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.