Fitch Affirms Buckeye Power's (OH) 'A' Rating; Outlook Remains Negative

Fitch Ratings affirms the 'A' rating on the following Buckeye Power, Inc. (OH) (Buckeye) revenue bonds:

--$17,916,582 Ohio Air Quality Development Authority (Buckeye Power, Inc. Project) series 2003;

--$11,822,393 Ohio Water Development Authority, series 2004;

--$73,040,823 Ohio Air Quality Development Authority, series 2010.

The Rating Outlook on all Buckeye bonds is Negative.

SECURITY

The bonds are secured pursuant to Buckeye's existing mortgage and deed of trust that includes a lien on substantially all of the cooperative's assets.

KEY RATING DRIVERS

FINANCIALS BELOW HISTORICAL LEVELS; BUT STABILIZING: The cooperative's financial metrics, once extremely robust, have fallen in recent years to marginally acceptable levels. The downgrade to 'A' in early 2011 and the Negative Outlook in January 2013 primarily reflect weakened financial metrics and increased electric rates driven by costs associated with a major capital expenditure program.

LONG-TERM WHOLESALE CONTRACTS: Buckeye's credit worthiness is supported by its diverse retail customer base and all-requirements contracts with its 25 Ohio-based distribution members that extend to 2057.

WELL POSITIONED ENVIRONMENTALLY: Buckeye has invested more than $1 billion over the past 10 years to upgrade environmental control systems on its coal-fired units. While environmentally positive, this aggressive strategy is being impacted by slower load growth, higher wholesale and member rates and uncertainty over Environmental Protection Agency (EPA) policy.

EXCESS CAPACITY: Buckeye has added a significant amount of capacity in recent years, which is well in excess of members' needs. The utility relies importantly on day-ahead energy sales into PJM, which adds to variability and makes it harder to accurately forecast future financial results. Recent growth in the members' industrial sector, including additions to Honda Motor Company facilities and new natural gas processing plants in eastern Ohio, are helping to absorb some of this surplus.

ELECTRIC RATES REASONABLE: Buckeye and its member systems' have increased rates significantly in recent periods, to cover costs associated with its capital program. With these rate adjustments now complete, margins should improve and future increases are expected to track normal costs of operation.

RATING SENSITIVITIES

CONTINUED SUBPAR RESULTS: With the major capital program now complete, maintaining the 'A' rating will depend on Buckeye's ability to generate predictable margins and maintain reasonable debt service coverage (DSC) and liquidity ratios that are consistent with rating-category medians, without an overreliance on off-system sales.

CREDIT PROFILE

Buckeye is a not-for-profit generation and transmission (G&T) cooperative that supplies wholesale electricity to approximately 390,000 customers, through its 25 Ohio electric distribution cooperative members. The retail customer base is heavily weighted toward residential users (90% of total users and 70% of energy sales).

Members' energy needs are met through a combination of owned and purchased resources, with heavy reliance on Buckeye's investment in the coal-fired Cardinal Station Units 2 & 3, which has historically accounted for over 90% (including supplemental purchases) of the energy supplied to members. The remaining requirements are largely met through an 18% interest in Ohio Valley Electric Corporation (OVEC) assets, and other power purchases. Buckeye is also an active participant in the wholesale power market (primarily PJM), on both a short-term and intermediate-term basis.

Buckeye has largely completed a long-term capital investment program, which will total about $2 billion. The program has included major environmental upgrades, system improvements and the acquisition of new generation. Future capital investments will moderate significantly; but leverage ratios will remain high for some time.

SURPLUS POWER SUPPLY

Power supply coordination at Buckeye is currently facilitated by the cooperative's 'PJM Services Agreement' with American Electric Power Service Corporation (AEPSC), pursuant to which AEPSC has agreed to serve all of Buckeye's native load power and energy requirements using Buckeye's Cardinal, Mone and NYPA entitlements, and to act as principal for scheduling purposes with respect to PJM through May 2015. Thereafter, Buckeye expects to provide its own scheduling needs.

Buckeye is currently in a sizeable surplus position. Over the long-term, Buckeye expects that its resources will be used to meet future members' power needs. However over the near term, Buckeye will be challenged to reduce the burden associated with its surplus capacity through short-term excess energy sales and the periodic assignment of capacity.

The Ohio Public Utility Commission, as part of a state-wide plan, ordered AEP Ohio generation to be moved from Ohio Power Company to AEP Genco on Jan. 1, 2014. This will result in restructured contracts, shift the obligations of Ohio Power, which has helped coordinated power supply arrangements with Buckeye, to AEP Generation Resources Inc. (AEP Genco), an unregulated merchant generating company. Buckeye's new partner will continue to provide support services at cost, and the two parties recently came to an agreement regarding a corporate guarantee and contract terms. The current station agreement between the two parties, with modifications, will stay in place to 2026.

RATES COMPETITIVE; BUT LESS FLEXIBLE

Buckeye's wholesale rates are determined by the board of directors, subject to the requirements of the wholesale power agreements. Neither the wholesale rates of Buckeye nor the retail rates of its members are subject to regulation by the Ohio Public Utilities Commission. Wholesale rates allow for a monthly pass through of fuel and transmission costs.

