Fitch Ratings affirms the 'A' rating on the following Delaware Municipal
Electric Corporation's (DEMEC) bonds:
--$52 million electric utility revenue bonds, series 2011.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a first lien on net revenues, which are
principally derived from power sales contracts (PSC) between DEMEC and
the electric enterprise funds of seven project participants related to
the Beasley Power Station. Other net revenues include administrative
charges derived from full requirements contracts with the same seven
participants, but annual amounts are nominal.
KEY RATING DRIVERS
SMALL JOINT ACTION AGENCY: DEMEC is a project-based joint-action agency
providing power to seven electric distribution systems located in
Delaware. The agency's lone generating asset is the Beasley Power
Station, consisting of two natural gas-fired simple-cycle combustion
turbine generation units (Units 1 and 2), each with 45 MW of capacity.
TAKE-OR-PAY OBLIGATION: Bondholders are secured by PSCs requiring the
seven project participants to satisfy project payment obligations as an
operating expense of their city electric systems. The PSCs remain in
effect as long as the bonds are outstanding.
STABLE CREDIT FUNDAMENTALS OF PARTICIPANTS: The credit quality of the
seven participants underpins the project rating. Fitch expects
participants' generally sound financial and debt metrics and service
territory characteristics to continue.
DIRECT BONDHOLDER EXPOSURE: A 25% step-up provision included in the PSCs
provides additional bondholder protection from a default of one or more
participants with the exception of Newark, DE, whose 42.1% entitlement
share in the project would not be sufficiently covered by the other
participants. However, Fitch believes the solid credit characteristics
exhibited by Newark's electric utility adequately mitigate the direct
exposure.
LARGE GENERAL FUND TRANSFERS: The participants are required under the
PSCs to pay project debt service as an operating expense paid prior to
making general fund transfers to their respective host cities and
satisfying any direct debt obligations. The first claim on participant
revenues somewhat offsets concerns over the sizeable transfers made by
each of the utilities, which prevent the accumulation of stronger levels
of liquidity and net assets at the participant level.
RATING SENSITIVITIES
CHANGE IN PARTICIPANT CREDIT QUALITY: Meaningful changes in the credit
fundamentals of the Delaware Municipal Electric Corporation Beasley
Project participants would likely trigger a rating review to consider a
corresponding rating action.
CREDIT PROFILE
DEMEC is a joint action agency serving nine municipal electric utilities
located in the state of Delaware. Members include Newark (GO bonds rated
'AA+'/Stable Outlook), New Castle, Middletown, Dover (electric revenue
bonds rated 'AA-', Stable Outlook), Smyrna, Seaford, Lewes, Clayton and
Milford. The member utilities provide electric distribution service to
nine of the 10 largest cities in the state and on a combined basis serve
nearly 67,000 customer accounts and a total population of about 126,000.
The seven participants in the Beasley Project are required to pay their
proportional share of the project costs from electric system revenues
pursuant to power sales contracts. The contractual obligation of each
participant is take-or-pay, requiring the payment of all costs
(including debt service) whether or not the project is operating or
operable. The power sales contract also contains a step-up provision
requiring each participant to purchase up to 125% of its original
purchase obligation if another participant were to default on its
obligation.
SOLID PROJECT MEMBERS
The credit quality of the Beasley Project's participants continues to
sufficiently support the project rating. Each participant generally
exhibits healthy cash flow, minimal to no debt and in some instances,
cash reserves consistent with the project rating. Weaker liquidity with
remaining participants is a result of sizeable general fund transfers
typically used in Delaware to keep property tax rates low.
Newark's utility system routinely generates strong operating margins in
excess of 20%, providing positive cash flow after covering its full
obligations, including purchase power costs and a sizeable 20% transfer
to the city's general fund after satisfying operating expenses and debt
service obligations. The system's 62 days of cash on hand is low, but is
nonetheless acceptable given the utility's limited role as a
distribution only system and its ability to automatically recover the
vast majority of its operating expenses from a power cost adjustment
that can be made on a monthly basis if needed.
