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 January 12, 2016 - 4:06 PM EST
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Fitch Affirms San Miguel Electric Cooperative, TX at 'A-'; Outlook Revised to Positive

Fitch Ratings has affirmed the 'A-' underlying rating on the following San Miguel Electric Cooperative's (SMEC) senior secured debt:

-- $77.2 million Atascosa County Industrial Development Corporation variable rate pollution control refunding revenue bonds (San Miguel Electric cooperative, Inc. Project) series 2008.

The rating on SMEC's senior secured debt takes into consideration approximately $91.5 million of parity secured obligations under the Mortgage Indenture that are not publicly held.

In addition, Fitch has affirmed the 'A-' rating on SMEC's implied senior unsecured obligations. The rating is implied because SMEC's $35 million of outstanding senior unsecured obligations are not publicly held.

The Rating Outlook has been revised to Positive from Stable.

SECURITY

SMEC's senior secured obligations are secured by a mortgage interest in substantially all of SMEC's tangible and certain intangible assets.

The series 2008 variable rate bonds are unconditionally guaranteed by National Rural Utilities Cooperative Finance Corporation (CFC; Issuer Default Rating of 'A').

KEY RATING DRIVERS

STEC CREDIT QUALITY DRIVES RATING: The Positive Outlook reflects the improving credit quality of South Texas Electric Cooperative (STEC; rated 'A-'/ Positive Outlook), which is now obligated for all of SMEC's operating expenses, including debt service, through 2037 pursuant to its wholesale power contract.

CONTRACTUAL OBLIGATIONS AMENDED: SMEC historically served two customers equally: Brazos Electric Cooperative (Brazos; implied senior secured obligations rated 'A'/Stable Outlook) and STEC. However, as of Dec. 31, 2015, STEC assumed 100% of the obligation for SMEC's project output and costs, including debt service, when Brazos assigned its wholesale power contract to STEC. The SMEC project will be used to meet a portion of STEC's resource requirements and is scheduled as a baseload unit in 2016.

STABLE FINANCIAL POSITION: The underlying rating and Outlook are also supported by SMEC's financial metrics, which remained adequate even with the lower sales experienced in 2014 and 2015 as Brazos scheduled lower output from its share of the project. Financial performance is in line with Fitch's medians for 'A' rated G&T cooperatives. Management expects equity to increase from 20.5% at the end of fiscal 2014.

PROJECT RATE COMPETITIVENESS RISK: SMEC's forecasted rate in the range of $50/MWh - $54/MWh through 2020 should provide STEC with price stability, even though in recent years market energy prices within ERCOT have softened (average price of $30/MWh in 2015) as a result of lower natural gas prices and renewable development.

RATING SENSITIVITIES

UPWARD MOVEMENT IN STEC's RATING: Continued healthy financial performance at South Texas Electric Cooperative (STEC), as additional peaking capacity and purchased power costs are absorbed, could support higher ratings for STEC and San Miguel Electric Cooperative.

CHALLENGES ABSORBING NEW RESOURCES: Lower than anticipated financial performance at STEC as a result of the cooperative's ability to absorb the additional SMEC capacity in addition to new generation resources on its own balance sheet could return the rating Outlook to stable.

CREDIT PROFILE

San Miguel electric cooperative operates a single lignite-fired generation plant in south Texas. The plant entered commercial operation in 1982 and has a license to operate to 2037. Consultant reports indicate that the useful lives of the generating unit and mine resources extend through the term of the customer contract. Environmental retrofits for existing regulations have been completed. The project also includes operation of the nearby lignite mine.

SMEC's rating is driven by the credit quality of STEC as the departure of Brazos results in STEC becoming the sole purchaser of the SMEC project capacity and energy. The wholesale power agreement between STEC and SMEC, which extends to December 2037 (as amended in 2009), obligates STEC for SMEC's total costs, including all debt (or similar) obligations, without limitation. The SMEC project is expected to become a more meaningful component of STEC's overall power supply planning and will account for approximately 33% of STEC's power generation capacity in 2016, up from 15% in 2012.

