Fitch Rates Indianapolis, IN Thermal Energy System Revs 'A'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A' rating to the following Indianapolis, IN revenue bonds (issued on behalf of its Board of Directors for Utilities of its Department of Public Utilities, dba Citizens Energy Group):

--$51 million thermal energy system first lien revenue refunding bonds, series 2016A.

The bonds are expected to sell via negotiation at the end of October. Bond proceeds will be used to advance refund outstanding series 2008 and 2010A bonds for interest savings and pay issuance costs.

In addition, Fitch affirms the following ratings:

--$134 million thermal energy system first lien revenue bonds, series 2008, 2010A, 2010B, 2013A, and 2014A at 'A'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a first lien on net revenues of Citizens Thermal Energy System (Citizens Thermal, or the system) and certain other pledged funds under Citizens Thermal's master indenture.

KEY RATING DRIVERS

CENTRAL SERVICE PROVIDER: Citizens Thermal is an established provider of a regulated steam system and also provides unregulated chilled water services to customers in the Indianapolis metropolitan area. The system is a division of the City of Indianapolis' Citizens Energy Group (CEG).

CONCENTRATED BUT STABLE CUSTOMER BASE: The system's cost advantage over in-house services provides for relative customer stability, helping to partially mitigate considerable revenue concentration among largest payers and the limited term of many customer contracts relative to the system's outstanding debt. Customer contract renewal rates have been very strong.

STEAM SYSTEM RATE RELIEF: CEG has a strong track record of timely and successful execution of periodic rate cases for all of its regulated utilities. The 2013 rate case for the steam system resulted in a $7.6 million revenue increase beginning in 2014, which improved steam system margins and eliminated the segment imbalances between the steam and chilled water systems demonstrated previously.

STABLE FINANCIAL METRICS: Consolidated cash flows improved over the past two years, leading to higher debt service coverage (DSC) and stronger liquidity, which Fitch believes is necessary to offset customer concentration and competitive challenges. DSC was a solid 1.85x in fiscal 2015 and days cash on hand improved to 185 days.

LIMITED CAPITAL NEEDS: Capital needs through 2021 are a manageable $30 million and are expected to be fully funded on a pay-go basis, which should keep finances stable, rates competitive and leverage low.

RATING SENSITIVITIES

CUSTOMER RETENTION: Citizens Energy Group's Thermal Energy system's long-term credit quality hinges on its ability to retain its customer base largely by maintaining competitive rates. Any meaningful loss of customers and resulting strain on margins would be viewed negatively.

STABLE COST RECOVERY: Insufficient rate recovery that leads to measurable decline in financial metrics and reduces financial flexibility could result in downward rating pressure.

CREDIT PROFILE

Citizens Energy Group (CEG) is the trade name under which the city of Indianapolis, by and through the Board of Directors of the Department of Public Utilities, provides energy services to customers in and around Marion County. CEG has six operating segments providing a range of utility services, each as a stand-alone entity.

Citizens Thermal provides regulated steam and unregulated chilled water services for heating and cooling, respectively, to businesses and residents in the city's central business district. The system operates as a distinct unit of CEG, which is an executive department of the city.

CONCENTRATED CUSTOMER BASE

With just 160 steam customers and 60 chilled water customers, the system's customer base is small and highly concentrated with leading customers for both steam and chilled water comprising 77% of total Thermal System revenues in 2015.

Customers are signed to contracts of varying terms, but most are signed to contracts of 10 years or less and nearly all contracts are shorter than the maturity of the bonds. The potential loss of existing customers and resultant pressure on rates is a going concern, but Fitch believes this is mitigated by the system's competitive rates and the costs customers face switching to in-house services.

Furthermore, the largest customers are well-established entities that are likely to continue to anchor Indianapolis' economy, such as Indiana University - Purdue University Indianapolis (IUPUI), Eli Lilly, Indiana University Health, and Eskanazi Hospital. The continuation of customer retention trends will continue to be an important rating factor, and will be monitored closely by Fitch.

IMPROVED FINANCES AND DEBT METRICS

The steam and chilled water systems operate separately. Each segment maintains separate financial records and bank accounts, and operating costs and debt service for each are paid out of their own source revenues. However, pledged revenues are derived from the combined entities.

Consolidated financial metrics have been steady since fiscal 2010, although underlying segment imbalances, a result of insufficient revenues for the larger regulated steam system, were previously a concern for Fitch. The imbalances were corrected in fiscal 2014, largely as a result of the rate relief approved by the Indiana Utility Regulatory Commission (IURC) to fund the steam system's conversion of the Perry K plant. In fiscal 2015, both utilities contributed roughly equal net income for the overall Thermal system.

DSC improved to 1.88x in fiscal 2014, marking three consecutive years of improvement. DSC was similarly strong in fiscal 2015. The operating margin (15.2%) improved as well, to higher than the 10.4% average of the previous four fiscal years. Healthier margins coupled with a $12 million cash infusion from the sale of a chilled water plant in late 2013 have also supported an increase in cash/liquidity, which totaled a fairly robust $46 million in fiscal 2015 or 185 DCOH.

CEG's $20 million line of credit with JP Morgan provides additional liquidity, and can be used for operating and capital purposes. The line of credit was extended to June 21, 2017. Including the line of credit, total liquidity on hand was 265 days in 2015.

The thermal system has a total of five series of fixed-rate bonds outstanding totaling $134 million as of the end of the third quarter 2016. The 2016A bonds are estimated to provide over $6 million in gross savings ($5 million net present value [NPV]), or an average of roughly $500,000 annually through maturity in 2029. After issuance, debt service will be level at approximately $16 million annually through 2025, but steps down considerably to just under $4 million per year thereafter. All debt matures by 2034.

In 2015, debt was 5.5x FADS, an improvement over the 8.2x just a few years earlier. Debt as a percentage of total capitalization has also declined to 61%. With no new debt projected, debt ratios are expected to continue to improve.

RATE RELIEF EXPECTED TO CONTINUE

Rates for steam customers are regulated by the IURC, which is required to review basic rates and charges at least every four years. However, CEG's policy is to file rate plans more frequently, approximately every three years. CEG has been successful in getting approval of its rate filings historically. Rate relief has improved with the passage of legislation that shortens the approval process and allows CEG to recover IURC-approved but unearned revenue requirements that may result when revenues are affected by weather or other factors that can lower demand.

The most recent steam rate order approved a $7.6 million (11.4%) increase effective May 2014. The IURC also approved an operating expense rate adjustment mechanism to track savings related to the conversion of the Perry K plant. On April 22, 2016, CEG filed a petition with the IURC to approve a decrease in steam rates. A settlement was reached, resulting in a $2.4 million (3.4%) decrease in rates. The case remains pending with the IURC. Steam rates across all three customer classes include a quarterly fuel cost adjustment to capture natural gas price fluctuations. Chilled water rates are unregulated.

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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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013253

Endorsement Policy

https://www.fitchratings.com/regulatory

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Fitch Ratings
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Andrew DeStefano
Director
+1-212-908-0284
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
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Senior Director
+1-212-908-0723
or
Media Relations:
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elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Andrew DeStefano
Director
+1-212-908-0284
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Joanne Ferrigan
Senior Director
+1-212-908-0723
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com