South Carolina Public Service Authority; Retail Electric

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1 Summary: South Carolina Public Service Authority; Retail Electric Primary Credit Analyst: Jeffrey M Panger, New York (1) ; jeff.panger@spglobal.com Secondary Contact: David N Bodek, New York (1) ; david.bodek@spglobal.com Table Of Contents Rationale Outlook SEPTEMBER 28,

2 Summary: South Carolina Public Service Authority; Retail Electric Credit Profile South Carolina Pub Svc Auth rev Long Term Rating A+/Stable Outlook Revised Rationale S&P Global Ratings has revised the outlook on the Public Service Authority of South Carolina's (Santee Cooper) electric revenue debt to stable from negative and affirmed its 'A+' unenhanced long-term and underlying ratings on the utility. At the same time, S&P Global Ratings affirmed its 'A-1' commercial paper rating on Santee Cooper. Following what we believe is a credible financial projection, we expect that Santee Cooper will maintain fixed cost coverage metrics and liquidity consistent with the 'A+' rating. Although the projection incorporates moderate rate increases, we believe that they will be manageable within the context of the utility's competitive position. Finally, we believe that a lower load forecast relieves the authority of the immediate need to add generating capacity, and (coupled with the decision to suspend the V.C. Summer nuclear units 2 and 3 project), alleviates the need to issue additional debt. As such, we expect that debt ratios will improve against both current measures and projections pre-dating the project suspension. We view the decision to suspend the project as incrementally stabilizing the rating through eliminated construction risk and exposure to additional costs. Although the utility still faces other exposures, suspension of the project makes economic sense, in our view. On Aug. 2, 2017, we lowered our ICR to 'A+' from 'AA-' and maintained our negative outlook following the decision by Santee Cooper's decision to suspend the units' construction. In lowering the rating, we cited our opinion that, without a generating asset to show for its issuance of $4.6 billion of debt, Santee Cooper had diminished debt issuance and rate-raising capacity, and hence weakened credit quality. Meanwhile, we maintained the negative outlook pending greater clarity regarding the impact of the suspension on financial metrics, rates, and power supply plans. In our opinion, Santee Cooper has clarified these matters. Although we still believe that exiting the project resulted in diminished credit quality, we also believe that, in light of the spiraling costs and delays, and a changing landscape for load growth, carbon regulation and natural gas prices, the authority acted prudently in ending the project to reduce its exposure to future risk. The 'A+' rating on Santee Cooper reflects our view of the following credit strengths: Adequate coverage of debt service (inclusive of commercial paper payments paid from revenue) after transfers. We calculate this coverage at 1.33x in 2016, 1.36x in 2015, and 1.47x in Based on what we believe are reasonable assumptions (including sizable but manageable rate increases), management projects coverage in the 1.40x-1.45x SEPTEMBER 28,

3 range over fiscal years ; Strong liquidity. Unrestricted cash and investments measured nearly $817 million, representing 249 days of operating expenses. Supplementing liquidity is $100 million in unused capacity related to a revolving credit agreement. Santee Cooper also had $350 million in unissued CP capacity at fiscal year-end Projections suggest that unrestricted cash will be drawn on yet remain at robust levels, assuming the adoption of forecasted rate increases; A broad and diverse customer base. the utility serves 178,000 customers directly and nearly 771,000 indirectly, the latter chiefly via sales to wholesale customer Central Electric Power Cooperative, which accounted for 60% of the authority's 2016 revenue; and, A responsive cost recovery mechanism. Santee Cooper's cost tracker covers about 75% of costs and minimizes budget variance. We view as credit supportive a board-approved automatic fuel cost adjustor (based on three month rolling average), and an automatic adjustor for variance in the demand component of non-firm sales and off-system sales. In our opinion, the following factors represent credit risks: Managerial uncertainty, and legal and political fallout in the aftermath of the decision to suspend the project's construction; A substantial carbon footprint, at a time of heightened regulation ; Nuclear risk related to its one-third interest in V.C. Summer nuclear unit 1, which provides 11% of the authority's energy requirements; and High debt levels and substantial capital costs. Santee Cooper has about $8.2 billion in long-term debt and commercial paper, representing 80% of total capitalization. Our business profile assessment on the utility is '4' on a scale '1' to '10', '1' being the strongest. In our opinion, the business profile assessment reflects Santee Cooper's rate-setting autonomy, solid competitive position, and strong management. Offsetting this in part are the nuclear project's cancellation and exposure to environmental regulation given the utility's substantial carbon footprint. Santee Cooper faces managerial uncertainty, and legal and political fallout in the aftermath of the project's suspension. The CEO, Lonnie Carter has announced his retirement, and an interim CEO has yet to be named. The utility already faces two class action lawsuits over the project that we anticipate will take years to work its ways through the courts, but will undoubtedly impose financial and managerial burdens. Santee is also facing legislative hearings. Finally, Governor Henry McMaster, who is running for a full term election in 2018, has stated a desire to sell the state-owned utility or its stranded assets. For legal, economic, and political reasons, we do not believe that this will be attainable, but that it is even being explored speaks to significant ratepayer animus and the potential that the issue will be further politicized, possibly resulting in the imposition of constraints to rate-setting autonomy. We consider Santee Cooper's service area to be broad and deep. The utility serves about 178,000 residential, commercial, and industrial electric customers directly, and another 771,000 customers indirectly through wholesale electric supply arrangements with cooperative and municipal utilities. Central serves most of the latter group, via its 20 member electric distribution cooperatives. The combined direct and indirect base of customers is weighted to residential, which adds to demand stability. Santee Cooper's wholesale power sales contract with Central extends through 2058 (as does Central's contracts with SEPTEMBER 28,

