Fitch Upgrades Dover, DE's Electric System Revs to 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings has upgraded the rating on the following Dover, DE (the city) revenue bonds:

--$21.7 million electric revenue bonds, series 2008 and 2010 to 'AA' from 'AA-'.

The Rating Outlook is Stable.

SECURITY

Outstanding bonds are secured by net revenues of the city's electric utility system (the system).

KEY RATING DRIVERS

STABLE SERVICE TERRITORY: The city's electric utility system provides retail service to a service territory that functions as both the county seat and state capital. Dover Air Force Base and the state's presence anchor the city's economy and generally offset the city's relatively weak income levels and higher than average unemployment.

CONSISTENTLY STRONG FINANCIAL PERFORMANCE: The upgrade reflects the continuation of robust cash flow metrics and healthy liquidity that consistently outperform Fitch's rating category medians. Fitch calculated debt service coverage adjusted for transfers to the city's general fund has been above 2.5x in most years while days of cash on hand has remained well in excess of 200 days. Fitch expects operating results will strengthen going forward based on the system's current financial forecast ending in fiscal 2021.

POWER SUPPLY MANAGEMENT RISK: Dover meets the majority of its energy requirements through the PJM Interconnection LLC (PJM) market purchases and short-term bilateral contracts with various counterparties. While the city's power supply is capably managed by a non-profit energy manager, the city remains exposed to market price volatility and liquidity risks.

COMPETITIVE RATES: The city's retail electric rates are now considered competitive relative to other retail providers in the state following three consecutive years of meaningful cost reductions. The relatively low rates provide the system with additional flexibility.

FAVORABLE DEBT PROFILE: Leverage ratios compare favorably to Fitch's median ratios for the rating category and should continue improving as the city remains committed to funding the utility's capital needs entirely from excess cash flow.

REVENUE AND SALES CONCENTRATION: The system remains exposed to modest revenue and sales concentration derived from its more sizeable customers. However, Fitch derives sufficient comfort from the composition, demonstrated stability and long-standing presence of the system's 10 largest customers.

RATING SENSITIVITIES

ESCALATION IN UTILITY TRANSFERS: An increase in the city's reliance on utility transfers to support general fund operations resulting in diminished cash flow metrics and reduced operating flexibility at the utility could ultimately pressure the rating.

MAINTENANCE OF LIQUIDITY: Sustaining the utility's sizeable cash reserves remains a critical rating factor given the utility's potential exposure to collateral posting requirements and reliance on market purchases for power supply.

CREDIT PROFILE

The city's electric utility system serves the city of Dover and neighboring areas immediately beyond city limits. Residential customers dominate the customer base, but account for just 28% of energy sales. Moreover, the system's 10 largest customers, which include Dover Air Force Base, compose a significant 35% of annual load and system revenue, respectively. The concentration and relative lack of diversity in energy sales and revenue poses some concern, although the system's largest customers are all believed to be highly stable customers unlikely to depart the service area.

ACTIVELY MANAGED POWER SUPPLY

Dover meets the majority of its energy requirements through PJM market purchases and short-term bilateral contracts with various counterparties for periods ranging from three to nine years. Through a five-year management agreement, the city's power supply is capably managed by The Energy Authority (TEA), a non-profit energy manager owned by seven public utility systems operating across the nation.

The city currently owns two generating stations with a total combined capacity of 148 megawatts (MW). Each of the generating facilities is dispatched solely to meet peak demand. North American Energy Services Corporation (NAES) has operated both plants since 2006 pursuant to an operating agreement between the city and NAES.

Dover's city council recently voted to retire multiple units at one of the two generating stations after determining that the projected escalation of fixed operating and maintenance costs would make the dispatch of the units no longer economically advantageous. To replace the capacity resulting from the closure of the units, the city entered into a five-year contract with Calpine for up to 40 MW of capacity beginning when the units come offline. Longer-term power supply options, including potentially owning and financing its own generating facility, are currently being considered as the city works to complete its integrated resource plan.

STRONG CASH FLOW METRICS

The city's electric utility routinely generates robust operating margins leading to strong Fitch calculated debt service coverage and sizeable cash reserves. Debt service coverage improved to 5.54x in fiscal 2015 following a year in which cash flow metrics weakened due to a decrease in rates followed by extreme winter weather conditions that led to an unanticipated spike in purchased power costs. Debt service coverage, despite fiscal 2014 results, has remained at no less than 3.0x over the prior seven years while days of unrestricted cash on hand has stayed equally strong with well over 200 days.

The utility makes a sizeable transfer each year to the city's general fund, resulting in lower but still strong coverage ratios that consistently exceed 2.0x notwithstanding fiscal 2014 when purchased power costs spiked due to extreme winter weather conditions. The city revised its policy in recent years to allow for a higher transfer amount as a means to support the city's general fund operations. The current policy, adopted in 2015, limits the transfer to no more than $10 million, equal to a considerable 14.1% of the utility's total revenue in fiscal 2015.

The percentage transferred far exceeds the median percentage (5.6%) for the rating category, but concerns are mitigated by the utility's typically strong operating margins and robust cash reserves. Moreover, the transfer is made, pursuant to the revenue bond resolution, after satisfying annual operating expenses and debt service obligations. Approximately one-third of the general fund's total income for fiscal 2015 was derived from utility transfers, evidencing the city's heightened reliance on utility cash flows.

FINANCIALS FORECAST TO REMAIN STRONG

Financial projections through fiscal 2021 show the continuation of strong cash flow metrics leading to maintenance of sizeable cash reserves. Outstanding series 2010 bonds fully matured in fiscal 2016, prompting projected annual debt service obligations to decline by half. Debt service coverage is forecast to grow as a result, increasing to no less than 4.70x, even after the annual transfer to the city's general fund is made. The forecast assumes the general fund transfer remains unchanged at $10 million, and does not incorporate any additional electric rate increases or additional borrowings.

SOLID SERVICE TERRITORY

Dover's economy is generally stable, despite persistently higher than average unemployment and relatively weak wealth indicators. The city ranks second among the state's largest cities and its role as both the state capital and county seat for Kent County provide for a steady employment base rooted in the government sector.

Dover's three largest employers - Dover Air Force Base, the State of Delaware, and Bayhealth Medical Center (revenue bonds rated 'AA-'/Outlook Stable) - anchor the city's economy, directly accounting for nearly 75% of employment opportunities within the city. Composition of the city's 10 largest employers has exhibited little change over the prior 10 years.

Wealth indicators fall anywhere from 10% to 25% below state and national figures, and unemployment (6.8% in July 2016) has remained above state and national figures. Nevertheless, the utility's collection of revenues remains very strong, with annual write-offs of less than 0.5%.

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

Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012
U.S. Public Power Rating Criteria (pub. 18 May 2015)
https://www.fitchratings.com/site/re/864007

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+1-212-908-0773
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
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Jeremy Williams
Analyst
+1-646-582-4870
or
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+1-512-215-3730
or
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alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler
Senior Director
+1-212-908-0773
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jeremy Williams
Analyst
+1-646-582-4870
or
Committee Chairperson
Kathy Masterson
Senior Director
+1-512-215-3730
or
Media Relations
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com