TEXT - S&P affirms Rochester Gas & Electric ratings

Wed Nov 28, 2012 5:28pm EST

Related Topics

Overview
     -- We are affirming our ratings on Central Maine Power Co. (CMP), New 
York State Electric & Gas Corp. (NYSEG), and Rochester Gas & Electric Corp. 
(RG&E) based on the company's efforts to strengthen ring-fencing provisions. 
We are removing the ratings from CreditWatch with negative implications. The 
outlook is negative. 
     -- The affirmation follows today's downgrade of ultimate parent Iberdrola 
S.A. and Iberdrola USA to 'BBB' from 'BBB+'. The downgrade reflects that, 
despite Iberdrola's strategic focus on debt reduction, we believe that the 
group's improvement in credit ratios could be constrained by potential delays 
in tariff deficit securitization and the difficult macroeconomic and business 
environment in its key markets. The outlook is stable.
     -- CMP, NYSEG, and RG&E have all made filings with their respective 
public service commissions that seek enhancements to the current ring-fencing 
provisions, including the establishment of a minimum equity ratio tied to the 
ratemaking capital structure that would prevent dividends to the parent below 
that level.
     -- The negative outlook reflects a one in three chance that we could 
lower the ratings on RG&E if the company is unable to strengthen the current 
ring-fencing provisions.

Rating Action
On Nov. 28, Standard & Poor's Rating Services affirmed its ratings on RG&E, 
including the 'BBB+' corporate credit rating, the 'A' senior secured issue 
rating, and 'BBB+' senior unsecured issue ratings and removed the ratings from 
CreditWatch with negative implications where they had been placed on Oct. 15, 
2012. The outlook is negative.

Rationale
The rating action follows the downgrade on ultimate parent Iberdrola S.A. to 
'BBB' from 'BBB+' and the removal of the rating from CreditWatch with negative 
implications on Nov. 28. We regard the U.S. utilities, which include CMP, 
NYSEG, and 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 CMP, NYSEG, and RG&E therefore do not reflect 
significant support from Iberdrola S.A., but, without additional enhancement 
of the ring-fencing provisions, they are effectively capped at the rating on 
the parent.

The U.S. utilities do not currently have sufficient ring-fencing measures in 
place to separate the ratings from the parent. Iberdrola USA is currently 
working with both the New York Public Service Commission (NYPSC) and Maine 
Public Utilities Commission (MPUC) to add additional insulation measures at 
CMP, NYSEG, and RG&E. In September 2012, the company filed with the NYPSC a 
supplement to the pending internal reorganization petition, which seeks 
enhancement to the current ring-fencing provisions, including the 
establishment of a minimum equity ratio tied to the ratemaking capital 
structure that would prevent dividends to the parent below that level. In 
October, the company filed with the MPUC a petition to amend the minimum 
common equity ratio in its 2008 merger order in Maine. The company expects to 
have these measures in place in the first quarter of 2013. If the companies 
are able to put ring-fencing measures in place to sufficiently insulate them 
from the parent company, they would be able to achieve ratings separation and 
avoid a downgrade strictly because of the downgrade at the parent company. 
Absent any additional insulation provisions, the utility ratings would be 
lowered to that of the parent and continue to be capped at the parent ratings.

The downgrade of Iberdrola reflects our view that, despite its strong emphasis 
on improving credit quality, Iberdrola's strategic plan for 2012-2014 could 
fail to improve credit ratios to levels commensurate with the 'BBB+' rating, 
including Standard & Poor's-adjusted funds from operations (FFO) to debt of 
more than 20%. We believe that management is committed to reducing debt by EUR6 
billion by 2014 through a combination of lower capital investments, asset 
disposals, tariff deficit securitization repayments, and positive free cash 
flows in all businesses. Nevertheless, our projections of flat EBITDA over 
2012-2014 due to the tough fiscal and economic environment in Spain, as well 
as potential delays in the receipt of EUR3 billion of past tariff deficit 
receivables, lead us to expect that Iberdrola will sustain adjusted FFO to 
debt of about 18%.

We consider that Iberdrola has taken actions to reduce its exposure to Spanish 
country risk, which we now see as "moderate". The stable outlook reflects our 
expectation that Iberdrola will maintain ratios in line with the rating. 
Furthermore, if we downgrade Spain by one notch, the rating on Iberdrola would 
not be affected, given our view of its only "moderate" country risk exposure.

Standard & Poor's bases its ratings on electric utilities CMP, NYSEG, and RG&E 
on each company's stand-alone credit profile because their ultimate parent 
company, Spanish utility holding company Iberdrola S.A. (BBB/Stable/A-2), has 
assumed the debt of NYSEG's parent company, Iberdrola USA (BBB/Stable/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 without sufficient ring-fencing 
measures, 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 a 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 Sept. 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 Sept. 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 and 
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.

Outlook
The negative outlook reflects the one-in-three chance that we will lower the 
ratings on CMP if the company is unable to put sufficient ring-fencing 
measures in place to separate the ratings from parent Iberdrola S.A. If the 
company is unable to put sufficient ring-fencing measures in place at the U.S. 
utilities, we will lower the ratings to that of the parent company. Our 
baseline forecast shows adjusted FFO to total debt averaging about 20% and 
adjusted debt leverage below 50% over the near to intermediate term. We will 
revise the outlook to stable if the company is able to achieve its plan of 
strengthening the current ring-fencing measures in place. Based on the lower 
rating of the parent company and the negative outlook, we would not consider a 
higher rating at this time.

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
     -- 2008 Corporate Ratings Criteria: Ratios And Adjustments, April 15, 
2008 
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- Methodology: Differentiating The Issuer Credit Ratings Of A Regulated 
Utility Subsidiary And Its Parent, March 11, 2010 
     -- Credit FAQ: What's Behind Our Rating Actions On Spanish Power 
Utilities?, April 4, 2012

Ratings List
Ratings Affirmed; Outlook Negative
                                              To                 From
Rochester Gas & Electric Corp.
 Corporate Credit Rating                      BBB+/Negative/--   BBB+/Watch 
Neg/--

Rochester Gas & Electric Corp.
 Senior Secured                               A                  A/Watch Neg
  Recovery Rating                             1+                 1+
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