Newark's continued practice of making sizeable transfers to its general
fund from its electric utility remains a concern. The transfer amount
has remained at or close to $10 million over the prior five fiscal
years, equal to almost 20% of the utility's annual gross income. By
comparison, the median transfer percentage for similarly rated utilities
is 4%.
Financial metrics of the remaining participants are also sound. Milford,
the second largest member, ended fiscal 2015 with strong debt service of
5.24x and nearly 160 days of unrestricted cash on hand. Middletown's
practice of transferring all of its excess operating cash flow to the
city's general fund is of some concern, but operating margins have
averaged a strong 24% over the prior three years and the system has no
long-term debt obligations. Fitch notes that only four of the seven
participants have long-term debt obligations, with total obligations
being nominal.
LIMITED BUT STABLE SERVICE TERRITORY
Economic and demographic indicators vary somewhat for each member city,
but metrics in general appear stable. Newark's economy is anchored by a
significantly sized healthcare and education sector. Christiana Care
Health System, one of the largest private employers in Delaware, and the
University of Delaware (UD), enrolling approximately 21,000 students at
the Newark campus, are key employers.
Newark's June 2016 unemployment rate of 5.3% remains nominally higher
than state and national rates, but has trended downward in recent years.
The city's employment prospects should benefit going forward by the UD's
recent purchase and continued development of a former Chrysler assembly
plant that was shuttered in 2008 amid the economic recession. UD is in
the midst of developing the 272-acre site into a science, technology and
advanced research campus in connection with several notable firms,
including Thomas Jefferson University, Dow Chemical and E.I. Dupont de
Nemours and Company.
Wealth measures for Newark rank somewhat lower than state and national
indicators, likely reflecting the city's large student population.
Nevertheless, Newark's electric utility continues to record low customer
receivables and minimal write-offs. Both Milford and Middletown exhibit
stronger wealth and employment indicators. Both cities have grown
considerably since 2000; Milford, which lies immediately outside of
Dover, the state capital, increased in population by 42% while
Middletown nearly tripled in size. The proximity to Wilmington and to a
lesser extent, Philadelphia, provides Middletown with good access to
sizeable employment centers.
STRONG PROJECT FINANCIAL PERFORMANCE
Beasley Project debt service coverage is required to equal no less than
1.1x, per the bond indenture. However, increased energy sales and
significantly higher capacity market revenues have provided for
considerably stronger debt service coverage ratios averaging about 3.45x
over the prior five years. With level debt service going forward, Fitch
expects coverage of project debt service will remain at a healthy level.
SATISFACTORY FINANCIAL PROFILE AT THE AGENCY LEVEL
The agency's financial profile on a consolidated basis remains sound,
despite a recent trend of incurring operating losses that led to debt
service coverage of well below 1.0x as a consequence of implementing a
rate stabilization plan (RSP). DEMEC, beginning in January 2012, elected
to forego wholesale rate increases as part of the RSP and instead offset
a short-term increase in capacity costs scheduled to last through May
2014 with a $33 million fixed rate, low interest borrowing from AMP's
line of credit.
The over collection of revenue from members since then, beginning in
July 2014 when capacity costs declined considerably and wholesale rates
were held relatively constant, yielded positive operating results
beginning in fiscal 2014 and provided for surplus revenue needed to
repay the loan from AMP by 2017. Fitch views the RSP as credit neutral
given the relatively short tenor of the loan.
DEMEC continues to target a modest 30 days of unrestricted cash on hand
and instead provide project participants with annual rebates from
surplus revenues. The dividend paid to members in fiscal 2015 totaled
$7.7 million. A $10 million working capital line of credit, a $20
million liquidity facility for collateral posting requirements and
DEMEC's ability to access members' liquidity on three days notice
through interim billing all provide sufficient cushion. The series 2011
bonds have a cash funded debt service reserve fund equal to maximum
annual debt service.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012
U.S. Public Power Rating Criteria (pub. 18 May 2015)
https://www.fitchratings.com/site/re/864007
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011704
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011704
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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