Fitch Affirms East Kentucky Power Cooperative's Sr. Secured Bonds at 'BBB'
Fitch Ratings affirms the 'BBB' rating on the following East Kentucky Power Cooperative (EKPC) outstanding secured bonds:
--$25.9 million County of Mason, KY pollution control revenue bonds, series 1984B;
--$6.5 million Pulaski County, KY solid waste disposal revenue bonds, series 1993B.
In addition, Fitch affirms the rating of 'BBB' on EKPC's implied senior unsecured obligations. The rating takes into account $400.7 million of parity debt at Dec. 31, 2011.
The Rating Outlook is Stable.
The senior secured obligations are secured by a mortgage interest in substantially all of EKPC's tangible and certain of its intangible assets.
KEY RATING DRIVERS
GENERATION AND TRANSMISSION COOPERATIVE: EKPC supplies wholesale power to its 16 member-owner distribution cooperatives who serve predominantly rural territories in central and eastern Kentucky. The cooperative's generation fleet is geographically diverse; however, the vast majority of power is derived from the cooperative's coal-fired units.
SOLID UNDERLYING COOPERATIVE FUNDAMENTALS: EKPC supplies power to its members pursuant to long-term, take-or-pay contracts that extend through Jan. 1, 2051, and require members to purchase from EKPC nearly all of their power requirements to meet system needs. This contractual relationship, together with the diversity and financial wherewithal of the member distribution cooperatives are fundamental to the rating.
IMPROVING FINANCIAL PROFILE: EKPC's financial profile has stabilized in recent years following a series of operational challenges and financial distress during the period 2004-2006. A more defined and comprehensive strategic plan has been adopted by the new management team and board of directors, which appears to be on track and supports credit quality.
SUBJECT TO RATE REGULATION: The electric rates charged by EKPC and its members are regulated by the Kentucky Public Service Commission (KPSC), which could limit the cooperative's financial flexibility and may delay the timing or amount of necessary rate increases. Regulation by the KPSC to date has been largely supportive.
SUFFICIENT POWER SUPPLY RESOURCES: EKPC's current portfolio of power supply resources is generally sufficient to meet anticipated demand through 2018, obviating the need for significant construction activity or additional debt. The environmental compliance risks related to its coal-dominated portfolio are lessened by the presence of emissions control equipment at its most active units.
ACCEPTABLE FINANCIAL METRICS: Fitch-calculated financial metrics for 2011 include debt service coverage (DSC) of 1.25x and equity to capitalization of 10.2%, both of which are consistent with the rating category. Total debt to funds available for debt service (FADS) of 10.4x is weaker than comparable Fitch rated cooperatives but Fitch expects that EKPC's high leverage to moderate as equity builds up pursuant to the strategic plan.
WHAT COULD TRIGGER A RATING ACTION
EXECUTION OF STRATEGIC PLAN: Successful execution of the current strategic plan and achievement of the cooperative's financial objectives could trigger consideration for an upgrade.
RESTRICTIVE RATE REGULATION: Future regulatory decisions that prevent the cooperative from adequately recovering costs would likely result in downward pressure on the rating or Outlook.
EKPC is a not-for-profit generation and transmission cooperative incorporated in 1941 and headquartered in Winchester, Kentucky. EKPC supplies wholesale energy, transmission and support services to its 16 member distribution cooperatives, who serve predominately rural territories throughout 87 counties in central and eastern Kentucky. In 2011, the EKPC membership provided retail electric service to more than 521,000 residences, farms and businesses. The rates and services provided by EKPC are regulated by the KPSC.
Adequate Power Supply Resources
EKPC owns and operates a portfolio of generating units with capacity totaling 2,929 MW. Nearly 64.3% of EKPC's generating capacity is coal-fired, but nine relatively new natural-gas fired units provide valuable peaking capacity, as well as fuel diversity. Additional capacity and energy supply to meet member load demand is derived from ownership of 15.2 MW of renewable landfill gas projects, its allocation of Southeastern Power Administration hydro-electric capacity, and modest amounts of purchased power. EKPC's existing resources are largely sufficient to meet forecasted demand over the near term. The cooperative has no plans for significant new construction prior to 2015.
EKPC has issued a request for proposals (RFP) to obtain up to 300 MW of generation resources with an online date between October 2015 and 2017. This capacity is planned to replace 200 MW of capacity from the Dale station as the unit approaches the end of its useful life in 2016, and potentially replace 100 MW of capacity from the Cooper unit 1. Power purchase agreements and facility ownership options are under consideration. Fitch does not evaluate the merits of owning versus purchasing power, but considers the costs and benefits to the entity of both scenarios.
Troubled Operating and Financial History
Over the past decade, EKPC has faced a series of circumstances which have challenged both the operational and financial performance of the cooperative. Beginning in 2004, alleged violations of environmental requirements, a forced outage at the cooperative's Spurlock Unit 1 generating facility and the determination that considerable new generating capacity would be required to meet anticipated load growth all contributed to higher operating expenses and capital requirements. At the same time, management's decision to forego timely rate increases produced negative net margins and severely strained cash flow. These events ultimately led to a period of financial distress.
Improved Performance Under New Leadership
In recent years a new leadership team has been assembled at the cooperative, which has worked to implement recommendations from a KPSC-ordered management audit, and draft a comprehensive strategic planning effort. Although the principal components of the strategic plan are still nascent, management's earlier initiatives have restored some stability to the cooperative's financial results and appear to have set the stage for continued improvement.
Fiscal 2011 results point to another year of stability and financial improvement, a result of KPSC's approved rate increase, healthier working capital, customer stability and fleet optimization. EKPC reported net margins of $55.8 million, an increase of 70% over the previous year. Fitch-calculated metrics for DSC and total debt to funds available for debt service were correspondingly stronger increasing to 1.25x and decreasing to 10.4x, respectively. EKPC reported a times interest earned ratio (TIER) of 1.48x, up from 1.28x in 2010.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 20, 2011;
--'U.S. Public Power Rating Criteria', dated March 28, 2011.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria
Michael Mohammed Murad, +1-212-908-0757
One State Street Plaza
New York, NY 10004
Dennis M. Pidherny, +1-212-908-0738
Chris Hessenthaler, +1-212-908-0773
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York