Fitch gives SMEPA bonds ‘A-’ and ‘stable’ outlook

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Published: September 30,2010

Tags: bonds, debt rating, energy, utilities

HATTIESBURG — Fitch Ratings has assigned an initial rating of “A-” to the following South Mississippi Electric Power Association (SMEPA) outstanding bonds:–$40 million Mississippi Business Finance Corporation Gulf Opportunity Zone bonds, series 2009A;
–$22.645 million Claiborne County, MS pollution control bonds, 1985 series G1 and G2.

In addition, Fitch also assigns an implied rating of “A-” on SMEPA’s remaining parity senior secured obligations. These debt obligations were privately borrowed from the Rural Utilities Service (RUS), National Rural Utilities Cooperative Finance Corporation (CFC) and CoBank – all frequent lenders to electric cooperatives.

The Rating Outlook is “stable.”

RATING RATIONALE:

–The rating reflects SMEPA’s strong financial profile and the results of its board-supported strategy to improve cash flow and liquidity in anticipation of future capital investment.
–The rating also reflects SMEPA’s capable and long tenured management team that has positioned the utility well for future growth and provided solid leadership in recent years, particularly following the severe damage and system-wide stress brought on by Hurricane Katrina in August 2005.
–SMEPA’s significant and increasing reliance on purchased power is a credit concern for Fitch, but risks are mitigated by the competitive terms, diversity and flexibility inherent in the cooperative’s largest supply contracts.
–Member cooperative performance in 2009 was strong as the aggregate member ratios for times interest earned (2.66x), debt service coverage (2.43x) and equity/capitalization (52%) all showed improving trends.
–SMEPA’s wholesale rates, as well as member retail rates, are expected to remain in line with other state-wide electric providers despite the cooperative’s planned investment in new generation and the prospect for increased costs from climate change legislation.
–While the cooperative maintains well diversified liquidity on hand (51 days at year end 2009), cash on hand (three days) is very weak compared to Fitch’s ‘A-’ category median (99 days). Fitch believes that a reliance on credit facilities instead of cash on hand for liquidity during times of crisis can be cause for concern.

KEY RATING DRIVERS:

–The Stable Outlook reflects Fitch’s expectation that any degradation in SMEPA’s financial metrics and ratios during the cooperative’s sizable, and largely debt funded, construction program will be limited.
–While SMEPA’s planned expansion of power supply resources is viewed positively, the challenges related to the higher risk Kemper County Integrated Gasification Combined Cycle Project (Kemper Project) and the considerable debt required to fund the planned investment bear monitoring by Fitch. The successful completion of the highly complex Kemper Project and the avoidance of significant cost overruns will be an important factor in SMEPA’s creditworthiness going forward. While the inability to recover costs is not a significant concern given SMEPA’s rate setting authority, cost overruns could translate into higher rates thereby diminishing the cooperative’s willingness to maintain its financial targets and/or deterring new electric load demand.
–Exposure to coal-fired generation could result in increased costs in the long term, depending upon future carbon emission and climate change legislation.

SECURITY:

The senior secured obligations are secured by a mortgage interest in substantially all of SMEPA’s tangible and certain of its intangible assets.

CREDIT SUMMARY:

SMEPA is a not for profit generation and transmission (G&T) cooperative that provides wholesale electric service to 11 retail electric distribution cooperatives located in Mississippi. SMEPA’s members serve a region covering more than 32,000 square miles. The members serve a population of nearly 1 million and a customer base of roughly 405,000. Residential customers accounted for 59% of total energy sales in 2009. A well diversified base of commercial and industrial customers accounted for nearly all of the remaining sales.

SMEPA relies heavily on power purchased from third parties, including Mississippi Power Company (MPC), to meet the energy demands of its membership. In 2009, SMEPA purchased nearly 66% of energy needs, including 33% from MPC. SMEPA’s remaining power requirements are sourced from a well diversified portfolio of owned generating resources with an aggregate summer capacity of 1,242 MW (380 MW coal-fired, 737 MW natural gas, and 125 MW nuclear).

SMEPA plans to rebalance its energy supply portfolio over the next several years, adding 253 MW of new owned generating capacity and replacing several large purchased power agreements. Significantly higher capital expenditures are therefore expected over the near term. Several new power purchase agreements will include many of the attributes of ownership and provide the cooperative with greater control over purchased resources, which is positive.

SMEPA reported continued strong performance in 2009 as revenue ($772 million), operating margin before interest ($79 million), net margin ($30 million) and debt service coverage (1.38x) all improved for the fourth year in a row following the impact of hurricane Katrina.

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