1 STANDARD POOR S RATINGS SERVICES McGRAW HILL FINANCIAL RatingsDirect @ Tri State Generation and Transmission Association Inc Colorado Rural Electric Coop Primary Credit Analyst David N Bodek New York 1 212 438 7969 david bodek@standardandpoors com Secondary Contact Paul J Dyson San Francisco 1 415 371 5079 paul dyson@standardandpoors com Table Of Contents Rationale Outlook Colowyo Coal Funding Corp Debt Springerville Generating Station Unit 3 Debt Related Criteria And Research WWW STANDARDANDPOORS COM RATINGSDIRECT APRIL 28 2016 1 1625605 1300019859 I Tri State Generation and Transmission Association Inc Tri State Generation Colorado Transmission Assn RURELCCOO A Stable Long Term Rating Colowyo Coal Funding Corp Tri State Generation Outlook Revised Colorado Transmission Assn Colorado Colowyo Coal Funding Corp Tri State Generation due 11 Rural Electric Coop Transmission Assn 10 19 coal contract receivable collateralized bnds 15 2016 A Stable Long Term Rating Outlook Revised Gallup New Mexico Tri State Generation Transmission Assn Colorado Gallup Tri state Generation ser 2005 due 08 15 Transmission Assn poll cntl rev rfdg bnds Tri State Gen Transmission Inc Proj 2017 A SPUR Unenhanced Rating Stable Outlook Revised Rationale Standard Poor s Ratings Services has revised its outlook to stable from negative and affirmed its A rating on the following The issuer credit rating ICR and senior secured debt on Tri State Generation and Transmission Association Inc Colo Gallup N M s debt issued on the utility s behalf Colowyo Coal Funding Corp Colo s bonds due Nov 15 2016 and guaranteed by Tri State and The cooperative s 2003 series A and series B pass through trust certificates that financed the construction of the Springerville Unit 3 power plant through a lease structure 494 9 million outstanding as of Dec 31 2015 The outlook revision reflects Tri State s significant progress in resolving the regulatory proceedings in which member cooperatives challenged the utility s ratemaking authority The revised outlook also reflects the utility s potential to achieve stronger annual debt service coverage DSC because of the reamortization of its debt through a 2014 refinancing Tri State produced 1 4x DSC and 1 3x fixed charge coverage FCC in 2015 We also consider the utility s projections of DSC of at least lAx and FCC of at least 1 3x through 2020 to be plausible The 2015 and projected DSC and FCC represent a departure from the weak coverage from operating revenues of less than 1 Ox during 2011 2012 and 1 lx in 2013 2014 During those years the utility used funds it had deposited with the Rural Utilities Service RUS as a form of a rate stabilization fund to supplement operating revenues and bolster financial performance The utility needed to use reserves because member discord limited or precluded rate adjustments in those years Tri State used bond proceeds to fund its deposits at the RUS Our FCC calculation treats capacity payments to other generation suppliers as debt service in lieu of operating expenses because we view these payments as a vehicle for funding the suppliers recovery of capital investments in WWW STANDARDANDPOORS COM RATINGSDIRECT APRIL 28 2016 2 1625605 1300019859 Tri State Generation and Transmission Association Inc Colorado Rural Electric Coop generation Standard Poor s treats fixed payments under purchase power agreements and Tri State s tolling contracts as debt service rather than operating expenses because we consider these payments as funding the other generation owners investments in plant Because of consolidation since 2009 lease payments relating to the Springerville coal plant are now recorded as debt service in the financial statements and Standard Poor s treats them as such The utility s 2014 refinancing transactions replaced RUS debt with capital market debt extended portions of existing debt balances and thereby reduced debt service for about 10 years Transactions in 2010 and 2014 transactions also deferred about 30 of principal to later years through the use of bullet maturities that postpone 250 million of principal repayment to 2024 500 million to 2040 and 250 million to 2044 Total debt at Dec 31 2015 was nearly 3 4 billion Although the amount of the restructuring s annual debt service savings will decline each year the utility nevertheless projects relatively stable DSC and FCC while introducing modest rate increases Tri State expects that lower debt service will reduce rate pressures on its member distribution cooperatives allow for greater use of cash financing of portions of its large capital program and appease members that have challenged recent years rate adjustments Tri State is a generation and transmission cooperative serving 44 members across a 200 000 square mile area in portions of Wyoming Nebraska Colorado and New Mexico It indirectly serves about 626 000 retail customers Its members have exclusive rights to sell retail electricity in their defined service territories Energy sales data show that Tri State s end use customers electricity consumption places it among the 10 largest generation and transmission cooperatives in the U S Leading customers concentration in the natural gas and petroleum sectors temper some of the benefits of the breadth of the customer base Sales to non members represented 16 23 of total energy sales during 2009 2013 and about 15 of operating revenues However a high level of contracted nonmember sales tempers risks of revenue stream volatility Also the percentage of members contributions to energy sales has been increasing rising to 84 74 in 2007 and 75 in 2015 from 80 in 2013 in 2008 We view the trend of