TEXT - Fitch affirms American Electric Power & units ratings
Feb 22 - Fitch Ratings has affirmed the ratings of American Electric Power Company (AEP) and subsidiaries and revised the Outlook of AEP and Kentucky Power Company (KPCO) to Negative from Stable. Fitch has maintained Negative Outlook for Ohio Power Company (OPCO). All other subsidiary Outlooks remain Stable. A complete list of rating actions is provided at the end of this release. OPCO is AEP's largest subsidiary. The Negative Outlook for both entities reflects uncertainty around increased financial and business risks with the restructuring of OPCO's regulated 13,300MW of, mostly coal fired power output in Ohio under a regulatory business separation order (Corporate Separation). Approximately 2,427MW of the total 13,300MW generation capacity is expected to be transferred to regulated affiliates KPCO and Appalachian Power Company (APCO) with the remainder to be transferred to AEP's independent generation business. Separately, approximately 1,900MW of generation capacity will be retired. Following the corporate separation, regulatory orders provide cash flow certainty from these plants under the transitional arrangements until mid-2015. Beyond that date, these facilities must operate as merchant power plants within the PJM wholesale electricity market, increasing the consolidated business risk profile of AEP. Thus, AEP will lose a stable source of regulated earnings and cash flows. Fitch does not expect power prices to recover before 2015, adding uncertainty to earnings and cash flows. Fitch will monitor management's plans to mitigate financial and business risks with increased investment in the federal energy regulatory commission (FERC) regulated transmission assets and potential deleveraging at AEP and OPCO. For OPCO, the financial profile in 2015 is uncertain especially regarding its capital structure and securitization of deferred regulatory costs. OPCO's historical financial profile was strong providing some leeway during the transition period and Fitch would expect to resolve the Negative Outlook prior to 2015 once regulatory approvals and financing orders are finalized. KPCO relied on AEP's eastern power pool to meet its electricity supply. The pool will terminate at the end of 2013 requiring KPCO to seek replacement power. Fitch believes that KPCO's capital expenditures are likely to increase as the company may replace its power supply with new generation capacity. KPCO's financing plans and requisite regulatory approvals will be key in resolving the Outlook. The Stable Outlooks at other subsidiaries reflect the stable earnings and cash flows from their primary regulated utility businesses. KEY RATING DRIVERS Diversified Business Profile: AEP's earnings and cash flows are predominantly derived from eight regulated electric utilities in 11 separate regulatory jurisdictions. Liquidity is good and debt maturities are manageable. Approximately 83% of consolidated assets will remain within regulated subsidiaries. Increased Business Risk Profile: In Fitch's opinion, AEPs risk profile will increase with the pending transfer of about 8,900 MW of generating capacity from its Ohio based regulated integrated utility (Ohio Power Company, 'BBB+', Negative Outlook) to a higher-risk, competitive merchant generation status. As merchant plants, Fitch believes AEP will recognize lower profits after 2015 as power prices are unlikely to recovery over the intermediate term. Transfer of regulated generating assets from OPCO will also adversely affect the river operations which currently benefit from regulatory cost recovery mechanisms. Uncertainty Over Long-Term Leverage: The corporate separation alters AEP's consolidated capital structure with debt retirement expected at the regulated OPCO subsidiary and new debt issued at AEP or its new IPP. Positively, the company plans to use lower leverage to manage its merchant operations in Ohio. Longer term performance of these assets is expected to be affected by, compliance with stricter environmental regulations, low capacity utilization, and a low electricity commodity price environment adversely affecting operating cash flow. Additionally, AEP may have to provide for margin calls/cash postings against the adverse movement in its hedged electricity sales positions if AEP's generation business fails to obtain standalone credit facilities at reasonable costs on its own. Dividend Policy: The company has increased its dividend payout ratio to 60%-70% from 50%-60% and it will adversely affect cash flow during uncertainty and increased business risk profile. Large Capital Expenditure Program: Average capital expenditures are forecast to range between $3.6 billion and $3.8 billion annually through 2015, a level that is significantly higher than historical capital expenditure. Fitch expects capital expenditures to be funded with a combination of internal cash flow and debt. Negative free cash flow