News Column

Fitch Affirms Various Lincoln Electric System, NE Ratings; Outlook Stable

May 20, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the following city of Lincoln, NELincoln Electric System (LES, or the system) ratings:

--$636 million electric revenue bonds at 'AA' (par amount as of Dec. 31, 2013);

--$150 million electric system revenue commercial paper note program at 'F1+';

--$150 million electric system revenue commercial paper bank note at 'AA'.

The rating on the bank note, which is a promissory note evidencing LES's obligation to the Bank of Tokyo-Mitsubishi UFJ, Ltd. for any draws made on a $150 million revolving liquidity facility, is based on LES's long-term rating.

The Rating Outlook is Stable.

SECURITY

The revenue bonds are secured by a first lien on LES's net revenues.

The commercial paper (CP) notes and bank note are secured by system net revenues, subject solely to the prior payment of LES's long-term debt.

KEY RATING DRIVERS

STRONG SERVICE TERRITORY: LES is a vertically-integrated, retail electric provider to 131,927 customers in a growing service territory exhibiting consistently strong employment figures. A preponderance of coal-fired generation meets 88% of LES's 2014 forecast energy requirements.

RATES PROVIDE FLEXIBILITY: Considerable revenue-raising flexibility resulting from very low electric rates will become increasingly more important as costs of environmental regulations materialize. Measured rate increases nearly every year suggest a constructive relationship with city council, which must approve any such increases.

CASH FLOWS EVIDENCE STABILITY: Extraordinarily stable cash flow metrics evidence LES's overall strong financial position and management. Debt service coverage has remained nearly unchanged at an average of slightly more than 2x annually over the past five years.

BELOW-AVERAGE BALANCE SHEET: Balance sheet metrics, including lower cash balances under a new liquidity target instituted in 2012, are below-average versus Fitch's 'AA' rating category medians. However, monthly minimums for cash on hand and the historical stability of LES's financial and asset operations provide some comfort.

STRONG MANAGEMENT TEAM: The system's stable and healthy overall financial position evidences management's proficiency. LES is proactive in risk management, forecasting, and disclosure.

STRONG LONG-TERM RATING AND SUFFICIENT LIQUIDITY: LES's strong 'AA' long-term rating and its sufficient internal liquidity sources, including a $150 million revolving liquidity facility, support the 'F1+' rating on its CP note program.

RATING SENSITIVITIES

RATE ACTION: Timely and sufficient rate action to support its financial position, particularly as current and expected environmental regulations add incremental costs, will be an important rating factor over the next several years.

BALANCE SHEET WEAKNESS: Stalled improvement in balance sheet metrics could drive longer-term rating action. Forecast metrics slowly improve but remain below Fitch's rating category medians.

TIGHTER LIQUIDITY: While its minimum liquidity thresholds make it unlikely, any sustained compression in LES's CP coverage below 1.25x could ultimately lead to negative rating action.

CREDIT PROFILE

STRONG SERVICE TERRITORY

LES is a vertically-integrated retail electric provider in a strong service territory exhibiting some of the lowest unemployment rates in the country (3.4% in March 2014). In addition, healthy customer growth has averaged nearly 1% annually since 2006 to 131,927 today.

The city of Lincoln is the state capitol and home to the flagship campus of the University of Nebraska, both of which create considerable economic activity in the region.

RATE FLEXIBILITY

New environmental costs incurred to retrofit existing facilities or through higher wholesale power costs may press LES to implement additional rate increases during the next several years. The headroom provided by its low rates, a practice of regular rate increases over the past decade, and a demonstrated willingness to raise rates midyear or with short notice in response to natural disasters provides good indication of LES's capacity to raise revenues. Nevertheless, Fitch believes this is the foremost challenge facing the system.

LES's rates rank 13th lowest in its June 2013National Electric Rate Survey of 106 cities (as of Jan. 1, 2013), and currently forecasted rate increases through the 2018 planning period are commensurate with historical changes.