4 its members). Sales to Central account for about 60% of Santee Cooper's revenue, and are on a cost-of-service basis; Central pays a pro rata share of the authority's fixed and variable costs of generation, including those associated with the suspended nuclear project. The contract allows Central to opt out of future generation projects. In our opinion, should Central do so, this could place a constraint Santee's power supply plans. Central is transitioning to serving its upstate Saluda County members (about 22% of Central's load) with power sourced from Duke Carolinas LLC. The phased-in transition, which began in January 2016, extends over six years, and ultimately affects about 1,000 MW of load. Net of the effect of the move of Central load to Duke Carolina, Santee Cooper's demand growth has been largely flat over the past several years. In light of over-capacity, projections of minimal load growth, and the suspended nuclear project, management does not anticipate needing to add generation before We understand that the authority is considering bringing an idled coal unit (Cross unit 2) back into service (a process that would take two years and cost up to $150 million, mainly for environmental retrofits), which would further defer the need to add additional generation. However, bringing back Cross 2 would be only an interim solution, and undertaken in consideration of the status of carbon regulation and power costs. Given the current outlook for fuel prices, a long-term solution would likely involve adding gas-fired generation. Management projects that in today's dollars, the cost of medium- and long-term solutions would be more economical than had Santee Cooper continued building the nuclear project. Supplying about 85% of the authority's energy needs are a diverse set of generating assets -- coal, gas, nuclear, hydro and landfill gas. Unit availability has been generally adequate and stable. Santee Cooper has a substantial carbon footprint, and at a time of heightened regulation, this raises credit concerns. The authority relied on coal-fired generation to meet slightly less than half of its 2016 energy needs. Although coal units are generally compliant with existing Environmental Protection Agency (EPA) regulations (and we view the capital costs of additional controls as manageable), Santee Cooper is exposed to financial and operational risks associated with regulation targeting greenhouse gas emissions at existing units. The fate of the EPA's Clean Power Plan (CPP), which has been stayed by the U.S. Supreme Court, is uncertain, but while its implementation will likely be delayed, we believe that carbon regulation is inevitable. Insofar as the associated costs and timing of such regulation are uncertain, we have not factored in the potential negative impact into the rating. Customer concentration is not a significant credit risk. The largest customers include Nucour Corp. (5%) and Century Aluminum Co. The authority had expected the latter to cease operations but it signed a three year contract with Santee Cooper, albeit at 50% of prior load, and with fairly rapid termination notice provision. Century, which accounted for almost 9% of operating revenues in 2014, accounted for just 2% in While Santee derives little net margin on these sales, they shoulder a portion of the utility's fixed costs. Finally, we view demographics as somewhat below average, but largely credit neutral, as median household effective buying incomes are 88% of the U.S. average and unemployment is on a par with the U.S. rate. The cancellation of the nuclear project has relieved Santee Cooper of the need to issue about $2.5 billion in debt that it previously anticipated issuing. As a result, amortization costs are lower than expected, allowing the authority to withdraw 3.7% rate increases proposed for each of the next two years. We understand that Santee Cooper has reached an agreement with Citibank N.A. to monetize its settlement claim with SEPTEMBER 28,