BOARD AND CUSTOMER CHANGES AS BRAZOS DEPARTS SMEC

Brazos and SMEC were in litigation in 2014 regarding Brazos' minimum scheduling requirements under its wholesale power contract. The litigation was settled by Brazos, SMEC and STEC in fall of 2015. The settlement permits Brazos to exit SMEC by making a final payment to SMEC that is designed to cover its remaining debt, plant and mine decommissioning costs. In return, SMEC has assigned royalties from its oil and gas leases equally to STEC and Brazos. These revenues will no longer move through SMEC and offset the wholesale power rate in fiscal 2016.

Effective Dec. 31, 2015, Brazos assigned all of its rights and obligations under its wholesale power contract to STEC. Brazos and its 16 electric distribution cooperative members have withdrawn their membership from SMEC and no longer have members on the Board of Directors. A membership meeting occurred on Jan. 5, 2016, consisting of STEC and its eight members, to elect a new Board of Directors and adopt amended articles of incorporation and by-laws. The new 17-member Board of Directors is made up of two representatives each from STEC's eight member cooperatives and one representative from STEC.

STEC EXHIBITS STRONG FINANCIALS WHILE MANAGING HIGH GROWTH

STEC is a G&T wholesale provider to eight distribution cooperative members in the growing south Texas region. STEC's eight distribution cooperative members serve approximately 260,000 customers in 42 counties. Growth in the past four years has been exceptionally strong given the economic growth in the region related to the Eagle Ford shale development. STEC's overall MWh sales have averaged 9% annual growth over the past five years, with much of this growth in the large commercial and industrial load sector (27% over the past five years). Lower oil and natural gas prices have raised the potential for slower growth to occur within the service area, although STEC reports its members continue to work through a backlog of requests for new service.

STEC's overall financial metrics have been strong during a period of very rapid growth with debt service coverage of between 1.4x and 1.5x in the past three years and equity of 17.8%, nearing the cooperative's target of 20%.

SOLID FINANCIAL METRICS

SMEC's own financial position remains stable and is in line with Fitch's 'A' category medians for the sector. Fitch-calculated debt service coverage remained at 1.36x and 1.25x in fiscals 2014 and 2013, respectively, although sales were lower than historical years due to unit outages, lower scheduling and lower real-time market energy prices. Debt service coverage is expected to increase in fiscal 2015 and beyond given decreasing debt service payments as multiple amortizing loans have just been repaid. Management has an internal 1.2x debt service coverage target.

Debt levels at year-end 2015 are moderate with approximately $149 million debt outstanding, net of a $55 million deposit in the RUS cushion of credit funded with the cash settlement payment received by Brazos. While the cash received from Brazos will not immediately repay outstanding debt, the deposit to the RUS cushion of credit can only be used for future federal debt repayment.

A high amount of SMEC's debt is in the variable rate mode ($113.4 million at year end 2015) and has a bullet maturity in 2020 ($77.2 million), but the related risks are mitigated by the contractual obligations of STEC, as well as its broader resource base. SMEC expects to refinance the debt in 2020 to a final bullet maturity in 2037.

Liquidity has been modest with unrestricted cash and investments declining to $2.3 million at year end 2014, or 8 days cash on hand. However, two lines of credit provide a combined $185 million of additional liquidity, or 487 days liquidity on hand at the end of fiscal 2014 with the available amounts. Management indicates that cash balances at the end of fiscal 2015 increased to $9.7 million (unaudited).

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Public Power Rating Criteria (pub. 18 May 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=997776

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997776

Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Fitch Ratings, Inc.
Primary Analyst
Kathy Masterson, +1-512-215-3730
Senior Director
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Alan Spen, +1-212-908-0594
Senior Director
or
Committee Chairperson
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com


Source: Business Wire (January 12, 2016 - 4:06 PM EST)

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