Buckeye's wholesale rate to members has risen steadily in recent years. For example, total cost per kWh to members equaled 4.65 cents in fiscal year (FY) 2008 and was 7.02 cents for FY 2013. As of July 1, 2012, the costs of environmental upgrades were fully embedded in rates. Buckeye members' average residential rate is about 13 cents per kWh.

Future forecasts anticipate average annual wholesale rate increases of about 1.3% per year over the next 10 years, tracking expected general costs of operation. Even with these increases, system-wide rates are expected to remain competitive with other utilities in the Midwest region; but overall rate flexibility has been somewhat diminished.

Of Buckeye's roughly 10 million MWHs for sale annually, approximately 8 million MWHs are sold to its members, leaving 2 million MWHs for sale to outside purchasers. In FY 2013, off-system net margins totaled around $10 million, accounting for roughly one-third of Buckeye's total annual net margins. Any shortfall in these net margins is normally made up by rate adjustments to members. Buckeye is currently evaluating future pricing assumptions and expects to be even more conservative in its forecasts. In the interim, management has undertaken cost saving initiatives to reduce fuel and structural costs at major generating facilities, with OVEC savings expected to total about $8 million per year; and Cardinal Station cost reductions targeted at a minimum of $3 million annually.

WINDING DOWN OF CAPITAL EXPENDITURES

Buckeye is nearing the completion of an extensive 10-year environmental and upgrade program that exceeded $2 billion. Originally centered on air-quality upgrades at the Cardinal Station, the program has evolved over time to also include the installation of state-of-the-art emissions control at OVEC units, as well as the acquisition of additional generating capacity. Outlays will decline materially in future years. For example, capital expenditures, which totaled $209.7 million in FY 2012, declined to $27.2 million in FY 2013.

FINANCIAL PERFORMANCE STABILIZING

Buckeye's financial position and performance metrics, while respectable, have declined over the past many years, in large part due to the cooperative's heavy capital program and increased borrowings. For FY 2013, Buckeye's reported DSC of 1.18x, a times interest earned ratio (TIER) of 1.45x and an equity to asset ratio of 18.7%. This was up from prior years' results.

Fitch calculated DSC for FY 2013 was 1.1x, compared with 0.99x in FY 2012 and equity to capitalization was 19.7% versus 17.9% in FY 2012. Debt to funds available for debt service (FADS) remained elevated at over 10x; but is down from 13.2x in FY 2012. While the weakened financial performance was not unexpected given Buckeye's sizable capital plan, current ratios remain weak compared with other 'A' rated wholesale utilities.

Based on five months (Nov. 30) actual results for FY 2014, Buckeye expects net margins to exceed its $30 million forecast, putting the utility in a better position to pay down a portion of short-term debt and restructure some of its other obligations. Buckeye's latest financial forecast assumes net margins will reach $40 million in FY 2015 and FY 2016. This assumes 1% load growth and no excessive rate increases.

Forecasted results should produce DSC of about 1.2x and an equity to capitalization ratio approaching 21%. The forecast also includes lower estimates for margins earned on excess sales. Debt to FADS is expected to gradually trend down, helped by a meaningful increase in depreciation expense and reduced capital expenditures.

For FY 2013, Buckeye's cash on hand stood at 19 days, which is very low by any rating standard. During FY 2013, Buckeye extended its multi-year $200 million unsecured revolving credit facility to Feb. 25, 2018, and liquidity on hand totaled 176 days, up meaningfully from 98 days in FY 2012. This credit facility is used to fund operating and short-term capital needs. At June 30, 2013, $40 million was drawn under this facility.

In addition, Buckeye has two short-term lines of credit totaling $50 million. Between August 2013 and September 2013, Buckeye placed a total of $50 million into the federal Cushion of Credit, which was funded through its existing lines of credit. These proceeds are expected to repay FFB debt over the following two quarters.

STABLE CUSTOMER BASE

The Buckeye member service territories are located throughout the state of Ohio and include portions of 77 of the state's 88 counties. The territories encompass mostly rural areas, comprising roughly 35% of the state's land area and only 10% of total population (approximately 908,770). Importantly, each of Buckeye's members serve legally defined exclusive areas, without competition.

The 10 largest retail customers account for less than 10% of total energy sales. Moreover, several of these customers are served on an interruptible basis further limiting the cooperative's risk of serving this load. The Buckeye members demonstrate reasonable financial profiles, with an aggregate TIER of 2.60x and debt/capitalization at a 48% for FY 2012.

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

The rating action was informed by information from Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria

Applicable Criteria and Related Research:

--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013);

--'U.S. Public Power Peer Study Addendum -- June 2013' (June 13, 2013);

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

Applicable Criteria and Related Research:

U.S. Public Power Peer Study -- June 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710397

U.S. Public Power Peer Study Addendum -- June 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710641

U.S. Public Power Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=813980

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