5 Toshiba Corp for upfront cash proceeds of $831.2 million (91.5%). Santee Cooper's share of the settlement claim was $976 million, however the first payment of $67.5 million due October 2017 was not monetized and Santee Cooper expects to receive it in full in October Because we believe that Toshiba is in severe financial distress and does not have access to debt or equity markets, we questioned the value of its parental guarantee over subsidiary Westinghouse Electric Co. LLC, (WEC), the Summer project consortium's leader. As such, we view the monetization of the settlement as removing some uncertainty and a positive development. Santee Cooper's financial forecast suggests base-rate increases totaling 13% through 2026, and in our opinion, this reduces future financial flexibility. (Given the outlook for fuel prices, the utility anticipates a 27% in system rate through 2026). Insofar as the monetized settlement is for more than anticipated, the ultimate rate increases may be slightly lower. Nevertheless, while the projected rate increases are meaningful, we anticipate that they will be manageable within the context of the authority's competitive position, particularly in light of the fact that the cost pressures related to the nuclear units also impact South Carolina Electric & Gas Co. (SCE&G). Currently, residential, commercial, and industrial rates are, on balance, slightly higher than Progress Energy and Duke Energy, but well below SCE&G. According to the Department of Energy's Energy Information Administration, the authority's weighted average retail revenue per kilowatt-hour (kwh) was 16% below the state average in 2015, (the most recent year of available competitive information). However, subsequent rate increases, including a 5.34% rate increase in 2016 and 2.09% for 2017, have eroded a portion of this advantage. We believe that Santee Cooper's financial metrics support the rating. Coverage of fixed costs (debt service on long-term debt and principal and interest payments on commercial paper paid from revenue), after payments in lieu of taxes and transfers to the state was 1.33x in This is down from 1.36x in 2015 and 1.47x in The utility estimates 1.41x coverage after transfers for fiscal We believe that the financial forecast of 1.40x-1.44x coverage through 2026 is conservative based in that it assumes receipt of a lower amount of settlement money from Toshiba. Santee Cooper's liquidity is robust. The utility had $817 million of unrestricted cash at fiscal year-end 2016 (Dec. 31), representing 249 days of operating expenses. The utility also had $100 million available under a revolving credit agreement, boosting liquidity to 279 days of fiscal 2016 operating expenses. In addition, Santee Cooper had $750 million of bank lines backing commercial paper (CP) at fiscal year-end 2016, $350 million of which represented unused capacity. We anticipate that the utility will scale back lines (and hence CP capacity) now that the nuclear project has been suspended. Again, assuming no receipt of settlement money, the authority's forecast suggests it will draw on unrestricted cash and investments to meet amortization costs in 2017 and 2018, but they will remain at a level that we still consider strong. The utility is highly leveraged. At Dec. 31, 2016, Santee Cooper had $8.2 billion of debt outstanding, more than half of which related to the Summer project. Debt-to-capitalization was 80% in 2016, but with reduced capital needs relative to what had been expected before project suspension ($750 million through 2027, not including potential costs of adding new gas fired generation), management projects the ratio to improve to 69% by SEPTEMBER 28,

6 Outlook The stable outlook reflects Santee Cooper's projects maintaining fixed cost coverage metrics and liquidity at levels that we view as consistent for the rating. Although these projections incorporate moderately large rate increases, we believe that they will be manageable within the context of the utility's competitive position. Upside scenario We do not anticipate raising the rating given the financial forecasts for coverage and liquidity, the overhang of legal and political fallout from the suspended project, diminished financial flexibility from future rate increases, and high debt levels that we do not expect to improve meaningfully over the next two years. Downside scenario We could lower the rating in that time if financial results for coverage, liquidity or debt reduction fall meaningfully short of projections, or if political and legal fallout from the project suspension meaningfully burdens the utility or constrains financial flexibility. Santee Cooper is highly leveraged and the bulk of debt is associated with a nonperforming asset, so additional debt could also exert downward pressure on the rating. Ratings Detail (As Of September 28, 2017) South Carolina Pub Svc Auth retail elec Short Term Rating A-1 Affirmed South Carolina Pub Svc Auth retail elec Long Term Rating A+/Stable Outlook Revised South Carolina Pub Svc Auth retail elec taxable cp, tax-exempt sub- ser D&DD Short Term Rating A-1 Affirmed South Carolina Pub Svc Auth retail elec (AGM) South Carolina Pub Svc Auth retail elec (AGM) South Carolina Pub Svc Auth retail elec (AMBAC) South Carolina Pub Svc Auth retail elec (ASSURED GTY) SEPTEMBER 28,

7 Ratings Detail (As Of September 28, 2017) (cont.) South Carolina Pub Svc Auth retail elec (BHAC) (SEC MKT) South Carolina Pub Svc Auth retail elec (MBIA) (National) South Carolina Pub Svc Auth retail elec (National) South Carolina Pub Svc Auth retail elec (National) South Carolina Pub Svc Auth retail elec (National) South Carolina Pub Svc Auth rev oblig (Taxable) ser 2016D due 12/01/2056 Many issues are enhanced by bond insurance. Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at for further information. Complete ratings information is available to subscribers of RatingsDirect at All ratings affected by this rating action can be found on the S&P Global Ratings' public website at Use the Ratings search box located in the left column. SEPTEMBER 28,

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