Fitch Upgrades Arkansas Electric Cooperative to 'AA-/F1+'; Outlook to Stable
--implied senior secured obligations to 'AA-' from 'A+';
--$250 million maximum commercial paper program to 'F1+' from 'F1'.
AECC's long-term rating takes into account approximately $876.2 million in parity secured debt. However, AECC's rating is assigned to 'implied' obligations since none of the outstanding debt is publicly held.
The Rating Outlook is revised to Stable from Positive.
The senior debt obligations are secured by a first lien on essentially all AECC assets, owned and intangible, which include electric generation and transmission facilities. AECC's commercial paper (CP) notes are unsecured subordinated obligations. As of July 31, 2016, AECC had $54.9 million of CP notes outstanding.
KEY RATING DRIVERS
SOUND COOPERATIVE FUNDAMENTALS: AECC's credit strength stems from its long-term (2042) all-requirements contracts with its 17-member distribution cooperatives, low-cost power resources, competitive wholesale rates and diverse member base. AECC is one of the largest generation and transmission cooperatives in the U. S., and it provides electricity to all the distribution cooperatives in Arkansas.
STRONG FINANCIAL PERFORMANCE: The rating upgrade reflects Fitch's expectation that margins will continue the improvement observed in recent years as a result of wholesale rate increases and transmission revenue collections. Coverage of full obligations has ranged from 1.31x-1.62x, and should remain in-line with Fitch's 'AA-' rating category median.
CONSTRUCTIVE STATE REGULATORY OVERSIGHT: AECC and its members are subject to state regulatory oversight by the Arkansas Public Service Commission (APSC), unlike most of their peers. However, AECC's long history of constructive treatment by the APSC, including the allowance of fuel, purchased power, and transmission automatic cost recovery mechanisms for AECC and its members, and legislation which has allowed for an expedited rate review process since 2009, partially mitigate the rate regulatory concern.
LOW-COST POWER SUPPLY: AECC benefits from competitive-cost power supply, resulting in members' average revenue per kwh of $5.01 cents for fiscal 2015 - among the lowest of the G&T cooperatives. AECC's energy mix continues to diversify with the addition of renewables and entry into the regional transmission organizations. Reliance upon coal-fired generating resources has declined to 46.9% of energy requirements.
MODERATING CAPITAL PLAN: AECC's 5-year capital plan totals $385.6 million, a reduction of roughly 33% from the prior forecast. The lower capex reflects the decision (Entergy Arkansas, Inc, is the majority plant owner) to potentially shut down the White Bluff coal plant (2027), rather than implement costly environmental upgrades. With this reduced capex plan, new financing needs are lower, and net debt is expected to decline through 2019. AECC's 2015 debt-to-funds available for debt service (FADS; 9.4x) is in-line with the 'AA-' wholesale system median (9.6x) and should strengthen going forward.
SOLID MEMBER BASE: AECC's members are dispersed throughout Arkansas, providing power to roughly 30% of the state's consumers. The retail revenue base is heavily weighted toward stable, residential users, which account for 62% of 2015 total member revenues. Member energy sales have rebounded since the economic recession and returned to growth (1.7% 5-year CAGR).
SOUND CP PROGRAM: The upgrade of the short-term rating reflects the long-term rating upgrade. AECC's maximum $250 million CP program is supported by an equally sized unsecured revolving credit facility (RCF) provided by a diverse syndicate of banks, and unrestricted cash and additional lines of credit, which provided a solid 226 days operating liquidity at fiscal year-end 2015.
MAINTENANCE OF STRONG FINANCIAL POSITION: Arkansas Electric Cooperative Corporation's financial metrics are poised to strengthen, as capex slows, leverage abates, and cash flow improves with the recently implemented wholesale rate increase and approved cost recovery mechanisms. Failure to achieve the projected improvements in coverage and reduction in leverage could result in downward rating pressure.
AECC is a generation and transmission cooperative providing wholesale electricity to 17 members, consisting of rural distribution cooperatives in Arkansas. The distribution cooperatives provide retail electric service to 523,000 customers located in all of the state's 75 counties. AECC provides competitive cost wholesale power, with strong financial metrics supported by sound member systems. AECC continues to maintain among the lowest wholesale power costs and the highest equity-to-capitalization ratio of their G&T peers.
AECC's power supply is predominantly coal-fired, accounting for 46.9% of energy requirements for 2015. However, any emissions-related risk is moderated by AECC's solid balance sheet, low wholesale rates, and a declining reliance on coal-generation.
SOUND LONG-TERM CHARACTERISTICS
AECC's rating upgrade is predominantly driven by its sound financial coverages, strong balance sheet, moderate leverage and sufficient liquidity - all of which are expected to strengthen in-line with 'AA-' peer medians. Through the third quarter of fiscal 2016 (ended July; 3Q16), AECC's net margins are strong ($31 million) and close to budget for the year ($33 million).
The rating upgrade further reflects AECC and its Board's commitment, with the support of the APSC, to maintain rates adequate for sound financial targets consistent with the 'AA-' rating. Its regulatory exposure is moderated by its long-standing constructive working relationship with the APSC, as evidenced by the recent approval of AECC's rate request in full (4.69% effective April 1, 2016). The APSC ruling also approved rate adjustment mechanisms which cover about 71% of AECC's operating expenses, further mitigating regulatory risk.
AECC's prospective business risk is declining as major capital additions for new generation are behind them, effective cost recovery mechanisms are in place and new debt requirements are expected to be modest. Environmental expenditures are manageable through 2020 (excluding plant carbon emissions) with low-cost Department of Agriculture's Rural Utilities Service (RUS) funding already approved for those expenditures and a strong balance sheet to support the additional leverage.
AECC maintains adequate levels of liquidity, totaling $390.4 million as of 3Q16 . Internal cash reserves provided 87 days operating cash (FYE2015), which is below average for the 'AA-' rating category (153 days). However, incorporating available external liquidity sources, days liquidity rises to 226 days, in-line with peer medians.
For FYE2015, AECC's total liquid resources provided 1.29x coverage of the Fitch-maximum potential liquidity requirements, in excess of the 1.25x coverage expected for the 'F1+' rating level. This calculation takes into account advances made by the members to AECC as potential liquidity requirements, as those funds are due immediately upon the members' request. However, the members have not requested total reimbursement of their advances under this member line of credit program since it was put in place in the 1980s.
SOUND CP PROGRAM
AECC maintains a maximum authorized CP program of $250 million. CP is used primarily to interim-finance capital expenditures that will ultimately be refinanced with long-term debt, typically from the RUS.
The CP can be issued with maturities of up to 397 days. In the past three years, AECC's CP outstanding has not exceeded $150 million and the CP maturity has been 90 days or less. The CP has provided a low-cost liquid resource with average interest rates of less than 0.3% for the past three years. As of July 31, 2016, CP outstanding totaled $54.9 million. AECC does not anticipate using more than $50 million in CP per year to interim-fund capex over the next five years.
To support its CP program, AECC maintains an unsecured, RCF as provided by a diverse syndicate of six banks, led by Natural Rural Utilities Cooperative Finance Corporation. The vast majority of the CP liquidity support is with participating banks that have short-term ratings of 'F1' or 'F1+' by Fitch. The RCF was recently extended to a five-year commitment, expiring Dec. 21, 2020. AECC has not had any difficulty remarketing its CP, nor has it ever had to draw upon the credit facility.