TEXT-S&P puts Rochester Gas & Electric on watch negative
Overview -- We are placing our 'BBB+' corporate credit rating on ultimate parent Iberdrola S.A. on CreditWatch with negative implications, which reflects the potential for a downgrade if we lower the rating on Spain to speculative grade. -- On Oct. 10, 2012, we lowered our sovereign ratings on the Kingdom of Spain to 'BBB-/A-3'. The outlook remains negative. -- We consider that Spain-based utility Iberdrola has "high" exposure to domestic country risk as it derived about 47% of revenues from Spain in 2011. -- Furthermore, we see a risk that Iberdrola will struggle to achieve and maintain cash flow measures commensurate with the 'BBB+' rating in a more challenging economic and fiscal environment. -- We are placing our 'BBB+' corporate credit ratings on Rochester Gas & Electric on CreditWatch with negative implications. -- The ratings on Rochester Gas & Electric (RG&E), New York State Electric & Gas (NYSEG), and Central Maine Power (CMP) are all capped at the rating on the parent. Rating Action On Oct. 15, 2012, Standard & Poor's Rating Services placed its ratings on RG&E, including the 'BBB+' corporate credit rating, the 'A' senior secured issue rating, and the 'BBB+' senior unsecured issue ratings on CreditWatch with negative implications. Rationale The rating action follows the downgrade on the Kingdom of Spain to 'BBB-/A-3' from 'BBB+/A-2' with a negative outlook, which resulted in the ratings on ultimate parent Iberdrola S.A. being placed on CreditWatch with negative implications. We regard the U.S. utilities, which include NYSEG, Central Maine Power Co. (CMP), and Rochester Gas & Electric Corp. (RG&E), as effectively under Iberdrola S.A.'s direct control, and none individually is a significant source of cash flow for the holding company. Our ratings on NYSEG, RG&E, and CMP therefore do not reflect significant support from Iberdrola S.A., but they are effectively capped at the rating on the parent. We consider that Spain-based utility Iberdrola has "high" exposure to domestic country risk as it derived about 47% of revenues from Spain in 2011. Furthermore, we see a risk that Iberdrola will struggle to achieve and maintain cash flow measures commensurate with the 'BBB+' rating, mainly adjusted funds from operations (FFO) to debt of more than 20%, in a more challenging economic and fiscal environment. The group is due to announce its strategic plan on Oct. 24, 2012. We will assess whether this plan will be sufficient to counterbalance the potential downside in our forecasts as a result of ongoing weak power market fundamentals in Spain and the U.K.; increased political risk; delays in tariff deficit securitization; and/or a potential electricity market reform that could have adverse consequences for Iberdrola. The U.S. utilities do not currently have sufficient ring-fencing measures in place to separate the ratings from the parent. If the companies were to put ring-fencing measures in place to sufficiently insulate them from the parent company, they might be able to achieve ratings separation and avoid a ratings downgrade strictly because of a ratings downgrade at the parent company. Iberdrola USA is currently working with the New York Public Service Commission to add additional insulation measures at NYSEG and RG&E. In September 2012, the company filed with the NY PSC a supplement to the reorganization petition, which discusses enhancement to the ring-fencing provisions, including a minimum equity ratio to restrict dividends to the parent. Absent any additional insulation provisions, the utility ratings would continue to be capped at the parent ratings. Standard & Poor's bases its ratings on electric utilities NYSEG, RG&E, and CMP on each company's stand-alone credit profile because their ultimate parent company, Spanish utility holding company Iberdrola S.A. (BBB+/Watch Neg/A-2), has assumed the debt of NYSEG's parent company, Iberdrola USA (BBB+/Watch Neg/A-2). We regard the U.S. utilities as effectively under Iberdrola S.A.'s direct control, and none individually is a significant source of cash flow for the holding company. Our ratings on the utilities therefore do not reflect significant support from Iberdrola S.A., but they are effectively capped at the rating on the parent. Our ratings on RG&E reflect an "excellent" business risk profile under our criteria. The profile benefits from the utility's low-operating-risk transmission and distribution (T&D) business strategy. The company's financial risk profile is "aggressive" in our assessment, and while it has improved, a sizable capital spending program could cause pressure. RG&E is primarily an integrated electric and gas transmission and distribution utility and has approximately 367,000 electric and 303,000 natural gas customers in the Rochester, N.Y., area. RG&E operates under regulatory agreements that provide for full and timely recovery of purchased electricity and gas costs, stranded costs, and authorized returns that have been in line with industry averages. While Standard & Poor's views the regulatory environment in New York as less credit supportive than in some states, RG&E has been able to reach a constructive multiyear settlement in its rate case filing, reducing the need for regular rate filings and ensuring cash flow stability. RG&E is currently operating under a three-year settlement effective through Dec. 31, 2013. The multiyear settlement, which includes several credit-enhancing recovery mechanisms, is essentially favorable for RG&E's credit quality because it should help it maintain cash flow stability. RG&E's financial risk