CHICAGO--()--Fitch Ratings has downgraded the ratings for Appalachian Power Co. (APCo) as follows:
--Issuer Default Rating (IDR) to 'BBB-' from 'BBB';
--Senior unsecured debt to 'BBB' from 'BBB+';
--Preferred stock to 'BBB-' from 'BBB';
--Pollution control revenue bonds to 'BBB' from 'BBB+'.
The Rating Outlook has been revised to Stable from Negative. Approximately $3.6 billion of debt is affected.
The ratings downgrade reflects APCo's projected credit metrics that are more consistent with the 'BBB-' rating category following a trend of weakening coverage measures and high debt leverage, due to higher operating and maintenance expenses, under-recovery of fuel costs and elevated levels of capital expenditures. Additionally, APCo's financial position has been negatively impacted by the termination of the off-system sales rider (which was replaced with a 75% sharing mechanism), and less than full fuel recovery in Virginia. Fitch highlighted the utility's dependence on constructive outcomes in pending and planned rates cases to improve financial performance and enhance credit ratios. Fitch views the outcome for APCo's 2008 rate case in Virginia as reasonable with a $168 million base rate increase compared to a request of $208 million but a below average return on equity (ROE) of 10.2%. However, other factors have arisen, specifically the impact of the economic recession on the utility's service territory and deferrals of cost recoveries, which have reduced sales, earnings and cash flows. The utility posted EBITDA to interest coverage and funds from operations to interest coverage of 2.8 times (x) and 3.0x, respectively, for the 12-month period ended June 30, 2009. Leverage, as measured by the ratio of debt to EBITDA was 5.5x for the same time period.
Going forward, Fitch projects APCo's credit metrics will improve moderately, but remain within the guidelines for the new rating category. Both EBITDA to interest and FFO coverage are expected to remain above 3.0x over the next two years. Factors contributing to the expected improvement in financial performance include the company's 2008 rate case outcome in Virginia, which provided for a $168 million increase in base rates beginning October 2008, as well as Fitch's expectation that the company will receive a balanced result in its pending 2009 rate request of $154 million and notes that the current case will be administered under regulations promulgated after the 2007 Virginia Energy Law was passed. However, the economic downturn will continue to result in cost recovery deferrals in Virginia and West Virginia and slowdown the improvement in credit metrics, as evidenced by the West Virginia Public Service Commission's (WVPSC) decision to suspend APCo's $398 million filing under its expanded net energy charge (ENEC) which incorporates the company's incremental fuel, purchased power and environmental compliance project expenses to December 2009 from earlier this year. While the Commission did not contest the validity of the ENEC, given the current economic recession and the magnitude of the rate request, the WVPSC found it unreasonable to meet the request for implementation of rates. Fitch maintains that APCo will continue to be dependent on reasonable outcomes in its fuel cost recovery and base rate cases over the next two years and/or continuing parent company support to preserve current rating levels.
In August 2009, APCo filed a revised request with the Virginia State Commerce Commission (VSCC) for a $154 million base rate increase based on a 13.35% ROE, which includes a 0.85% ROE performance incentive increase for investment in new generation and environmental retrofits as permitted by law. The major component of the rate request is for the recovery of fixed costs related to cost of service. The new base rates will be effective, subject to refund, on Dec. 12, 2009. A final order from the Commission is expected in the second quarter of 2010. A separate $24 million rate filing was made for the recovery of transmission service expenses. Also in August, the VSCC issued an order providing the company with a $130 million fuel revenue increase. APCo had filed for a $227 million fuel revenue increase in May of this year.
Earlier this year, APCo's parent, American Electric Power Co. (AEP, IDR rated 'BBB', Stable Outlook by Fitch) reduced its 2009 capital budget to $2.6 billion from $3.3 billion and its 2010 capital budget to $1.8 billion from $3.4 billion. The reductions in capital spending for 2009 and 2010 are spread across AEP's utility operating companies in generation, transmission and distribution. Discretionary projects are being deferred until the economic climate warrants the additional investment. APCo's capital spending budget for 2009 and 2010 has been reduced to $0.7 billion from $1.4 billion from the prior 2008 forecast. Thee reductions were primarily made in environmental capex and distribution capital. Funding for APCo's capex program will be met through internally generated cash flows. Additionally, AEP has infused $250 million of equity into APCo, following the parent's $1.69 billion common stock offering in April 2009. APCo used the proceeds to reduce its money pool borrowings, and as a result the company has a solid liquidity position with approximately $425 million available as of June 30, 2009.
APCo, a wholly owned subsidiary of AEP, is a regulated electric utility engaged in the generation, transmission and distribution of electric power to approximately 942, 000 customers in West Virginia, Virginia and Tennessee.