rising member sales as reducing the utility s exposure to wholesale markets and their uncertainties The cooperative s mortgage indenture provides that its revenues and most of its tangible assets secure its first mortgage bonds The Springerville plant s Unit 3 and its related assets secure another approximately 495 million of debt The A ratings reflect our views of the following credit strengths The utility projects what we consider to be sound DSC of at least 1 4x and FCC of at least 1 3x through 2020 based on the benefits of reamortizing debt and implementing moderate rate increases Tri State s financial forecast assumes that its nearly 3 4 billion debt balance as of Dec 31 2015 will rise an average of 100 million per year through 2020 to reach 3 8 billion These projections of 500 million of additional debt compare favorably with the 1 4 billion of capital spending it forecasts during those years The utility projects that its 2014 debt reamortization and the near term annual debt service reductions will leave a greater percentage of operating cash flow available for capital spending Long term all requirements wholesale power supply contracts with members contribute to the stability and WWW STANDARDANDPOORS COM RATINGSDIRECT APRIL 28 2016 3 1625605 1300019859 Tri State Generation and Transmission Association Inc Colorado Rural Electric Coop predictability of the revenue stream and extend through 2050 except for two that expire in 2040 Tri State members large customer base contributes to revenue stream diversity However residential customers modest 30 share of energy sales sparse customer density low service area income levels and customer concentrations in the natural gas and petroleum sectors temper these benefits Standard Poor s ratings also consider these exposures in its analysis Tri State sources nearly two thirds of its energy from owned and contracted coal resources We believe this high reliance exposes the utility and its customers to the costs of complying with emissions regulations such as the Environmental Protection Agency s Clean Power Plan Although Tri State has made significant strides in extinguishing several members challenges to its ratemaking authority in Colorado Nebraska and New Mexico settlement discussions in New Mexico are ongoing and could influence the utility s ratemaking authority in that state Furthermore the cooperative has yet to establish a track record demonstrating that extinguishing the regulatory challenges to its rates is capable of fostering member cohesiveness that restores ratemaking and financial flexibility Tri State s debt structure includes large bullet maturities in 2024 2040 and 2044 without sinking funds Although these structures skew DSC ratios relative to those of cooperative utilities that exclusively use amortizing debt our analysis considered imputing a mortgage style amortization for comparability and that analysis suggested that coverage would remain sound under that scenario The use of significant bullet maturities defers to later years a sizable portion of the utility s financial burden Tri State s nearly 3 4 billion of debt at year end 2015 was sharply higher than 2008 s 1 7 billion in part because of 2009 s consolidation of debt associated with the utility s lease interest in the Springerville Unit 3 coal generating station in Arizona More recently debt rose from 3 billion at Dec 31 2012 to 3 4 billion at Dec 31 2015 Although the utility projects about 1 4 billion of 2016 2020 capital spending its financial forecast plausibly shows it adding a lesser 500 million of debt because it expects that because its 2014 refinancing transaction reduced near term debt service it will have greater cash flow available for funding of capital spending which will temper debt issuance Investments in transmission and existing coal facilities represent the largest elements of the capital plan Six owned and leased coal fired base load generation stations providing 1 874 megawatts MW of capacity dominate Tri State s 2 841 MW power supply portfolio Other key generation resources include 967 MW from natural gas or oil fueled peaking power plants low cost hydroelectric power purchases from the Western Area Power Administration WAPA and renewable resources consisting principally of wind turbines Members 2015 peak demand was 2 753 MW and peak demand has been between 2 600 MW and 2 800 MW during 2010 2015 Tri State produces almost two thirds of the electricity it sells The utility added the 416 MW of Springerville leased coal capacity in 2006 and about 220 MW of gas fired capacity under tolling contracts in 2009 In 2011 Tri State purchased the Fort Lupton Colo 272 MW gas fired combined cycle power plant from Starwood Energy Group The utility had leased 150 MWs of the plant under a tolling agreement before purchasing it Although it purchased the combined cycle facility subject to an obligation to sell a portion of the plant s output to another party under a purchase power agreement that runs through 2019 the cooperative nevertheless expects the transaction to provide it with sufficient generation capacity through 2022 The utility did not change rates in 2010 and 2011 and raised them 3 9 WWW STANDARDANDPOORS COM RATINGSDIRECT in 2012 and 4 9 in 2013 Challenges by New APRIL 28 2016 4 1625605 1300019859 Tri State Generation and Transmission Association Inc Colorado Rural Electric Coop Mexico members blocked rate adjustments in that state Average wholesale rates of 7 1 cents per kilowatt hour were unchanged for all members during 2013 2015 partially because of member discord with Colorado and Nebraska members challenging the utility s