Fitch Ratings has assigned an 'A' rating to Potomac Electric Power Co.'s (PEPCO), $250 million, 4.15% first mortgage bonds due March 15, 2043. The Rating Outlook is Negative.
Proceeds of the offering will be used to repay commercial paper borrowings and for general corporate purposes.
Negative Outlook: The Negative Outlook reflects credit quality measures that are weak for the rating category, a restrictive regulatory environment, and the regulatory risk associated with a large capital investment program and high level of O&M spending. To maintain current ratings will require a constructive rate decision later this year in PEPCO'S pending rate case as described below.
KEY RATING DRIVERS
Financial Metrics: After a substantial decline in 2011, credit metrics were relatively flat in 2012 and remain weak for the current rating. Metrics should improve moderately in 2013 reflecting the residual effect of 2012 rate increases in Maryland, the District of Columbia (DC), and in Federal Energy Regulatory Commission (FERC) transmission rates and an expected 2013 mid-year rate increase in Maryland. Going forward Fitch anticipates FFO-to-debt to range between 16% to 19% and FFO-to-interest to be approximate 4.0x.
Low Business Risk: PEPCO'S regulated electric transmission and distribution operations have minimal commodity, volumetric and environmental exposure. Both Maryland and DC have permitted revenue decoupling, which eliminates fluctuations due to weather and changes in usage patterns. However, the positive impact of decoupling is mitigated by a 50 basis point reduction in the authorized return on equity (ROE), regulatory lag and authorized ROEs that are generally below the industry average.
Significant Capital Investment: PEPCO is in the midst of a significant capital expenditure plan of approximately $3 billion over 2013-2017. A large portion of the expenditures are to address reliability issues that have been a point of contention with Maryland regulators. The capital plan will require annual rate increases in both Maryland and DC to improve credit quality and maintain current ratings.
Regulatory Environment: The regulatory environment in Maryland continues to be challenging. In its most recent rate case decided in July 2012, the Maryland Public Service Commission (PSC) granted only 27% of the company's requested revenue increase based on a 9.31% ROE, which is nearly 100 basis points below the industry average. More importantly, the PSC rejected proposals put forth by PEPCO to reduce regulatory lag. Specifically, the PSC denied PEPCO's request for a reliability investment recovery mechanism (RIM), which is intended to recover reliability-related capital investments between rate cases, and the use of fully forecasted test years.
What would lead to consideration of a negative rating action:
--The outcome of the pending rate case in Maryland is critical to maintaining current ratings. Without a supportive rate decision that allows a majority of Pepco's rate request ratings are likely to fall one notch.
What would lead to consideration of a positive rating action:
--Not likely at the current rating level.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 12, 2011)
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 12, 2012).
Applicable Criteria and Related Research
Recovery Ratings and Notching Criteria for Utilities
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology
Robert Hornick, +1-212-908-0523
One State Street Plaza
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Glen Grabelsky, +1-212-908-0577
Philip Smyth, +1-212-908-0531
Brian Bertsch, New York, +1 212-908-0549
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