at the subsidiary levels will be financed with a mixture of cash flowfrom operations, debt, and equity to maintain the regulatory capital structures at its regulated subsidiaries. Major projects include installation of new equipment to comply with the environmental regulations; distribution system enhancements, and investment in new FERC regulated transmission networks. AEP's direct transmission capex budget is expected to total approximately $2.1 billion over the next three years. FERC regulated transmission project earn a current return on construction work in progress and ROEs are typically above regulated utility ROEs. Regulated earnings from future transmission investments provide some offset to the lost earnings from the generation asset transfer. Movement In Credit-Metrics: AEP's current credit metrics are consistent with Fitch's 'BBB' IDR guidelines for a utility parent company. However, going forward, Fitch expects funds from operation (FFO) based credit metrics for consolidated operations to decline; Fitch expects FFO to interest ratio to be approximately 3.5x and FFO to debt ratio to approximate about 15% at the end of 2015,levels modestly below Fitch 'BBB' guidelines. Fitch understands that these ratios reflect transitioning of its largest regulated subsidiary from an integrated utility to an electricity distribution company, but the Negative Outlook reflects that the credit metrics could decline on a sustainable basis once the transition is complete. Financial Metrics At AEP And Its Regulated Operating Subsidiaries: American Electric Power Company (AEP): Historical FFO based credit metrics were in line with its current IDR, but the business risk profile was low (with over 95% earnings from regulated businesses) and its coal fired generating capacity helped the company to be a low-cost electricity provider in the majority of its service territories. Fitch expects FFO based interest coverage (FFO/interest) to decline to around 3.5x from 4.0x and FFO to adjusted debt ratio to decline to just under 15% from approximately 17% in recent periods. Ohio Power Company (OPCO): Historical FFO to interest ratio has averaged higher than 5x and FFO to adjusted debt ratio was about 23%, but Fitch expects FFO to interest ratio to fall to below 4x and FFO to adjusted debt decline below 15%. The credit metrics have been adversely affected by customer switching under open access to lower cost electricity providers in Ohio. Fitch expects the customer switching will continue, albeit at a slower pace as over 50% customer were switched by the end of 2012. Kentucky Power Company (KPCO): KPCO benefitted from AEP's eastern power pool and above average volume growth. Its FFO based interest cover (FFO/interest expenses) has been around 3.7x and FFO to adjusted debt ratio has been over 17%. Lack of fuel diversity, additional capacity needs, and retirement of its only coal fired facility will result in unusually higher capital expenditure at least through 2015. Fitch expects FFO based interest coverage ratio to decline to below 3x and FFO to adjusted debt to fall to around 10%. The company will require rate relief to improve its credit metrics and will be the source of Fitch's resolution of the Negative Outlook that it has currently assigned to KPCO's IDR. Appalachian Power Company (APCO): APCO operates as an integrated utility in Virginia and West Virginia and benefits from a constructive regulatory environment and has also benefitted from AEP's eastern power pool that will be terminated at the end of this year. The company's historical FFO to interest ratio has been around 3.5x and FFO to adjusted debt ratio around 16%. Fitch expects the company's credit metrics to remain with the guidelines for its IDR - FFO/interest around 3.9x and FFO/adjusted debt around 16%. Capex will likely increase as the company replaces power sourced from AEP's eastern power pool. AEP Texas Central Company (AEPTC): AEPTC, an electric distribution company in Texas. Fitch expects FFO/interest expenses and FFO/debt to remain at 3.5x and 16% respectively over the rating horizon. AEP Texas North Company (AEPTN): Like AEPTC, AEPTN benefits from a low risk profile and stable cash flow. FFO/interest expenses and FFO/adjusted debt, have been strong for its current IDR - 5x and over 23% respectively. Fitch expects FFO to interest expense ratio to remain over 4.5x and FFO to adjusted debt to be between 18% and 19% - well within the current rating guidelines. Indiana Michigan Power Company (IMPCO): Cash flow over the rating horizon (2013-2015) will benefit from recently concluded general rate case order in Indiana providing an additional $85 million in cash flow. Historical FFO/interest expense has been over 4.2x and FFO/adjusted debt ratio has been around 17%. IMPCO expects higher than normal capital expenditure to comply with new environmental regulations and to upgrade its nuclear plant capacity. Fitch expects FFO based credit