profile is aggressive. As of June 30, 2012, RG&E generated $208 million in adjusted funds from operations (FFO) and had total adjusted debt of $871 million. For the same period, adjusted total debt to total capital was about 55%, adjusted total debt to EBITDA was 4.1x, and adjusted FFO to total debt was 24%. The credit metrics reflect the off-balance-sheet debt imputation of about $89 million resulting from a shortfall in pension and other postretirement liability funding. While the financial profile should benefit from the approved and proposed rate increases, the large capital spending program and need for external financing will place some pressure on the credit protection measures, necessitating a balanced funding approach. Liquidity Liquidity is adequate under Standard & Poor's corporate liquidity methodology, which categorizes liquidity in five standard descriptors. Adequate liquidity supports our 'BBB+' issuer credit rating on RG&E. The company's projected sources of liquidity, mostly operating cash flow and available bank lines, exceed its projected uses, mainly necessary capital expenditures and debt maturities, by more than 1.2x. RG&E's ability to absorb high-impact, low-probability events with limited need for refinancing, its flexibility to lower capital spending or sell assets, its sound bank relationships, its solid standing in credit markets, and its generally prudent risk management further support our assessment of its liquidity as adequate. RG&E has no maturities in the next 12 months. Iberdrola USA manages RG&E's liquidity, and each of the U.S. operating utilities is a joint borrower in a $600 million utility-only credit facility maturing in 2016 with about $527 million currently available. We base our assessment of RG&E's liquidity on the following factors and assumptions: We expect the company's liquidity sources (including FFO and credit facility availability) over the next 12 months to exceed its uses by more than 1.2x. Debt maturities over the next year are manageable. Even if EBITDA decreases by 15%, we believe net sources will be well in excess of liquidity requirements. The company has good relationships with its banks, in our assessment, and has a good standing in the credit markets. In our analysis, based on information available as of June 30, 2012, we assumed liquidity of about $340 million over the next 12 months, consisting of projected FFO and availability under the credit facility. We estimate the company could use up to $235 million during the same period for capital spending and working capital. RG&E's credit agreement includes a financial covenant limiting the consolidated debt-to-capitalization ratio, with which the company was complying as of June 30, 2012. Recovery analysis We assign recovery ratings to first mortgage bonds (FMBs) issued by investment-grade U.S. utilities, which can result in issue ratings that are notched above a corporate credit rating on a utility depending on the category and the extent of the collateral coverage. We base the investment-grade FMB recovery methodology on the ample historical record of 100% recovery for secured bondholders in utility bankruptcies and on our view that the factors that supported those recoveries (limited size of the creditor class, and the durable value of utility rate-based assets during and after a reorganization, given the essential service provided and the high replacement cost) will persist. Under our recovery criteria, when assigning issue ratings to utility FMBs, we consider our calculation of the maximum amount of FMB issuance under the utility's indenture or other legally binding limitations relative to our estimate of the value of the collateral pledged to bondholders, management's stated intentions on future FMB issuance, as well as any regulatory limitations on bond issuance. FMB ratings can exceed a corporate credit rating on a utility by up to one notch in the 'A' category, two notches in the 'BBB' category, and three notches in speculative-grade categories. RG&E's FMBs benefit from a first-priority lien on substantially all of the utility's real property owned or subsequently acquired. Collateral coverage of more than 1.5x supports a recovery rating of '1+', reflecting our expectation for 100% recovery in the event of default, and an issue rating two notches above the corporate credit rating. CreditWatch Absent sufficient ring-fencing provisions the ratings of RG&E will remain capped at the rating on the parent and be lowered along with the parent rating. If the New York utilities are able to put sufficient ring-fencing measures in place to insulate them from the parent, we may separate the ratings at that time. We expect to resolve the CreditWatch listing on RG&E when we gain more information from Iberdrola in its new strategic plan or when we gain more information from the company regarding its ring-fencing plan. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept.18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- General Criteria: Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions, June 14, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 2008 Corporate Criteria: Ratios and Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link to Parent, Oct. 28, 2004 -- Credit FAQ: What's Behind Our Rating Action on Spanish Power Utilities, April 4, 2012 Ratings List Rating Placed On CreditWatch To From Rochester Gas & Electric Corporate Credit Rating BBB+/Watch Neg BBB+ Senior Secured A/Watch Neg A Senior Unsecured BBB+/Watch Neg BBB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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