Rating Action: Moody's assigns Aa2 to Memphis (TN) Electric System Revenue Bonds; outlook stable

Global Credit Research - 21 Aug 2020

Approximately $400 million of debt securities affected

New York, August 21, 2020 -- Moody's Investors Service assigned an Aa2 rating to the City of Memphis (TN) Electric Enterprise's (MLGW) $160 million Electric System Revenue Bonds, Series 2020A and $53 million Electric System Revenue Refunding Bonds, Series 2020B (Federally Taxable). Concurrently, Moody's affirmed the Aa2 credit rating assigned to MLGW's outstanding $178.5 million of Electric System Revenue Bonds that rank on parity with the Series 2020 offerings. The rating outlook is stable.

RATINGS RATIONALE

The Aa2 rating is driven by MLGW's monopoly position as a utility provider, a modest leverage profile, increased base distribution rates that will strengthen future cash flows, a low business risk profile as an electric distributor and an all-requirement power supply contract with the Tennessee Valley Authority (TVA: Aaa, stable) who bears all power procurement risks for MLGW. Together, these positive credit attributes translate into affordable electric rates for MLGW's customers and a strong financial profile. Challenges confronting the utility, however, include the below average socioeconomic profile within its service territory, uncertainty around its relationship with TVA moving forward and system reliability.

Concerns around system reliability reflects an under investment in MLGW's electric distribution infrastructure. In an effort to improve reliability, MLGW requested the City Council approve a series of electric rates increases that, combined with up to $326 million of incremental debt, will be used to fund $638 million of capital expenditures during the period 2020-2024 focused on improving reliability. In January 2020, the Memphis City Council approved a cumulative 7.2% multi-year rate increase plan that supports MLGW's credit profile. A 3.0% base rate increase was effective July 2020 with an incremental 2.7% effective January 2021 followed by a 1.5% effective January 2022. We calculate the cumulative impact of the rate increase at approximately $370 million through 2024.

MLGW sole electric provider is TVA, a federal agency that sells electricity on an all-requirement basis whereby TVA is reimbursed for its costs of production. Because of this arrangement, TVA is able to provide MLGW with reliable, low cost wholesale power from which MLGW's customers benefit in the form of affordable electric rates. MLGW, however, has commissioned a study to determine if it could source cheaper power by either generating its own electricity or by buying power from sources other than TVA and has plans to launch a Request for Proposal (RFP) for alternative power supply options in the near-term.

MLGW is legally allowed to terminate its relationship by providing TVA with a five-year notice. A RFP does not mean that MLGW plans to end its relationship with TVA, which would require approval by MLGW's Board of Directors and the Memphis City Council. Since MLGW's strong credit profile reflects in part its relationship with TVA, the termination of the relationship would be viewed negatively from a credit perspective and would likely trigger downward rating pressure, particularly if MLGW assumed all or a large portion of its power procurement responsibilities.

MLGW's fixed charge coverage and its adjusted debt ratio in fiscal year 2019 were approximately 5 times and 47%, respectively. While we expect these specific financial metrics to decline over the near-term by incremental debt incurred to fund infrastructure investments, they are expected to remain at levels commensurate with an Aa rated municipal utility at more than 3 times and less than 60%, respectively. MLGW's adjusted days liquidity on hand is expected to remain in a range of 70-100 days, which is weak for the rating category.

The impact of COVID-19 on MLGW's financial performance has been relatively modest. Sales volume is down 4.9% YTD June 2020 compared to YTD June 2019, primarily due to cooler weather (14.3% fewer cooling degree days). A related $48 million decline in revenue has been offset by a $33 million decline in power costs and a $14 million decline in O&M costs driven primarily by lower labor expenses and outside contracting expenses.

MLGW suspended disconnects for non-payment and waived late fees beginning in mid-March 2020. Age of accounts receivable has increased as a result of the suspension of disconnects. MLGW is planning to resume disconnects before the end of August 2020, which is expected to result in a reduction in past due accounts receivable balances.

RATING OUTLOOK

The stable rating outlook considers the utility's strong competitive position and stable financial performance that is expected to continue even with the higher infrastructure capital spending requirements.

FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGS

In light of the higher capital spending and the uncertainty around power procurement at MLGW, limited prospects exist for a rating upgrade in the near-term. Should these matters be addressed in a credit benign way, consideration of a higher rating could occur if liquidity was strengthened through a dedicated debt service reserve requirement or through the maintenance of a higher unrestricted liquidity such that days cash of hand comfortably exceeded 150 days on a sustained basis.

FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGS

Financial results weaken considerably on a sustained basis such that the utility's fixed charge coverage ratio declines to below 2 times on a sustained basis, if the utility provides TVA termination notice under the Power Contract, or if the rating on the city of Memphis were to be downgraded.

LEGAL SECURITY

The Series 2020 bonds are senior lien bonds secured by a pledge of the net revenues of MLGW after payment of O&M expenses. MLGW covenants to collect rates fully sufficient at all times for 100% of operating expenses and net revenue in each fiscal year will equal at least 120% of the debt service requirement on all senior lien revenue obligations. MLGW's bond indenture does not include a debt service reserve fund requirement, a negative credit factor considered in the rating.

USE OF PROCEEDS

Proceeds from the $160 million Series 2020A offering will be used to fund in part MLGW's 2020 and 2021 capital expenditure program. MLGW's capital expenditure program is focused on improving system reliability and the utility forecasts spending approximately $638 million during the period 2020-2024. An incremental $166 million bond offering is anticipated in 2022. Proceeds from the $53 million Series 2020B offering will be used to refund a similar amount of existing higher coupon debt.

PROFILE

MLGW, which is owned by the City of Memphis (General Obligation Bonds rated Aa2, stable outlook) provides electricity, gas and water services to customers within Memphis and Shelby County, Tennessee. Each utility service is operated by separate divisions; the Electric Division operates as independent entity for accounting and financial purposes, maintains a separate fund for its revenues and does not commingle Electric System funds or accounts with any other MLGW operation.

METHODOLOGY

The principal methodology used in these ratings was US Public Power Electric Utilities with Generation Ownership Exposure Methodology published in August 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1170209. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Scott Solomon Lead Analyst Project Finance Moody's Investors Service, Inc. 7 World Trade Center 250 Greenwich Street New York 10007 US JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Kurt Krummenacker Additional Contact Project Finance JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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