NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has assigned an initial rating of 'AA+' to the following District Energy Corporation (DEC) bonds:
--$18,220,000 facility revenue bonds, series 2013.
The bonds are expected to price via negotiation on June 6, 2013. Proceeds will be used to redeem outstanding revenue bond anticipation notes and finance remaining costs of constructing, equipping, and furnishing improvements to existing projects.
Fitch has not assigned a rating to DEC's series 2010A&B revenue bonds. However, Fitch has considered all of the corporation's outstanding debt in its analysis of the series 2013 bonds.
The Rating Outlook is Stable.
The bonds are special limited obligations of DEC secured by net revenues principally derived from four participants, pursuant to separate energy service agreements (ESAs).
KEY RATING DRIVERS
ESSENTIAL SERVICE PROVIDER: DEC provides essential heating and cooling services to four governmental participants in the city of Lincoln. Although its facilities and related ESA's are distinct, support for DEC's financial obligations is made jointly by the participants.
RATE DESIGN SUPPORTS HIGHER RATING: The wherewithal of the strongest participant to bear a greater proportion of DEC costs is a critical rating factor. A payment default by any participant would be borne by the others through a rate adjustment; effectively providing for an unlimited step-up obligation. DEC is required to set rates sufficient to recover all costs and can adjust rates with 30-60 days' notice to ensure timely recovery.
HIGHLY LIKELY PARTICIPANT PAYMENTS: Payment interruption risk to DEC is limited, reflecting strong participant credit quality and no ready heating and cooling alternatives. The unlikely failure to pay would result in the termination of services.
AMPLE RESERVES PROVIDE CUSHION: Reserve funds should continue to provide considerable cushion to absorb unexpected costs or short-term disruptions before rates can be adjusted. Cash on hand is forecast to settle at about 300 days by 2017 and a separate debt service reserve will be bond funded to six months of maximum annual debt service (MADS).
PARTICIPANT CREDITWORTHINESS IS KEY: Fitch's analytical focus on the strongest participant considers the participant's obligation and ability to service a greater proportion of DEC's financial obligations. A change in the credit quality of this participant could cause a similar change in DEC's rating.
DEC FINANCIAL STABILITY: DEC's own financial position is likewise important to the rating. Sufficient cash flow and liquidity, as well as coordinated oversight, will help ensure that the strongest participant's credit quality remains the principal rating factor on the bonds.
DEC is an inter-local company established in 1989 by the City of Lincoln and Lancaster County to provide governmental entities principally with heating and cooling services. These entities include the city of Lincoln, Lancaster County, the state of Nebraska, and the West Haymarket Joint Public Agency (WHJPA).
RATE STRUCTURE SUPPORTS HIGHER RATING
DEC's rate structure is critically important to its strong credit rating. In the unlikely event that any participant defaulted in its monthly obligation to DEC, rates to the remaining participants would be adjusted to make up the deficiency. (This is similar to how many all-requirements joint action agencies operate with an effectively unlimited step-up obligation.) Consequently, the rating on the bonds is driven by Fitch's view of the strongest participant's ability to assume a greater proportion of related DEC costs.
ESAs UNPERPIN SECURITY
The ESAs with its four participants underpin bondholder security. While they are not parity obligations of the participants' own unlimited general obligation bonds, the city, county, and WHJPA agreements are irrevocable and unconditional and include a fixed charge for the life of the DEC bonds. Fitch often makes a one-notch distinction in ratings for limited tax obligations where revenue raising ability is constrained.
The ESA with the state is subject to annual appropriation, which adds a degree of risk. However, the state would have to take specific action to exclude such payments from its budget.
Moreover, Fitch believes that nonpayment or a default by any participant is highly unlikely, given the strong credit quality each exhibits and the essential services that DEC provides. The participants have no ready alternative for heating and cooling and a failure to pay would result in the termination of services. In addition, each participant realizes cost efficiencies in DEC's centralized planning of fuel purchases and debt financings, and consolidated offsite facilities allow for more efficient use of building space.
EXPANDING ASSET BASE
DEC provides service from four facilities, one each for the participants it serves. The plants are not interconnected to provide for redundancies, which creates some outage risk. However, the facilities are relatively new and regular maintenance costs are low. Management expects that the plants could become interconnected over time, as demand grows with the service territory.
DEC currently provides heating and cooling services to approximately 1.5 million square feet of space. However, expanded service to a new county adult detention center facility and 16,000-seat Pinnacle Bank Arena will double this figure by 2015. The arena, which is expected to open later this year, will host the University of Nebraska men's and women's basketball teams and serve as a concert venue.
Continued expansion in the next couple of years will require careful financial management, and the value provided by LES (revenue bonds rated 'AA'/Outlook Stable), as system operator, is of paramount importance.
MIXED FINANCIAL POSITION
DEC's ample liquidity and rate-raising flexibility allow it to operate with tighter levels of cash flow. The operating fund, together with a rate stabilization fund and renewal and replacement fund, provided 899 days cash on hand at Dec. 31, 2012. Forecasted cash on hand settles at about 300 days in 2017, after the two new projects both achieve commercial operation. A debt service reserve funded to six months of MADS provides additional bondholder protection.
LES monitors DEC's budget and debt service coverage ratios each month to determine whether rate adjustments are necessary. Rates are set to achieve a modest debt service coverage ratio of 1.1x, and actual coverage levels are often slightly higher. Coverage equaled 1.15x in 2012 and is forecast to average 1.16x through 2017 with little variation. Conservative financial projections include no increase in sales after 2014, when all four projects are fully operational.
STRONG SERVICE TERRITORY
Lincoln is the state capitol and home to the flagship campus of the University of Nebraska, both of which create considerable economic activity in the region. Consequently, the city's unemployment rate peaked at just 4.8% during the most recent economic recession, which evidences the strength and depth of the service territory. The March 2013 rate was among the lowest in the nation at 3.4%.
Additional information is available at 'www.fitchratings.com'.
This rating action was informed by information identified in Fitch's U.S. Public Power Rating Criteria and Revenue-Supported Rating Criteria.
Applicable Criteria and Related Research:
--'Fitch Rates Lincoln Electric System, NE's 2013 Revs 'AA'; Outlook Stable' (May 17, 2013);
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012);
--'Revenue-Supported Rating Criteria' (June 12, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Rating Criteria
Revenue-Supported Rating Criteria
Ryan A. Greene, +1 212-908-0593
Fitch Ratings, Inc.
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Jessalynn Moro, +1 212-908-0608
Dennis Pidherny, +1 212-908-0738
Elizabeth Fogerty, +1 212-908-0526