is publicly held. Previously outstanding first lien obligations were recently defeased, although the first lien remains open.
Outstanding privately placed debt is secured by a second lien on net revenues after payment of operating and maintenance expenses and any first lien obligations. Net revenues include payments pursuant to long-term take-and-pay power supply contracts with Heartland's 34 participants. The power supply contracts are viewed as having an implied unlimited step-up provision. The district currently has no senior lien debt outstanding, although the senior lien remains open.
KEY RATING DRIVERS
SMALL WHOLESALE ELECTRIC PROVIDER: Heartland supplies wholesale power to its 34 long-term municipal, state institution and electric cooperative customers in eastern South Dakota, western Minnesota and Iowa. Long-term, take-and-pay power supply contracts extend well beyond the current maturity of outstanding debt obligations and are an operating expense at the customer level senior to any customer debt service.
SOUND MEMBER CREDIT QUALITY: Long-term customers are primarily small municipal electric systems serving largely rural, agriculturally-based communities with consistently low unemployment levels. The five largest customers (excluding Marshall, MN) account for more than two-thirds of peak customer demand and exhibit sound financial profiles with manageable debt levels, if any. However, customer concentration at the participant level remains a concern.
EFFECTIVE LOAD MANAGEMENT: Heartland's contract with Marshall, MN (its largest customer; 59 MW) expires in 2016. Although the district has replaced the expiring load with several new contracts totaling up to 86 MW, two of the largest - with Basin Electric Power Cooperative (BEPC) and Garden City, KS - only extend through 2020/2021, exposing Heartland to some degree of renewal risk.
IMPROVING FINANCIAL METRICS AND LEVERAGE: Solid gains have been made in recent years as a result of more effective resource management and wholesale rate increases putting the district on sounder financial footing following a period of instability. Fitch-calculated debt service coverage improved to 3.2x in fiscal 2014, following a period of deficient coverage in fiscal years 2011 and 2012. While cash on hand remained weak at about 25 days, a recently obtained $25 million revolving line of credit provides the district with greater liquidity going forward until planned rate increases and a rapidly diminishing debt burden should lead to more robust cash flow and liquidity metrics.
DIVERSE RESOURCE PORTFOLIO: Available power supply resources consist primarily of ownership interests in the Missouri Basin Power Project (MBPP) and the Whelan Energy Center Unit 2 (WEC 2). A long-term purchase power agreement for wind capacity together with customers' Western Area Power Administration (WAPA) allocations and dedicated generating units provide additional diversity to Heartland's total resource portfolio.
FAILURE TO SUSTAIN IMPROVED PROFILE: Any failure by Heartland and its customers to implement the planned rate increases and operating improvements necessary to sustain sound financial profiles consistent with the 'A-' rating category would likely result in downward pressure on the district's rating.
LOAD PROFILE REMAINS A RISK: The district and its customers remain exposed to sizeable increases in fixed capacity costs should existing power sales agreements with BEPC and Garden City, KS expire in 2020 and 2021, respectively, as currently scheduled. Additional financial strain attributable to recovering these costs could introduce downward pressure on the rating or Outlook.
SOLID CUSTOMER COMPOSITION
Heartland is a small wholesale electric provider providing low-cost power supply and related services to a customer base spread across mostly rural parts of South Dakota, Iowa and Minnesota. Long-term power sales contracts extend through either 2040 or 2050 for 24 of the district's 34 customers. All but two have contracts in place through at least 2029, well beyond the final maturity of outstanding debt obligations.
The broad service territory exhibits a diverse customer base supported by an agriculturally based economy that continues to result in exceptionally low unemployment rates. Wholesale customers consist primarily of municipalities providing electric distribution service to exceptionally small, mostly rural populations. The district's five largest customers, excluding Marshall, MN whose contract expires in 2016, accounted for 29% and 26% of the district's aggregate energy usage and revenue in fiscal 2014. The five largest customers all exhibit sound financial profiles supportive of the district's 'A-' rating.
DIVERSE POWER SUPPLY
The district's ownership interests in two large coal-fired units, various purchase power agreements, spot market purchases, along with its customers' Western Area Power Administration (WAPA) allocation and dedicated generating units provided 311-MW of capacity in fiscal 2014, slightly more than the district's peak requirements of 299 MW, which included a small reserve margin.
FINANCIAL PROFILE EXPECTED TO IMPROVE
Financial metrics strengthened in fiscals 2013 and 2014 as capacity costs related to a prior capacity agreement ended and several medium-term power sales agreements were executed, allowing the district to reduce its reliance on surplus sales. Fitch expects further improvement based on the district's current financial forecast as annual debt service obligations ramp down considerably, the need for surplus sales continues at a nominal level and the board approved plan to implement multiple rates increases proceeds.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria'(June 16, 2014);
--'U.S. Public Power Rating Criteria'(March 18, 2014);
--'U.S. Public Power Peer Study' (June 13, 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria
U.S. Public Power Peer Study -- June 2014