rate adjustments and the cooperative s allocation of demand and energy charges Because the utility has revised its rate structure s demand and energy charges and has made strides in resolving the customer conflicts it predicts it has appeased customers and can incrementally raise rates up to 10 by the end of 2018 Tri State lacks a formal fuel and purchased power adjustment mechanism Consequently its board s willingness to adjust rates as costs rise is an important credit quality indicator Projections of moderate rate adjustments support plausible financial projections Outlook The stable outlook reflects our view that 2014 s debt reamortization is producing annual debt service savings that are bolstering coverage benefiting bondholder protection and creating capacity to fund about two thirds of 2016 2020 capital needs with operating cash flow In addition progress in resolving customers challenges to the utility s autonomous ratemaking authority could create capacity to adjust rates to achieve the sound coverage the cooperative projects Upside scenario We do not expect to raise the rating within our two year outlook horizon because Tri State has yet to establish a track record of sound financial performance In addition we consider the local economy to be exposed to the volatile oil and gas sectors Furthermore the cooperative like many other utilities that depend heavily on coal for generation needs to develop a strategy for responding to the Clean Power Plan that will preserve financial metrics Downside scenario We could lower the rating if Tri State does not achieve sound coverage in line with its projections whether due to member discord a lack of ratemaking flexibility higher than expected costs attributable to the capital plan or complying with environmental regulations Colowyo Coal Funding Corp Debt In 2011 Western Fuels Colorado which is wholly owned by Tri State purchased the Colowyo Mine from Rio Tinto America Inc The utility sources coal from the mine to fuel its Craig plant under supply contracts expiring in 2017 The purchase included Tri State s agreement to guarantee about 35 million of Colowyo debt which ties our rating on Colowyo debt to our Tri State ICR The remaining 7 7 million of Colowyo Bonds mature in November 2016 The utility has set aside funds to economically defease all the Colowyo debt We consider the defeasance economic rather than legal The collateral is mainly Treasury bonds with a portion maturing shortly before each debt payment date If for some reason the collateral is insufficient to pay the bonds in full Tri State has an obligation to cover any shortfall We consider the remaining guarantee s contingent exposure to be nominal relative to the cooperative s 3 4 billion of debt The Colowyo bonds cannot be accelerated Tri State acquired the mine with unused bond proceeds The utility has not disclosed the purchase price however we WWW STANDARDANDPOORS COM RATINGSDMCT APRIL 28 2016 5 1625605 1300019859 Tri State Generation and Transmission Association Inc Colorado Rural Electric Coop believe it was favorable The mine might need considerable investments to extend its life beyond the 2017 expiration of the existing supply contracts Tri State has not quantified the amount of the investments Springerville Generating Station Unit 3 Debt In 2003 Tri State financed the construction and acquisition of the Springerville Generating Station Unit 3 by creating a lease structure with Springerville Unit 3 Holding LLC as the owner lessor The lessor issued notes to fund construction In turn a pass through trust purchased the notes with the proceeds of the Tri State 2003 series A and B pass through trust certificates that the utility sold to investors Although Tri State s obligation to make lease payments is a general unsecured obligation of the utility Unit 3 and its related assets at the plant site secure the certificates As of Dec 31 2015 495 million of certificates were outstanding Their maturities extend through 2033 The lessor owns the power plant and it leases the underlying land from Tucson Electric Power Co and has sublet it to Tri State The power plant lease is a triple net lease that is absolute unconditional and not subject to abatement The three month outage to repair turbine damage in 2012 highlights the significance of these lease provisions Based on its 51 equity interest in the Springerville Unit 3 Partnership L P Tri State fully consolidates the project s assets liabilities and expenses in its consolidated financial statements and its income statement does not include lease expense Related Criteria And Research Related Criteria USPF Criteria Applying Key Rating Factors To U S Cooperative Utilities Nov 21 2007 USPF Criteria Methodology Definitions And Related Analytic Practices For Covenant And Payment Provisions In U S Public Finance Revenue Obligations Nov 29 2011 USPF Criteria Assigning Issue Credit Ratings Of Operating Entities May 20 2015 Criteria Use of CreditWatch And Outlooks Sept 14 2009 Ratings Detail As Of Tri State Generation Transmission Assn unsecd revolv credit Long Term Rating Tri State Generation Outlook Revised A Stable Outlook Revised A Stable Outlook Revised Transmission Assn ICR Long Term Rating Tri State Generation A Stable Transmission Assn RURELCCOO Long Term Rating Many issues are enhanced by bond insurance WWW STANDARDANDPOORS COM RATINGSDIRECT APRIL 28 2016 6 1625605 1300019859 Copyright 2016 Standard Poor s Financial Services LLC a part of McGraw Hill Financial All rights reserved No content including ratings credit related analyses and data valuations model 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