TEXT - Fitch says reversal on lease tax deduction manageable for Con Ed
Jan 11 - The United States Court of Appeals for the Federal Circuit sided with the Internal Revenue Service and reversed an October 2009 decision that had allowed tax deductions on cross-border leases. Fitch Ratings expects Wednesday's reversal will have no material effect on Consolidated Edison Inc.'s (ED) 'BBB+' long-term issuer default rating and Stable Rating Outlook. The tax deductions claimed by ED related to a 1997 transaction in which an ED subsidiary leased an electric generating facility in the Netherlands and then immediately subleased it back to the lessor. The IRS claimed that the lease did not possess economic substance and, upon audit of ED's 1997 tax return, disallowed the tax losses. The U.S appeals court decision reverses an October 2009 decision of the United States Court of Federal Claims supporting the company's position. ED disclosed in its 10Q that, as of Sept. 30, 2012, its total tax exposure amounts to $370 million. The court ruling may affect other utility companies that are battling similar claims by the IRS, including Pepco Holdings Inc. and Exelon Corp., both of which have greater exposure than ED. While the amount in question is sizable, we believe the company's current financial profile provides enough cushion to absorb the excess cash flow exposure. Importantly, ED has ample liquidity, with total access to $1 billion under a $2.25 billion credit facility, and its credit metrics are solid for the rating category. Funds from operations-to-interest expense was above 5.0x and funds from operations-to-debt above 20% for the last-12-months period ended Sept. 30, 2012. If ED were to make a debt-financed payment of $370 million, we calculate credit metrics would continue to support the current ratings with FFO/interest roughly 4.5x and funds from operations/debt about 20%. Any rating concern is further alleviated by ED's ownership of its two low-risk regulated utilities, Consolidated Edison Co. of New York, Inc., and Orange & Rockland Utilities, Inc., which have historically provided earnings stability and predictability and proved to be reliable sources of cash flow.