NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA+' rating on the following revenue bonds issued by the city of Memphis, TN on behalf of Memphis Light, Gas and Water Division's (MLGW):
--$460.2 million electric utility revenue bonds, series 2003A, 2008 and 2010.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a subordinate lien on net revenues of the electric division. Outstanding electric utility revenue bonds, series 2014, which are not rated by Fitch, are secured by a senior lien on the electric division's net revenues. MLGW's outstanding bonds do not carry a debt service reserve. A default of the subordinate revenue bonds does not trigger a cross default of the senior revenue bonds.
KEY RATING DRIVERS
LARGE DISTRIBUTION SYSTEM: MLGW operates a combined utility system providing electricity, gas and water services to customers within the City of Memphis (GO bonds rated 'AA-'/Outlook Stable) and in portions of Shelby County, Tennessee. The electric division continues to generate sound financial metrics despite an ongoing trend of uneven sales and the relatively weak service area demographics.
RELIABLE POWER SUPPLY: MLGW remains the largest all-requirements customer of the Tennessee Valley Authority (TVA; global power bonds rated 'AAA'/Outlook Stable) pursuant to a rolling five-year contract.
SAVINGS FROM PREPAYMENT AGREEMENT: MLGW's prudent decision in 2003 to prepay for a sizeable portion of its capacity from TVA via a 15-year supplemental contract has resulted in a reliable long-term baseload supply and sizeable cost savings for MLGW. Fitch does not expect the expiration of the supplemental contract in 2018 to have a meaningful impact on the system's prospective financial performance.
STABLE FINANCIAL METRICS: Cash flow and liquidity metrics are consistently low compared to median ratios for the rating category. However, MLGW's obligation to automatically pass through in full its wholesale costs (equal to nearly 80% of total expenses) ensures timely cost recovery. Low retail rates provide additional flexibility.
LOW DEBT BURDEN: The vast majority of existing debt obligations fully mature by 2018, which should offset additional borrowing plans and lead to continued improvement in the utility's already favorable leverage ratios.
WEAK SERVICE TERRITORY: The system's service area is relatively stable and diverse but continues to exhibit high unemployment and low income levels. The resulting concern is mitigated, however, by MLGW's trend of strong collection rates, the obligation to automatically pass through power supply costs and competitive retail rates.
RATING SENSITIVITY
RATING STABILITY: Fitch expects Memphis Light, Gas and Water Division's stable financial position, low debt levels and sound overall operating profile will continue for the foreseeable future.
CREDIT PROFILE
LIMITED RISK DISTRIBUTION PROVIDER
MLGW is an enterprise fund of the city of Memphis (GO bonds rated 'AA-'/Outlook Stable), existing to provide electric, gas and water services to a broad and mostly diverse service territory. The combined utility consists of discretely accounted for electric, gas and water divisions with outstanding debt issued by MLGW separately secured only by net revenues of each individual division.
Exposure to operating risks related to direct commodity, power supply and asset ownership are somewhat limited given MLGW's role as retail electric distribution provider with no generating capacity of its own. TVA, the largest public power system in the U.S., provides all of the electric division's power supply pursuant to a five-year, rolling all-requirements contract.
TVA's resource portfolio is increasingly diverse, with owned generating assets well balanced between coal-fired, natural gas/oil-fired, hydro and nuclear. TVA expects its remaining capacity, together with the completion of Watts Bar Unit 2 and the future addition of natural gas-fired generation, will be sufficient to meet customer load growth over the medium term, despite recent and planned retirements of several of its coal-fired units. Fitch believes MLGW's contractual relationship with TVA is a positive credit factor given the authority's competitive wholesale power costs and diverse power resources.
PREPAY AGREEMENT
The vast majority of the electric division's outstanding debt stems from the 2003 issuance of $1.5 billion in electric system revenue bonds used to prepay TVA for a fixed portion of its energy requirements for a 15-year period ending in 2018. The prepayment represented the full cost of the prepaid capacity at TVA's November 2003 wholesale rate. In return, MLGW receives a fixed discount on the power purchased annually from TVA equal to the annual debt service on the prepayment bonds plus approximately $13 million per year.
The transaction locked in the discount on the prepaid capacity, but not the price of the power, which remains subject to variability. Fitch continues to view the prepayment transaction favorably for both MLGW and TVA. Acquiring the prepaid capacity ensured a long-term power supply and meaningful cost savings for MLGW, whereas TVA secured its largest customer for approximately half its energy requirements for 15 years.
CONSISTENT FINANCIAL RESULTS
Fitch calculated debt service coverage as well as coverage of full obligations, including a modest annual transfer made to the city's general fund, have been consistent over the prior five years, averaging about 1.82x and 1.15x, respectively. Median ratios for the rating category are slightly stronger at 2.02x and 1.30x. Liquidity continues to approximate management's prudent target of 45 days cash on hand, providing an adequate cushion relative to MLGW's limited role as a distribution system.
Financial results included in the latest financial forecast remain in line with more recent trends until the vast majority of debt currently outstanding fully matures in 2018. Debt service coverage escalates dramatically from an average of 1.71x between 2016-2018 to about 12x in the outer years of the forecast due to significantly lower annual debt service obligations. Liquidity generally continues at its current level, despite some modest fluctuation.
MLGW's projections conservatively incorporate no growth in customer accounts or energy sales and include the aforementioned 4% rate hike planned for fiscal 2019 and additional debt issuances in fiscal 2016 and 2018. Fitch considers the assumptions reasonable and expects MLGW will achieve its stated financial targets.
RAPID DECLINE IN LEVERAGE DESPITE ADDITIONAL BORROWINGS
Capital needs over the next five years appear manageable, despite the expected purchase and installation of smart meters for the vast majority of its customers. Projected spending through fiscal 2020 is estimated at $518 million. Expected funding sources include a recent (2014) bond issue totaling $71 million as well as additional borrowings of roughly $40 million and $30 million slated for 2016 and 2018, respectively.
The additional leverage represents somewhat of a departure from MLGW's historical practice of current funding its capital needs, although the rapid amortization of existing obligations, including the series 2014 bonds, will continue to allow for ample capacity to absorb the additional debt without leverage ratios weakening as a result. Nearly 90% of MLGW's total debt outstanding fully matures in 2018.
WEAK SERVICE TERRITORY
Economic and demographic indicators are considered weak, but the city's role as the county seat and the presence of its largest employer, Federal Express Corp. (Fedex), provide a degree of stability to the service territory. Despite trending downward in recent years, the city's September 2015 unemployment rate of 7.3% remained high relative to county, state and national figures. Wealth indicators, including per capita and median household income, range from about 20%-30% lower than state and national figures. In addition, the city's poverty rate (29.8%) is slightly more than twice the national average and well above the state figure. Nevertheless, MLGW reports strong collection rates with write-offs routinely below 1% of annual revenues.
Contact:
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Public Power Rating Criteria (pub. 18 May 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995337
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