TEXT - Fitch affirms Arkansas Electric Cooperative ratings
Jan 30 - Fitch Ratings affirms Arkansas Electric Cooperative Corporation's (AECC) implied senior secured obligations at 'A+'. Fitch also affirms AECC's 'F1' rating on its $250 million commercial paper program. The Rating Outlook is Stable. AECC's long-term rating takes into account approximately $557.5 million in parity secured debt that is privately held by: Cobank ($94 million); Federal Financing Bank ($263.1 million); Rural Utilities Service (RUS; $0.4 million); and a private placement of first mortgage bonds ($200 million). However, AECC's long-term rating is assigned to 'implied' obligations since none of the outstanding debt is publicly held. SECURITY Pursuant to AECC mortgage indenture, effective June 1, 2009, the senior obligations are secured by a first lien on essentially all AECC assets, owned and intangible, including its electric generation and transmission facilities. AECC's commercial paper notes are unsecured (subordinate) obligations. SENSITIVITY/RATING DRIVERS SOLID COOPERATIVE FUNDAMENTALS: AECC's credit strengths stem from its long-term (2042) all-requirements contracts with its 17 member distribution cooperatives, low cost power resources, competitive wholesale rates and sound member customer base. STRONGER MARGINS AND CASH FLOW: AECC's net margins and cash flow have notably improved with the rebound in industrial sales following the recent recession, and a 4% wholesale rate increase in November 2009. Fitch-calculated coverage of full obligations was close to 1.50x for 2010-2012, which is well above the same coverage reported in 2007-2009 (average of 1.08x) and the Fitch rating category median of 1.12x. STATE REGULATORY OVERSIGHT: AECC and its members are subject to rate regulation by the Arkansas Public Service Commission (APSC). Partially mitigating this concern is the long history of constructive regulatory treatment by the APSC; the favorable fuel/purchased power cost pass-through for AECC and its members; and existing legislation which allows for an expedited, streamlined rate review process since 2009. LEVERAGE RISING BUT MANAGEABLE: AECC's capital program totals $800 million through 2016, primarily for coal plant environmental upgrades related to more stringent emission standards. Positively, AECC has built up equity over the past 20 years and more recently increased rates twice, in anticipation of the higher capital spending beginning in fiscal 2012. AECC is projecting modest rate increases post-2013. GROWING MEMBER SALES: AECC's members are spread throughout the state. With AECC providing 100% of Arkansas Valley Electric Cooperative Corporation's power requirements beginning June 2011 (sales increase of 5.5%), AECC now provides power to all the distribution cooperatives' consumers in Arkansas. The members' customer base is heavily residential, accounting for 60% of member revenues. COMMECIAL PAPER LIQUIDITY ADEQUACY: AECC's maximum $250 million commercial paper (CP) program is supported by an equally sized unsecured revolving credit facility, with a syndicate of 10 banks (expiring April 28, 2014), as well as AECC's broader liquidity that includes $90 million in unrestricted cash (as of Oct. 31, 2012). Other increasing member demand obligations at AECC, however, are a concern. WHAT COULD TRIGGER A RATING ACTION STRONG FINANCIAL METRICS THROUGH CAPEX CYCLE: The continuance of strong cash flow and liquidity through the current cycle of higher capital expenditures and related borrowings could support a higher rating going forward. CREDIT PROFILE STRONG CREDIT FUNDAMENTALS AECC provides generation and transmission service to a customer base of 495,700 users via its 17 member retail electric cooperatives. The members provide electric service to approximately 31% of the state's consumers. AECC power supply is competitive cost, with AECC's average wholesale rates among the lowest of its peer G&T cooperative providers. AECC's power supply is predominantly coal-fired, representing 60% of energy requirements. This carbon exposure, is somewhat offset by AECC stronger than average balance sheet (34% equity to total capitalization as of Oct. 31, 2012) and competitive rates, which combined provide added rate and financial flexibility prospectively. RATE REGULATED BUT FAIR TREATMENT Unlike most of its cooperative brethren in other states, AECC is subject to rate and regulatory oversight by the APSC. Positively, AECC has a long history of constructive APSC decisions, including the use of a fuel and purchased power cost pass-through mechanism for AECC and its members; approval of investment in the Turk Power Plant (ultra super critical coal-fired facility); and support for the legislation which created an expedited rate review process (five month versus a 12-month review). AECC has utilized the expedited rate process twice since implementation in 2009, for an aggregate 9% wholesale rate increase. The expedited rate process, while limited to rate increases of 5% or less in a single year, adds greater rate certainty in a regulated environment. SIZEABLE CAPITAL PLAN AECC is in the midst of funding (primarily with debt) environmental upgrades at its jointly owned coal facilities, due to more stringent U.S. Environmental Protection Agency (EPA) emission and regional haze mandates. AECC estimates its share of the emission control upgrades is approximately $536.4 million through 2019. Positively, AECC has secured low cost RUS financing to fully fund these equipment upgrades as needed. Given that these coal plants (Flint Creek, White Bluff, and Independence System Electric Station) are fully depreciated, the added fixed costs related to the environmental upgrades should be manageable. AECC is also entering this higher capex cycle with a strong balance sheet. AECC built up equity capitalization to more than 40% by fiscal 2007 in anticipation of the higher capital expenditures beginning in fiscal 2012. Equity currently stands at 34% - well above Fitch's peer rating category median of 11.5% for 2011. Going forward, AECC's Fitch-calculated equity will fall to approximately 30% by 2016 (including Notes Payable to Members as debt), which is still very strong in comparisons to other G&T cooperatives and our Fitch peer medians.