Fitch Affirms Arkansas Electric Cooperative's Commercial Paper at 'F1'

Fitch Ratings has affirmed the 'F1' rating on Arkansas Electric Cooperative Corporation's (AECC or the cooperative) $250 million commercial paper (CP) program (maximum authorization).

SECURITY

AECC's CP notes are unsecured, subordinated obligations secured by the net revenues of the cooperative. The CP notes are subordinated in payment to senior secured debt obligations, totaling $784.8 million as of Oct. 31, 2013.

KEY RATING DRIVERS

SOLID LONG-TERM CREDIT FUNDAMENTALS: AECC's credit quality ('A+' long-term rating) stems from its long-dated (2042) all-requirements contracts with its 17-member distribution cooperatives, low-cost power resources, competitive wholesale rates and diverse member customer base.

CP LIQUIDITY SUPPORT: AECC's maximum $250 million CP program is supported by an equally sized unsecured revolving credit facility provided by a syndicate of seven banks. The credit facility was recently extended to June 12, 2016. AECC also has over $107 million in unrestricted cash as of Oct. 31, 2013 providing added liquidity. However, increasing member advances held by AECC (demand obligations) are a concern.

IMPROVED MARGINS AND CASH FLOW: AECC's net margins and cash flow have improved with the rebound in industrial sales following the recent economic recession and implementation of two wholesale rate increases. All-in debt service coverage is 1.46x or higher for fiscal 2010-13, from closer to 1.0x in 2007-09 - exceeding the rating category median debt service coverage of 1.12x.

STATE REGULATORY OVERSIGHT: Unlike most of their peers, AECC and its members are subject to rate regulation by the Arkansas Public Service Commission (APSC). Partially mitigating this concern is the long history of constructive regulatory treatment by the APSC; favorable fuel and purchased power cost pass-through for AECC and its members; and legislation which has allowed for an expedited rate review process since 2009.

LEVERAGE RISING BUT MANAGEABLE: AECC's capital expenditure program totals $597 million through 2017. The majority of the capital plan will fund environmental upgrades at AECC's coal facilities. Favorably, AECC has a solid balance sheet (34% equity capitalization as of Oct. 31, 2013) to support borrowing needs for the capital program. AECC already has Dept. of Agriculture Rural Utilities Service (RUS)-approved loans to cost effectively fund the capex. AECC is projecting moderate rate increases thru 2016.

RATING SENSITIVITIES

WEAKER FINANCIAL METRICS THROUGH CAPEX CYCLE: Maintenance of AECC's financial and liquidity metrics through the current cycle of higher capital expenditures and related borrowings is key to supporting AECC's short-term rating.

CHANGE IN LONG-TERM RATING: A change in AECC's long-term rating could lead to movement in its CP ratings. This recognizes the inherent link of long-term credit quality and short-term funding needs.

CREDIT PROFILE

STRONG CREDIT FUNDAMENTALS

AECC is a generation and transmission cooperative providing wholesale electricity to 17 member rural distribution cooperatives in Arkansas. The distribution cooperatives provide retail electric service to 508,100 customers located in all of the state's 75 counties. AECC's members are geographically diverse, providing power to roughly 31% of the state's consumers. The retail revenue base is heavily weighted toward stable, residential users, which account for about 59% of member revenues.

AECC maintains competitive-cost wholesale power, with solid financial metrics supported by sound member systems. AECC's power supply is predominantly coal-fired, accounting for 60% of energy requirements for 2012. The emissions exposure associated with the coal-weighted energy mix is somewhat offset by AECC's strong balance sheet (34% equity capitalization), competitive wholesale rates, and slightly lower coal-generation exposure in comparison to the other comparable systems in their region. AECC is a tax-exempt entity under Arkansas cooperative law, but taxable for federal income tax purposes.

CP PROGRAM

The $250 million authorized maximum CP program is subordinate in payment to AECC's $784.8 million senior secured debt, which includes 1st mortgage bonds and other privately held debt. The CP can be issued with maturities of up to 397 days, although in recent years, 60-90 days is the most typical maturity range. The CP is supported by a $250 million unsecured revolving bank facility with a syndicate of seven banks. This bank credit facility was recently extended two years to June 12, 2016. AECC further has a $75 million perpetual line of credit (undrawn) with National Rural Utilities Cooperative Finance Corporation.

AECC has a modest $10 million of CP presently outstanding. AECC typically uses CP for interim finance capital expenditures and then refunds the CP with long-term debt, typically loans from the Dept. of Agriculture's, RUS. AECC currently has approved RUS loans ($525 million undrawn) in excess of 2014 capital needs (just over $200 million), providing an added liquidity cushion.

INTERNAL LIQUIDITY ADEQUACY

AECC's liquidity ratio, as defined by available liquid resources divided by maximum potential liquidity requirements, was 0.97x for fiscal 2013, which is an improvement from fiscal 2012 (0.85x), but still below Fitch's short-term debt criteria of 1.10x minimum for an 'F1' rating. This calculation includes advances made by the members to AECC (promissory notes), as potential liquidity requirements. The promissory notes constitute demand obligations that are due back to the members upon their request.

Fitch mitigates this liquidity concern given AECC's very conservative fiscal nature, solid balance sheet, sound access to capital, and a history of successful remarketing of its CP (rates of 0.20%-0.23%, for 91-94-day paper in fiscal 2013). Additionally, AECC issues its CP in tranches that mature in amounts not more than $30 million. This strategy should allow AECC to meet any single maturity with cash on hand, without relying on the backup facility or other external liquidity. Lastly, the members have not requested immediate reimbursement of their advances under the member line of credit program since it was put in place in the late 1980s.

AECC has outlined reasonable settlement procedures in regards to its CP program. Based on the settlement procedures, needed fund transfers - whether to issue CP, provide contingency reserves for failed remarketings, or prepay outstanding CP - are received in a timely manner by the Paying Agent (US Bank) and AECC.

RECENT DEVELOPMENT - HIGHER TRANSMISSION COSTS

AECC joined the Midcontinent Independent System Operator, Inc. (MISO; a regional transmission operator) in late 2013. Transmission costs have been notably higher than anticipated, by about $27 million per annum. While AECC sufficiently offset the higher costs incurred in late 2013, they have filed with the APSC for a transmission rider to automatically pass through MISO costs beginning in 2014 and thereafter. The PSC's ruling is expected by mid-year. If the rider is not adopted by the PSC, AECC could alternatively increase their wholesale rate roughly 5% to cover the higher transmission costs. AECC is also pursuing additional filings with MISO, which if approved could reduce their transmission costs.

LONG-TERM RATING

For additional information on AECC's 'A+' long-term rating, see Fitch's press release dated Jan. 30, 2013, available at www.fitchratings.com.

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria, this action was informed by information from CreditScope.

This rating action was informed by information in Fitch's U.S. Public Power Rating Criteria, Rating U.S. Public Finance Short Term Debt, and Revenue Supported Rating Criteria.

Applicable Criteria and Related Research:

--'Rating U.S. Public Finance Short Term Debt' (Dec. 9, 2013);

--'U.S. Public Power Rating Criteria' (Dec. 18, 2012);

--'Revenue Supported Rating Criteria' (June 3, 2013);

--'Fitch Affirms Arkansas Electric Cooperative's Ratings at 'A+/F1'; Outlook Stable' (Jan. 30, 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027

Rating U.S. Public Finance Short-Term Debt

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724680

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818430

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