NEW YORK--()--Fitch Ratings has assigned a 'BBB+' rating to Southern California Edison's (SCE) $400 million issuance of SCE Trust II 16,000,000 5.10% Trust Preference Securities (preference securities). The Rating Outlook for SCE is Stable.
The preference securities are subordinated to SCE's senior debt, have no maturity date, and its dividends are cumulative.
The securities are eligible for 50% equity credit under Fitch's applicable criteria 'Treatment of Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' dated Dec. 13, 2012.
--A stable regulatory regime in the state of California;
--Strong projected operating cash flows, earnings and credit metrics;
--Manageable debt profile;
--SCE's tiered rate structure and competitive inroads from alternative energy supply are long-term concerns for investors;
--Execution and rate recovery of the utility's planned capex
Balanced Regulatory Regime
SCE's ratings recognize the relatively balanced regulatory compact in California.
The California Public Utilities Commission (CPUC) issued a final decision in the utility's 2012 general rate case (GRC) in the fourth quarter of 2012. The final CPUC decision approved revenue increases totaling $986 million during 2012 - 2014, representing approximately 60% of SCE's request.
The outcome in the 2012 GRC is consistent with past regulatory practices in the state, in Fitch's opinion, and supportive of SCE's current ratings.
Lower Authorized ROE
Fitch notes that the CPUC significantly reduced authorized return on equity (ROE) for California utilities in the first phase of its cost-of-capital (COC) proceeding, issued in late 2012. The CPUC final decision reduces SCE's authorized ROE to 10.45% from 11.50% beginning Jan. 1, 2013.
Fitch estimates that, all else equal, the change in ROE will reduce SCE's revenues approximately $170 million per annum.
The balanced tariff mechanisms in place in California provide SCE with a reasonable opportunity to earn its authorized return, in Fitch's opinion. This, and authorized ROEs that are still above the industry average, are key elements supporting SCE's current creditworthiness, in Fitch's opinion.
Large Capex Program
SCE's large capital investment program is focused on investment in distribution, transmission and renewable generation and is consistent with state and federal policy goals. Capex is expected to average more than $4 billion per annum during 2012 - 2014.
The balanced regulatory compact in California and the Federal Energy Regulatory Commission (FERC) reduces concern regarding the utility's large planned capex.
Nonetheless, poor execution of SCE's capex program or the inability to recover such costs in rates could lead to adverse rating actions.
The ratings also consider the ongoing outage at the San Onofre Nuclear Generating Station (SONGS). Units 2 and 3 have not operated since January 2012 when the nuclear power plant was taken out of service due to heat transfer tube leaks in the units' steam generators.
SCE has incurred $221 million of replacement power costs and $96 million of repair costs through Sept. 30, 2012. It remains unclear when and if both SONGS units will return to service at full capacity.
The CPUC has issued an order instituting investigation (OII) that will ultimately determine cost recovery regarding SONGS.
In Fitch's view the ongoing outage is a concern for investors that should prove manageable within SCE's current rating category. However, regulatory delay, mounting unrecovered costs and/or large unanticipated cost disallowances by the CPUC could lead to future, adverse rating actions.
Tariff Mechanisms Ameliorate Attrition
Revenue decoupling, regulatory balancing accounts, forward looking test years, single issue rate cases and pre-approval of planned capital expenditures greatly reduce SCE's exposure to regulatory lag and operating cash flow attrition, in Fitch's opinion.
Solid Credit Metrics
SCE is a wholly-owned subsidiary of Edison International (EIX; IDR 'BBB'; Outlook Stable). The utility's credit ratings are supported by strong and relatively predictable underlying earnings and cash flows, low debt leverage relative to earnings and cash flows.
Fitch expects SCE's credit metrics to remain consistent with its current 'A-' IDR, with EBITDA-to-interest and debt-to-EBITDA estimated to be better than 7x and 3x, respectively, in 2013 and 2014.
The ratings assume no adverse impact to SCE or its corporate parent from the Dec. 2012 filing of Edison Mission Energy (EME) and sixteen of its subsidiaries for protection under Chapter 11 of the U.S. Bankruptcy Code. EME is an intermediate holding company that holds a variety of competitive generation investments.
Liquidity and Maturities
SCE, as of Sept. 30, 2012, had available borrowing capacity of approximately $2.2 billion on its $2.75 billion of committed bank facility. SCE's 2012 - 2016 maturities are manageable, totaling $1.9 billion with $1.2 billion, $300 million and $400 million maturing in 2014, 2015 and 2016, respectively.
High SCE Funding Needs
As the result of SCE' large capex program, Fitch expects SCE to be free cash flow negative and that the external capital requirements at the utility will be funded with a balanced mix of equity and debt, consistent with its CPUC authorized capital structure.
The ratings also consider CPUC regulations that limit dividends and cash distributions from the utility to EIX. EIX relies on SCE dividends and benefits from its tax sharing agreement to meet its obligations.
What Could Trigger A Rating Upgrade
--An upgrade seems unlikely for SCE due to its large capex program and ongoing nuclear power plant outage.
What Could Trigger A Rating Downgrade
--Significant deterioration in the regulatory compact in California could result in downgrades at SCE, including disallowance of capex recovery and/or SONGS related costs.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 12, 2012);
--'Rating North American Utilities, Power, Gas and Water Companies' (May 16, 2012)
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies
Parent and Subsidiary Rating Linkage