Fitch Rates Rochester Public Utilities, MN's Series 2015E Refunding Revs 'AA-'; Outlook Stable
The bonds, together with other available funds of the city, will be used to advance refund a portion of the electric utility revenue bonds, series 2007C.
The Rating Outlook is Stable.
The bonds are special obligations of the city and are secured by a first lien on and solely from net revenues of the electric utility.
KEY RATING DRIVERS
ROBUST SERVICE AREA: The city of Rochester, MN and the surrounding service area is fundamentally sound, supported by a highly developed medical infrastructure tied largely to the Mayo Clinic. Rochester's unemployment rate, currently at 2.8%, is well below that of the state and nation, per capita income is strong and an upturn in housing and plans for a new downtown medical center and commercial/recreational complex should be positive contributors to the area economy.
COMBINED UTILITY SYSTEM: Rochester Public Utilities (RPU) provides electric and water service to a population of about 110,000. The bulk of its electric power (peak demand was 259 megawatts [MW] in 2014) is met through a take-and-pay contract (up to 216 MW) with Southern Minnesota Municipal Power Agency (SMMPA) that extends to 2030. Future power supply options are in an early stage of evaluation.
SOUND FINANCIAL METRICS: RPU's financial position remains sound. Fitch calculated debt service coverage (DSC) for 2014 and 2013 were 3.20 times (x) and 2.83x, respectively; coverage of full obligations (as adjusted for purchased power and payment in lieu of taxes) were 1.27x and 1.18x, respectively. RPU's financial forecast shows coverage trending higher over the next several years, with DSC (prior to adjustments) exceeding 3.0x.
CONSERVATIVE BUDGETING: Management employs a conservative approach to financial planning, including cost-of-service studies for the electric and water systems, targeted rate increases and effective cost controls. Significant changes to senior management occurred in 2014 with the retirement of the CEO and CFO; but new management and an established board appear well qualified.
SINGLE-UNIT RISK: RPU has exposure to the single-unit Sherco 3 coal-fired facility, SMMPA's principal asset. The risk is largely mitigated by SMMPA's obligation to supply replacement power if required, RPU's participation in Midwest Independent System Operator (MISO) and sufficient, reasonable-cost power in the region.
REDUCED SALES TO MAYO CLINIC: Rochester Public Utilities' largest customer, the Mayo Clinic, accounts for approximately 16% of the utility's total operating revenue. The loss or significant reduction of this load, while highly unlikely, would have a detrimental effect on the utility and service area.
FINANCIAL STRAIN: Weakened financial metrics resulting from wholesale power cost increases and inadequate retail rate support from RPU would be viewed negatively.
RPU owns and operates an integrated utility system that supplies electric power to 51,000 customers within Rochester corporate limits and adjacent rural areas. The customer base has been relatively stable over the past several years and growth is forecasted at around one percent annually. Power supply strategy incorporates demand side management, designed to achieve a 1.5% annual energy reduction. In 2014, electric operating revenues were derived from residential sales (30%), commercial and industrial sales (57%), steam sales (5%), wholesale sales (2%) and other (6%).
RPU receives virtually all of its power under a take-and-pay partial requirements contract with SMMPA, a joint-action agency providing wholesale electricity to 18 municipal electric systems in Minnesota. This is primarily through its 41% ownership in the 874 MW Sherco 3 coal-fired unit, pursuant to a contract that extends to 2030. RPU also has working agreements with The Energy Authority, which acts as an agent for Rochester to purchase power from MISO when necessary.
A new initiative, Destination Medical Center (DMC) is underway and projected to have a major impact on future economic growth of the community. In May 2013, the Minnesota legislature approved the financing plan for DMC, allocating $585 million to the project. In addition, the Mayo Clinic agreed to invest $3.5 billion of its own funds over the next 20 years. While two major users, Mayo and IBM, account for approximately 21% of total RPU energy sales, the high quality of these purchasers significantly mitigates this risk.
UPDATED RESOURCE PLAN
RPU employs a number of resources and power supply agreements to meet demand and energy requirements. The utility's future power resource strategy is to rely increasingly on MISO capacity and energy market, which provides a diversified fuel mix; build future natural-gas fired generation; and continue to invest in renewables to meet the intent of state renewable program. RPU updates its infrastructure plan every three years, together with financing requirements.
RPU'S Silver Lake plant, a 105 MW coal-fired generating plant, was decommissioned effective June 1, 2015, due to wholesale market factors and forthcoming environmental regulations. Two of the boilers remain in service, using natural gas to supply steam to the Mayo Clinic.
With the addition of new import transmission capabilities, RPU intends to replace a portion of the Silver Lake capacity through the open market. For planning purposes, this capacity will be limited to about 50 MW. As part of its infrastructure plan, RPU has begun preliminary engineering for installation of approximately 50 MW of reciprocating engine peaking generation at its West Side Energy Station, at an estimated cost of $75 million, with an anticipated operational date in 2018 or 2019.
EXPANDED TRANSMISSION CAPABILITY
The electric system is involved in the development of the CapX2020 transmission project. RPU will have a 9% investment (approximately $46 million) based on its load ratio share, along with five other participating utilities. The project includes a 345 KV transmission line and two associated 161 KV lines. This will improve reliability and increase RPU's import capability from 148 MW to about 370 MW. RPU expects to earn an approximate 12% rate of return on its investment.
GOOD FINANCIAL POSITION
The RPU board employs a three-year rate track for its utility systems. Despite rising fuel costs, Sherco's extended maintenance outage and a 4% SMPPA rate increase in 2010, RPU was able to show no rate increases for the years 2010 to 2013. A 3% electric rate increase was implemented in 2014, partly to cover the CapX2020 transmission project. For the years 2015 to 2017, assuming an annual inflation rate of 2% and a 4% and SMMPA rate increase in 2016, RPU projected system electric rate increases of 3.5% effective Jan. 1, 2015 and 1.7% effective Jan. 1, 2016 and Jan. 1, 2017, respectively. The 2015 increase is sized to meet the utility's operating income target and to bolster RPU's cash and liquidity position. A power cost adjustment factor was also established in January 2015.
The utility's longer-term financial strategy is designed to i) achieve stable net income; ii) hold adequate cash reserves; iii) maintain strong DSC ratio and iv) minimize the impact of rate increases from SMMPA.
RPU's financial position remains sound, supported by healthy internal policies, including a DSC target of at least 3.0x and a cash reserve policy targeted at $48.5 million at year end 2017. As of Dec. 31, 2014, unrestricted cash reserves were $38.7 million, around 120 days cash on hand. RPU's five-year capital plan includes $75 million for additional generation in the 2016-2017 timeframe, along with about $10 million for transmission and other facilities. Debt financing for known projects is estimated at about $87 million in 2016. City transfers remain stable, averaging about $8.3 million per year.
For additional information see the press release 'Fitch Affirms Rochester Public Utilities (MN) Revenue Bonds at 'AA-'; Outlook Stable' dated May 7, 2015 and available on Fitch's website at www.fitchratings.com.