OREANDA-NEWS. Fitch Ratings has affirmed the rating on Southern Illinois Power Cooperative's (SIPC) implied senior secured obligations and implied senior unsecured obligations at 'BBB'. The rating is on implied obligations because none of SIPC's \$664 million of outstanding long-term debt and \$65 million line of credit is publicly held.

The Rating Outlook is Stable.

SECURITY

Senior secured obligations benefit from a security interest in substantially all of SIPC's tangible and certain of its intangible assets. Under the terms of the wholesale power contracts, SIPC is required to establish rates sufficient to meet all of its costs and obligations and the members are required to pay for power at the rates established by the SIPC board.

KEY RATING DRIVERS

G&T COOPERATIVE: SIPC is a medium-size generation and transmission (G&T) cooperative that supplies power to seven member distribution systems and two wholesale customers in predominantly rural parts of southern Illinois. Member power is supplied pursuant to all-requirements take-or-pay contracts that extend through 2043. Approximately 60% of member retail load comes from stable residential users.

ABUNDANT GENERATION; PRIMARILY COAL: With the commercial operation of the Prairie State Energy Campus (PSEC), SIPC's power supply portfolio is more than sufficient to meet near-term load growth. Approximately 90% of the cooperative's energy supply is from coal-fired generation.

HIGH FIXED COSTS AT PSEC: Prairie State's high fixed cost will burden the G&T and its members financially over the next several years. However, longer term, the project's cost of power should be reasonably competitive within the region and PSEC should benefit from being one of the cleanest coal burning plants in the nation.

RATE MAKING FLEXIBILITY CONSTRAINED: While PSEC provides longer-term cost certainty to its owners, its high fixed costs will likely restrict rate setting flexibility over the short term. SIPC's wholesale rate averaged 7.65 cents per kilowatt-hour (KWh) in 2014, compared with 6.3 cents in 2011, prior to startup of PSEC. Member rates are generally competitive with other area cooperatives, but above investor-owned utilities.

TIGHT FINANCIAL METRICS: SIPC's financial metrics are modest compared with most other G&Ts. Fitch calculated debt service coverage (DSC) did improve in 2014 to 1.13x, which is above prior years, that were closer to 1.00x. Liquidity and equity ratios remain at the lower end of Fitch medians. Over time, a better level of coverage and balance sheet ratios are expected, which assumes supportive board actions.

RATING SENSITIVITIES

IMPACT OF NORRIS LEAVING: SIPC's newest customer, Norris, has decided not to become a long-term member after its five-year contract ends in 2017. This will require SIPC to update and modify its business plan to assure that its financial goals are met, which underpin the rating.

IMPLEMENTATION OF STRATEGIC PLAN: With the hiring of a new chief executive officer (CEO) in 2014, senior management is in the process of working with the board to update and improve the cooperative's business and financial strategies, focusing on rates, reliability and planning. Successful implementation of this plan could support a higher rating.

CREDIT PROFILE

SIPC supplies wholesale power to seven member distribution cooperatives and two wholesale customers that serve predominantly rural territories throughout southern Illinois. Member cooperatives provide electricity to over 100,000 end-use customers, and a total population of approximately 250,000. The service area is primarily residential and agricultural, with some members experiencing growth from a resurgence in the region's low cost, high sulfur coal industry, due to demand from local, environmentally retrofitted power plants and overseas customers. System load growth is forecast at about 1.5% per year.

SIPC's largest member is SouthEastern Illinois Electric Cooperative, which serves several coal companies in the area, and accounts for 36% of system megawatt-hour (MWh) sales. The newest customer addition is Norris, a cooperative system that is purchasing all of its power requirements under a five-year contract that began on Jan. 1, 2013. Norris has notified SIPC that is will not be extending the contract. SIPC expects the impact of this loss will be relatively minor and will actually delay the need for additional power resources from about 2018 to 2022.

UPDATED BUSINESS STRATEGY

The executive management team is led by Donald Gulley, President/CEO. He began his new duties at SIPC after previously serving as the vice president of regulatory and market affairs at Sunflower Electric Power Cooperative. SIPC recently updated its business strategies to support the needs of the membership, maximize the value of the G&T assets and improve its credit quality. Some of the key themes identified in recent planning sessions include member electric rate improvement and optimizing resource utilization.

COAL GENERATION SIGNIFICANT

SIPC'S power supply is predominantly fueled by coal (70% of capacity and over 90% of energy) and consists of 558 MW of owned generation assets, including the Marion units and the recently operable PSEC, and 38 MW in power purchase agreements with Southeastern Power Administration and Pioneer Trail Wind Farm. SIPC's 7.9% undivided ownership interest in the PSEC project (125 MW) will reduce its reliance on purchased power and is expected to provide long-term cost stability, and a reliable and affordable base load power supply, given the plant's ultra-efficient design and sufficient coal resources from an adjacent coal mine. Fitch expects PSEC to perform at a reasonable and healthy level of availability and capacity over time, although normal operating challenges will arise.

GENERALLY COMPETITIVE RATES

SIPC's wholesale rates have historically been competitive with neighboring investor-owned utilities. Prior to 2012, base rates had not been raised since 2008. However, a 22% increase was implemented in 2012, raising rates to about 8 cents per KWh, which was intended to capture the increased debt service and operating costs related to PSEC. For 2013, the wholesale rate was reduced by about 6%, helped by better customer efficiency due to the addition of Norris; and on Jan. 1, 2014 rates were increased by 2%, as planned, to generate cash for planned maintenance outages at the Marion plant.
Wholesale power rates to members averaged 7.65 cents per KWh in 2014. No increase is planned for 2015, but a single digit rate adjustmentis possible later this decade to cover normal increases in operating expenses. Members continue to feel rate pressure, but the gap between member rates and neighboring utilities is closing. Average residential rates approximated 11.40 cents per KWh in 2014.

FINANCIAL METRICS CONSTRAINED

SIPC's historical metrics have tracked at the lower end of Fitch-rated G&T cooperatives. While SIPC's large rate increase helped boost operating margins, the incremental revenue mainly served to pay for the project's costs and will provide limited improvement to near-term financial ratios. The G&T's longer-term goal is to achieve a 15% equity ratio, a times interest earned ratio (TIER) of around 1.25x and DSC of 1.20x by 2019. SIPC member cooperatives demonstrate adequate financial metrics.

Long-term debt has grown significantly since 2006, reflecting costs associated with PSEC, and totaled \$664 million as of Dec. 31, 2014. The cooperative also has a \$65 million revolving line of credit with National Rural Utilities Cooperative Finance Corporation (CFC) and other bank participants, which runs until mid-2019. At 2014 year end, \$33 million of the line was outstanding, primarily related to a planned turbine outage that year. The credit facility is intended to support working capital needs and provide added liquidity, given SIPC's limited cash balances. While Fitch views this facility as an offset to the utility's low cash position, overall liquidity remains weak in comparison to the universe of Fitch-rating cooperatives.