Fitch Rates Atlantic City Electric First Mortgage Bonds 'A-'
Fitch Ratings has assigned an 'A-' rating to Atlantic City Electric Co.'s (ACE) proposed new $150 million issue of first mortgage bonds. The Rating Outlook is Stable. Proceeds will be used to repay at maturity $7 million of 7.63% medium term notes due Aug. 29, 2014, to repay commercial paper that may be issued to prepay a $100 million variable rate term loan and for general corporate purposes.
KEY RATING DRIVERS
Improving Credit Metrics: Credit quality measures have been improving since 2012 due in large measure to rate increases, storm cost recovery and cost control and are supportive of the existing ratings. Over the 2014 - 2015 periods Fitch estimates EBITDA/interest to average about 4.0x, FFO/interest 4.0x and FFO/Debt about 20%. Debt/EBITDA is expected to average a relatively high 4.0x.
Pending Exelon Merger: ACE's ratings are unaffected by the pending merger of its parent Pepco Holdings, Inc. and Exelon Corp. However, by law merger approval requires the BPU to find the proposed transaction is in the public interest, which has been interpreted to mean there must be a positive benefit for rate payers, which will likely require some form of customer credits and/or other concessions that could temporarily reduce earnings and cash flow.
Transmission Rate Challenge: Regulators in New Jersey and neighboring states have challenged ACE's Federal Energy Regulatory (FERC) transmission rates. The regulators are seeking to reduce the FERC authorized return on equity (ROE) and require companies to provide additional data to justify capital and operating cost recovery. ACE's current FERC authorized base ROE is 11.3% for facilities placed into service after Jan. 1, 2006 and 10.8% for facilities placed into service prior to 2016, which also qualify for a 50 basis point incentive adder for being a member of a regional transmission organization. Fitch calculates the earnings at risk for ACE to be modest with a 1% change in the FERC authorized ROE equivalent to about $3 million after-tax.
Challenging Regulatory Environment: ACE recently entered into a settlement agreement that provides for a $19 million rate increase based on a 9.75% return on equity (ROE). In addition, the proposed increase includes consideration of a consolidated income tax adjustment, which lowered the rate base. The proposed increase, which is subject to approval by the New Jersey Board of Public Utilities (BPU), equates to about 30% of the $61.7 million tariff increase requested by the company.
Previously, in June 2013, the BPU approved a $25.5 million increase in electric distribution base rates following a settlement agreement also based on a 9.75% ROE. In this instance the tariff adjustment was about 36% of ACE's rate request. Separately ACE was allowed full recovery of approximately $70 million of storm restoration costs over three years with no carrying costs on the unamortized balance. In light of the disappointing rate order, ACE intends to reduce capital expenditures by $150 million through 2015.
Manageable Capital Budget: Projected capex of $1.2 billion over the five-year period 2014 - 2018 should be manageable with only moderate external financing required. Fitch estimates the expenditures will be about 2.2x depreciation and amortization, roughly in line with the industry average.
Consolidated Tax Adjustment: In Jan. 2, 2013, the BPU initiated a generic proceeding to examine whether a consolidated tax adjustment (CTA) should be continued. Under current BPU policy, when a New Jersey utility is included in a consolidated tax return a portion of any tax benefits associated with an affiliates tax losses are used to reduce rate base. Currently, there is no time table for a decision.
Positive Rating Action: Given Fitch's expectation for merger related concessions, positive rating action is not likely during the pending merger review.
Longer term, ratings could be upgraded if Adjusted Debt to EBITDAR fell below 3.75x and FFO coverage increased above 5.0x on a sustained basis.
Negative Rating Action: Ratings could be lowered if Adjusted Debt to EBITDAR increased above 4.25x and FFO coverage below 4.0x on a sustained basis.
Lack of support for utility investments or a change in commodity cost recovery mechanisms could also lead to lower ratings
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For more information:
One State Street Plaza
New York, New York
United States, 10004
Philip W. Smyth, CFA, Senior Director
Fitch Ratings, Primary Analyst
Glen Grabelsky, Managing Director
Fitch Ratings, Secondary Analyst
Tel: +1 212-908-0549
Robert Hornick, Senior Director, Secondary Analyst
Fitch Ratings, Inc.