EXCEPTIONALLY STABLE CASH FLOWS

Cash flow metrics are exceptionally stable and in line with Fitch's 'AA' rating category medians. Management sets a target ratio of 2.0x debt service coverage, which it rarely misses. In addition, forecasted coverage remains in line with this target.

BELOW-AVERAGE BALANCE SHEET METRICS

In contrast to its strong cash flow metrics, LES's balance sheet ratios compared unfavorably to rating category medians. LES's rate-raising capacity and the historical stability of its financial and asset operations provide some comfort. However, forecast balance sheet metrics remain below the medians through LES's 2018 planning period, and a stalled trend of improvement could drive longer-term rating action.

A new liquidity policy instituted in 2012 sets minimum cash balances for each month. This prudently assumes that various, identified risks based on 10 years of budget data could interrupt LES's business operations at any point of the year. Nonetheless, the 2014 forecast available balance ($51.2 million) represents a near halving of the 2012 high ($100.7 million). The 2013 balance was $69.8 million.

In addition, the 2013 ratio of equity to capitalization (29.5%) was measurably below the rating category median (52.0%). While equity ratios are slowly improving and should benefit from LES's ample generating capacity, LES's target equity ratio remains lower than the median.

LARGELY COAL-FIRED GENERATION

LES's largely coal-fired generation (88% of 2014 forecast energy) has contributed handily to its low rates but presents some challenges as environmental regulations develop. Some of the system's owned or participatory units will require retrofits over the next several years to comply with existing and expected regulations. While total costs remain uncertain, a Jan. 2014EPA decision on the Laramie River Station currently suggests upwards of $75 million in additional costs to LES. LES would likely debt-finance the project, which could further pressure balance sheet ratios without supplemental cash flows.

LES's rolling sustainability target advances efforts to diversify fuel sources by meeting projected load growth (59MW) with renewable resources and demand side management. LES estimates that 23% of 2016 energy will be met with renewable resources. The system recently entered into a 20-year power purchase agreement for 100MW of additional wind capacity beginning in 2016.

COMMERCIAL PAPER PROGRAM

LES's strong long-term credit characteristics, coupled with its sufficient liquidity sources, support the 'F1+' rating on its CP note program. Liquidity sources include a three-year, $150 million revolving liquidity facility provided by the Bank of Tokyo-Mitsubishi UFJ, Ltd. (IDRs rated 'A/F1' by Fitch), as well as the system's own cash and investments.

Total available sources provided 1.4x the maximum borrowable amount of CP at April 30, 2014. This was essentially unchanged during each month of the prior year and comfortably exceeded Fitch's expected coverage metric of 1.25x the maximum program size for the 'F1+' rating.

LES uses its $150 million CP note program for interim funding of capital needs. The program has been an inexpensive source of borrowing; the weighted average cost was 0.14% in 2013 and 0.16% in 2012, reflecting, in part, LES's strong credit quality. LES had $85.5 million of available CP capacity at March 31, 2014.

COMMERCIAL PAPER LIQUIDITY FACILITY

The liquidity facility, which is sized to the maximum authorized amount of the CP note program, covers principal payments if rollover proceeds are insufficient to pay amounts due at maturity. The facility expires on Aug. 28, 2015, barring certain events of default that Fitch considers unlikely.

The unlikely occurrence of an accelerated term loan payment pursuant to the facility could cause LES short-term financial pressure. However, LES would likely use available cash balances for interim funding needs and refinance any such obligation with long-term debt. Fitch believes that the system's very low rates provide considerable headroom for such purposes.

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

This rating action was informed by information identified in Fitch's U.S. Public Power Rating Criteria and Rating U.S. Public Finance Short-Term Debt criteria.

Applicable Criteria and Related Research:

--'U.S. Public Power Rating Criteria' (March 18, 2014);

Applicable Criteria and Related Research:

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=740841

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830874

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

Ryan A. Greene, +1 212-908-0593

Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Christopher Hessenthaler, +1 212-908-0773

Senior Director

or

Committee Chairperson

Dennis Pidherny, +1 212-908-0738

Managing Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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