February 12, 2016 - 5:05 PM EST
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Fitch Rates Lower Alabama Gas District's Gas Revs 'A-'; Outlook Stable

Fitch Ratings has assigned an 'A-' rating to the following bonds issued by the Lower Alabama Gas District:

--Up to $675 million gas project revenue bonds series 2016A.

Proceeds will be used to prepay a 30-year supply of natural gas, pay costs of issuance, and fund required reserve accounts. The bonds are expected to sell via negotiation during the week of Feb. 15, 2016.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by the trust estate pledged under the indenture, including revenues derived from the sale of natural gas and payments received from the commodity swap provider.

KEY RATING DRIVERS

COUNTERPARTY PAYMENT OBLIGATIONS: The rating on The Lower Alabama Gas District (LAGD or the District) gas project revenue bonds reflects the structured nature of the prepaid energy transaction and Fitch's analysis of the principal transactional counterparties, including J. Aron & Company (J. Aron; the gas supplier) and the Clarke-Mobile Counties Gas District (CMC), which has agreed to purchase all of the gas delivered to LAGD pursuant to the transaction. Other counterparties will include two investment agreement providers determined at bond closing. The obligations of J. Aron will be guaranteed by The Goldman Sachs Group, Inc. (GSG, Issuer Default Rating [IDR] 'A'/Stable Outlook).

WEAK LINK COUNTERPARTY: The rating on the bonds is driven by the credit quality of the weakest counterparty whose default risk is not otherwise mitigated. Although the investment agreements related to the debt service reserve account (DSRA) and the working capital account (WC) are undetermined, the providers are expected to be a financial institution(s) with a minimum IDR of 'A' with a Stable Outlook from Fitch. CMC is not publicly rated by Fitch, but the utility exhibits credit quality that supports the rating, and is also the current constraint in the transaction's rating.

SOLID PURCHASING UTILITY: CMC will purchase 100% of the gas volumes available to LAGD from this gas prepay transaction. CMC is a gas distribution utility in south Alabama with a small 6,000 retail customer base and a substantial industrial demand that accounts for around 98% of volume deliveries. CMC will expand its wholesale gas sales with volumes provided by this gas prepay transaction to Louisiana Municipal Gas Purchasing and Distribution Authority, a.k.a. the Louisiana Municipal Gas Authority (LMGA) and South Alabama Gas District (SAGD). CMC's financial profile is mixed with strong financial margins, low liquidity and above average but rapidly amortizing leverage.

COMMODITY SWAP PROVIDER: The commodity swap provider will be RBC Europe Limited (RBCEL, not rated by Fitch), a subsidiary of Royal Bank of Canada (RBC, IDR 'AA'/Stable Outlook). A custodial agreement between J. Aron, RBCEL, and The Bank of New York Mellon Trust Company, N.A. (custodian) will, in Fitch's view, insulate bondholders from the credit risk of the commodity swap provider.

RATING SENSITIVITIES

CHANGE IN COUNTERPARTY RATINGS: The long-term rating of The Lower Alabama Gas District gas project bonds will continue to be determined by Fitch's assessment of the structure, including the role and credit quality of each counterparty in the structure. Therefore, unless otherwise mitigated, shifts in the rating or credit quality of The Goldman Sachs Group, Inc., the investment agreement provider(s), or the Clarke-Mobile Counties Gas District below the current rating on the bonds would result in a downgrade. Conversely, shifts in the rating or credit quality of all of the counterparties above the current rating on the bonds would result in an upgrade.

CREDIT PROFILE

LAGD is a gas district and public corporation incorporated pursuant to the Alabama Gas Districts Act, by the municipalities of Jackson and Evergreen, AL to acquire long-term natural gas supplies for CMC and SAGD for ultimate delivery to retail customers and other public agencies. The District is governed by a board of directors that includes the general managers of CMC and SAGD, as well as the Mayors of Jackson, AL and Monroeville, AL, and is managed by representatives of CMC and SAGD.

The District entered into a prepaid energy transaction in September 2007 with Societe Generale Energie (USA) Corp; however, the transaction was terminated in 2012 following the occurrence of a mandatory redemption event related to the interest rate swap provider. The related bonds were redeemed in full on March 1, 2012. The District is currently a participant in another prepaid gas transaction, but has not issued debt at the District level related to that transaction.

STRUCTURE DESIGNED FOR TIMELY PAYMENT

LAGD will use the bond proceeds to prepay J. Aron for a specified 30-year supply of natural gas. By virtue of the sales, hedging and investment agreements outlined below, the project is structured to ensure that monthly net payments to the District are sufficient to pay scheduled debt service, regardless of changes in natural gas prices, the physical delivery of gas or the acceptance of delivered gas.

