NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has assigned an 'A-' rating to Potomac Electric Power Co.'s (Pepco) proposed new $400 million issue of first mortgage bonds due March 15, 2024. The Rating Outlook is Stable.
Proceeds of the offering will be used to repay at maturity $175 million, 4.65% senior notes due April 15, 2014 (the notes were secured by a like amount of first mortgage bonds), to repay outstanding commercial paper and for general corporate purposes.
Key Rating Drivers
Credit Metrics: Credit metrics are relatively well positioned within the current rating category. Going forward Fitch anticipates FFO to debt to range between 18% - 19% and FFO/interest and EBITDA/interest in the 4.5x - 5.0x range. The one measure that is moderately weak for the rating is Debt/EBITDA, which is expected to approximate 4.0x over the next few years.
Revenue Stability: Pepco's regulated electric transmission and distribution operations have minimal commodity, volumetric and environmental exposure. Regulators in both Maryland and DC have permitted revenue decoupling, which eliminates the negative revenue impact of mild weather and changes in usage patterns, and also permit full recovery of power procurement costs with a modest profit margin. Moreover, the significant presence of state and federal government customers tends to reduce economic volatility in the region.
Challenging Regulatory Environment: Earnings and cash flow measures have been constrained by a string of restrictive rate decisions in Maryland dating back to 2007. The two most recent cases were based on returns on equity (ROE) of 9.36% and 9.31%, respectively, which are among the lowest in the industry. Particularly troubling is the PSC's continued reluctance to permit forward adjustments to address regulatory lag which will likely prevent Pepco from earning its allowed ROE.
Aggressive Rate Strategy: To combat regulatory lag management plans to continue annual rate filings while simultaneously seeking alternative rate making mechanisms. Requests for alternative rate making mechanisms have largely been denied, although a limited Grid Resiliency Charge was recently permitted in Maryland.
Significant Capital Program: Pepco is in the midst of a significant capital program of approximately $3 billion over 2014-2018. A large portion of the expenditures are to address reliability issues that have in the past been a point of contention with Maryland regulators. The capital plan will require annual rate increases in both Maryland and the District of Columbia (DC) to maintain credit quality and ratings. The large capex budget is particularly challenging given the rate lag issues and low authorized ROEs, particularly in Maryland.
Pending Rate Cases: Rate cases are pending in both the District of Columbia (DC) and Maryland that will impact earnings and cash flow measures over the next 24 months. In DC, a decision in Pepco's $44.8 million rate request is expected within the next several weeks. In Maryland, the company filed a $43.3 million rate request in December 2013 and a decision is expected in 2014 Q3. Both cases are premised on a 10.25% ROE.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Positive rating action is not expected, but could occur if regulatory policies are implemented that promote timely recovery of invested capital.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A sustained pattern of adverse regulatory decisions that erode current financial measures.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Utilities
Robert Hornick, +1 212-908-0523
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Daniel Neama, +1 212-908-0561
Philip Smyth, +1 212-908-0531
Brian Bertsch, +1 212-908-0549