OREANDA-NEWS. Fitch Ratings has affirmed the rating for Sulphur Springs Valley Electric Cooperative (SSVEC), AZ's implied senior secured obligations at 'A-'.

The SSVEC rating takes into account approximately \$174 million of secured debt obligations but is implied since none of the debt is publicly held.

The Rating Outlook is Stable.

SECURITY
SSVEC's senior secured obligations are secured by a lien on substantially all of its assets.

KEY RATING DRIVERS

ELECTRIC DISTRIBUTION COOPERATIVE: SSVEC is a non-profit, distribution cooperative providing electricity to a primarily residential customer base of approximately 51,000 in southeastern Arizona.

PARTIAL REQUIREMENTS POWER SUPPLY: Power supply is met (approximately 80%) through a long-term, partial requirements contract with the Arizona Electric Power Cooperative (AEPCO). Supply needs not provided by AEPCO are purchased on the market.

IMPROVEMENT IN FINANCIAL METRICS EXPECTED: Debt service coverage and liquidity measures are expected to improve in fiscal 2015 following a 4.92% rate increase and various cost reductions made at the utility. Fiscal 2014 metrics were viewed as adequate for the rating with debt service coverage and equity/capitalization at 1.42 times (x) and 34.4%, respectively. Very low cash reserves (12 days cash on hand) are supplemented by external short-term lines of credit, but total liquidity is still low for the rating (85 days).

RATE REGULATED ENTITY: Financial flexibility at SSVEC is somewhat limited, as rates are subject to approval by the Arizona Corporation Commission (ACC). SSVEC's recent success in requesting a rate increase through the ACC's recently adopted streamlined rate process for power cooperatives was viewed positively, although SSVEC's ability to recover costs in a full and timely manner remains a concern for Fitch.

ENVIRONMENTAL COST PRESSURE: Power costs may increase significantly over the next four years depending on the outcome of a still unresolved dispute between AEPCO and the EPA. An agreement between AEPCO and the EPA reduces projected capital costs to a manageable level, but the proposal is still waiting for final approval.

MIXED SERVICE AREA: SSVEC's service area is a mix of semi-urban, rural, and agricultural areas. Energy sales and peak demand have remained fairly stable over the past few years.

RATING SENSITIVITY

RECOVERY OF HIGHER POWER COSTS: An unfavorable resolution to the ongoing dispute between the EPA and AEPCO that significantly raises SSVEC's cost of power could put downward pressure on the rating unless offset, as expected, by SSVEC's wholesale power and fuel cost adjustor.

CREDIT PROFILE

SSVEC is a not-for-profit, distribution cooperative providing electric service to a primarily residential customer base totaling 51,013 (fiscal 2014) in Southeast Arizona. SSVEC's service area includes most of Cochise County and portions of Pima, Santa Cruz, and Graham Counties.

SSVEC's customer base is primarily residential (81%), although residential customers accounted for less than half (42%) of retail energy sales in fiscal 2014. A non-concentrated group of commercial and industrial customers accounted for 36% of retail sales with irrigation customers, consisting of the water pumping needs of agricultural interests, comprising the bulk of the remainder at 22% of sales.

RATE REGULATION LIMITS FLEXIBILITY

Arizona is one of the few states where municipal and cooperative electric utilities, including SSVEC, are subject to fiscal and operating oversight by a state regulatory commission. Fitch generally views regulatory oversight unfavorably, as state commissions add a layer of uncertainty and lag in terms of cost recovery. This is a challenge not shared with most other public power entities.

Positively, SSVEC received approval for a \$4.9 million rate increase (4.92%) that was implemented in April 2014. The increase was approved through a new streamlined rate approval process that reduced the timeline for approval by about half from approximately 13 months to six months.

SSVEC benefits from a wholesale power and fuel cost adjustor (WPFCA) that was approved by the ACC in April 2012. The WPFCA allows SSVEC to automatically pass through increases and decreases in wholesale power costs within a specified range without seeking additional ACC approval. Fitch views the WPFCA positively as it can be used to offset power cost volatility.

RATE INCREASE EXPECTED TO IMPROVE FINANCIAL PERFORMANCE

SSVEC's coverage levels weakened somewhat in fiscal 2014 with Fitch calculated debt service coverage declining to 1.42x from 1.61x in fiscal 2013. Coverage of full obligations also declined in fiscal 2014 to 1.19x from 1.24x in fiscal 2013. Fitch expects coverage levels will improve in fiscal 2015 due to the recently implemented rate increase, generally flat sales with some increase in wholesale sales, and cost restructuring at the utility.

IMPROVED BUT LOW LIQUIDITY LEVELS

SSVEC's cash position is expected to continue improving modestly over the near term but remain relatively low for the rating. Days funds on hand increased to 12 in fiscal 2014 compared to just two in fiscal 2012. Cash balances are expected to nearly double in fiscal 2015 with a projected ending balance of \$5.5 million compared to \$2.8 million at the end of fiscal 2014.

Cash balances are augmented by using lines of credit to meet working capital needs. However, relying on external sources of credit presents greater risk than holding sufficient cash on hand as the primary source of liquidity. SSVEC's line of credit for fiscal 2014 amounted to \$17.6 million, leaving liquidity at a still low 85 days.

ENVIRONMENTAL REGULATION MAY RAISE COSTS

AEPCO provides SSVEC with power primarily from its dual-fuel capable (coal and natural gas) but principally coal-fired Steam Units 2 and 3 (ST2 and ST3) located at Apache Generation Station in Cochise County. The EPA issued a final ruling in November 2012 imposing stricter haze related emission standards on several power facilities within Arizona, including the Apache Station.

AEPCO, the EPA, and the state have negotiated a proposed agreement that would convert ST2 to natural gas along with other changes. The agreement, if finalized, would reduce estimated environmental compliance costs to much more manageable levels that originally projected. The agreement is proceeding through the regulatory approval process.

An unfavorable ruling for AEPCO and the subsequent installation of SCR and related emissions reduction equipment would likely lead to a significant increase in AEPCO's wholesale power rate that would pressure SSVEC's financial performance without a commensurate increase in retail rates.