measures to decline through 2015 but credit profile should remain within its current rating with management deferring some of its environmental capital expenditure. Public Service Company of Oklahoma (PSCO): Historically, PSCO's credit metrics has been strong for its credit ratings. With increased capital expenditure over the forecast period ending 2015, the company's FFO to interest ratio should taper to around 4x from about 5x and FFO/adjusted debt ratio should be about 16% - remaining within the guidelines for PSCO's current IDR. Southwestern Electric Power Company (SWEPCO): SWEPCO's cash flow will benefit from approval of a new general rate case in Texas and inclusion of its new generating capacity in Louisiana's formula base rate. The historical credit metrics of SWPECO has been in line with its current IDR, with FFO to interest ratio exceeding 3.5x and FFO based leverage (FFO/adjusted debt) remaining around 16%. Fitch expects these ratio to remain around 3.5x and 16% respectively through 2015. Strong Liquidity: AEP currently has approximately $4.2 billion of total liquidity available under their respective credit agreements, including $279 million of cash and cash equivalents. $1.75 billion of the consolidated revolving credit facilities will mature in June 2016, $1.75 billion will mature in June 2017 and the remaining $1.0 billion credit line established to fund OPCO maturities will expire in 2015. The company is in compliance with the financial covenants of the bank facilities. Current liquidity should be sufficient to meet its short-term debt obligations - $981 million at the end of December 2012. Manageable Maturities: Debt maturities over next three years are manageable and include $1.792 billion in 2013, $995 million in 2014, and $1.405 billion in 2015. Maturing debt will be funded through a combination of internal cash flow and debt. Bonus Depreciation for 2013: AEP expects to generate approximately $792 million of cash in 2013 from bonus depreciation deductions at its subsidiaries. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided for a special allowance for bonus depreciation in 2011 and 2012. As part of the budget compromise, bonus depreciation rules allow a tax deduction of 50% in 2013, the same as 2012. Fitch affirms the following ratings with the Negative Outlook: American Electric Power Company --Long-term IDR at 'BBB'; --Senior unsecured at 'BBB'; --Junior subordinated 'withdrawn'; --Short-term IDR and commercial paper 'F2'. Ohio Power Company (OPCO) --Long-term IDR at 'BBB+'; --Senior unsecured and pollution control revenue bonds (PCRBs) at 'A-'; -- Short-term IDR at 'F2'; Kentucky Power Company (KPCO) --Long-term IDR 'BBB-'; --Senior unsecured at 'BBB'; --Short-term IDR 'withdrawn'. Fitch has affirmed the following ratings with a Stable Outlook: AEP Texas Central Company (AEPTC) --Long-term IDR at 'BBB+'; --Senior unsecured and PCRBs at 'A-'; --Short-term IDR 'F2' AEP Texas North Company (AEPTN) --Long-term IDR at 'BBB+'; --Senior unsecured at 'A-'; --Short-term IDR at 'F2'. Appalachian Power Company (APCO) --Long-term IDR at 'BBB-'; --Senior unsecured and PCRBs at 'BBB'; --Short-term IDR 'withdrawn'. Indiana Michigan Power Company (IMPC) --Long-term IDR at 'BBB-'; --Senior unsecured and PCRBs at 'BBB'; --Short-term IDR 'withdrawn'. Public Service Company of Oklahoma (PSCO) --Long-term IDR at 'BBB'; --Senior unsecured and PCRBs at 'BBB+'; -- Short-term IDR at 'F2'. Southwestern Electric Power Company (SWEPCO) --Long-term IDR at 'BBB-'; --Senior unsecured at 'BBB'; --Short-term IDR 'withdrawn'. RATING SENSITIVITY: Positive: An ugrade of AEP, OPCO or KPCO is considered unlikely given they each have Negative Rating Outlooks. --For AEPTN and APETC: Increase in FFO/adjusted debt ratio to over 21% on a sustainable basis and FFO/interest ratio of 4.5x or higher on a sustainable basis. --For all other rated operating subsidiaries: Increase in FFO/adjusted debt ratio to over 18% on a sustainable basis and FFO/interest ratio of 4x or higher on a sustainable basis. Negative: Future developments that may, individually or collectively, lead to negative rating action include: --For AEP : Decline in the FFO based credit metrics on a sustainable basis with FFO/interest expenses declining below 3.5x and FFO/adjusted debt ratio declining to or below 16%. --For OPCO, AEPTN and APETC: Decline in the FFO based credit metrics on a sustainable basis with FFO/interest expenses declining below 3.8x and FFO/adjusted debt ratio declining to or below 18%. --For all rated other operating subsidiaries: Decline in the FFO based credit metrics on a sustainable basis with FFO/interest expenses declining below 3.2x and FFO/adjusted debt ratio declining to or below 13%. Additionally, new environmental rules or changes to the regulatory framework of the individual regulated operating company could lead to a negative rating action.
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