DISTRICT SELLS GAS TO CMC AT MONTHLY INDEX RATE

LAGD will sell all of the natural gas delivered by J. Aron to CMC (the purchaser) pursuant to a Gas Supply Contract (GSC). Gas volumes will be purchased by CMC at a price equal to a monthly index less a discount, and used to meet the utility's system requirements, as well as its obligations under wholesale contracts with other public gas authorities.

COMMODITY SWAP HEDGES COUNTERPARTY RISK

To hedge the risk of changes in gas prices, LAGD will enter into a commodity swap agreement (front-end swap) with RBCEL, exchanging a monthly index price for a fixed price that is sufficient, together with the payments for gas, to cover the District's debt service requirements. RBCEL will also enter into a matching swap agreement with J. Aron (back-end swap), exchanging a fixed price for a monthly index price to further hedge its position.

FAILURE TO ACCEPT OR DELIVER GAS

The failure by J. Aron to deliver gas, or the District to accept gas deliveries, is not expected to jeopardize the transaction's performance. If J. Aron fails to deliver gas for any reason, it is required to pay LAGD for the undelivered volumes at prices sufficient to allow the District to meet its obligations, including debt service payments. Alternatively, under the GSC, if the District provides notice to J. Aron to remarket gas to other purchasers that it does not need, or does not accept delivered gas, J. Aron is required to remarket such gas. If the gas cannot be remarketed, J. Aron is required to purchase the gas for its own account. In either case, J. Aron's payments from the remarketing or purchasing of the gas will be based on index prices sufficient to preserve transactional cash flows.

BONDS SUBJECT TO EXTRAORDINARY REDEMPTION

The bonds are subject to extraordinary redemption prior to maturity. Under certain circumstances (a designated seller default and buyer default) or events such as changes in tax laws (designated non-default termination events), the bonds may be called prior to the stated maturity through the extraordinary redemption mechanism. In the case of an extraordinary redemption, J. Aron will be required to make an early termination payment, which together with available funds in the WC, debt service account, and DSRA, will be sufficient to pay off the bonds plus accrued interest, ultimately covering all principal, unamortized premiums, and accrued interest through the redemption date. Bondholders take the risk of early redemption in these events but should receive full payment.

GSG, the parent company of J. Aron, will provide a financial guaranty to secure the supplier's performance under the purchase agreement, including its obligation to make a termination payment.

CMC'S CREDIT QUALITY SUPPORTS RATING

The credit quality of CMC is a factor in the rating given its requirement to purchase the total gas quantity over the 30-year term of the structure. The transaction's one-month debt service reserve fund and the remarketing provisions in the GSC provide only limited support for a payment default by CMC. Bondholders therefore bear CMC's credit risk.

CMC provides direct gas distribution to three member cities on a non-competitive basis and to six other communities that have franchise agreements with CMC for the next 19-30 years. CMC serves a small customer base of around 6,000 in a weak service area with high unemployment (11.9% in Dec 2015) and low wealth levels (median household income at 65% and 51% of the state and national average, respectively).

CMC's debt service coverage on its own revenues bonds has been over 2.0x in the past two years, consistent with CMC's internal target established in 2012. However, distributions to the member cities have been high in order to fund operations at the Black Belt Energy Gas District, an affiliate-like entity. Debt service coverage after these distributions was more modest at 1.5x and 1.3x in fiscals 2014 and 2015, respectively.

Management expects these distributions to decline beginning in fiscal 2016. Liquidity is weak, at 38 days liquidity at the end of fiscal 2015, including an available line of credit. CMC plans to add a dedicated $10 million LOC to the liquidity risk associated with customer default on the large volumes for sale under the prepay transactions. An unexpected customer default could put CMC at risk for up to 55 days of gas already consumed by the defaulting customer (and therefore not available for remarketing).

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria

Criteria for Rating Prepaid Energy Transactions (pub. 02 Dec 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874366

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=999495

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999495

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
Primary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
Fitch Ratings, Inc.
33 Whitehall St
New York, NY 10004
or
Secondary Analyst
Major Parkhurst
Director
+1-512-215-3724
or
Committee Chairperson
Michael Rinaldi
Senior Director
+1-212-908-0833
or
Media Relation:
Elizabeth Fogerty, New York, +1 212-908-0526
[email protected]


Source: Business Wire (February 12, 2016 - 5:05 PM EST)

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