NEW YORK--()--Fitch Ratings has assigned a 'BB+' rating to PPL Capital Funding's issue of $450 million 5.90% series B junior subordinated notes due 2073. PPL Capital Funding's ratings are based on an unconditional guarantee by its parent PPL Corporation (PPL). The Rating Outlook is Stable.
The long-term Issuer Default Rating (IDR) of PPL and PPL Capital Funding is 'BBB', and the Outlook for both is Stable.
The notes are junior and subordinated in right of payment and upon liquidation to all of PPL Capital Funding's senior indebtedness. The junior subordinated guarantee from PPL is unsecured, will rank junior, and will be subordinated in right of payment and upon liquidation to all of PPL's senior indebtedness. So long as there is no event of default under the subordinated indenture, PPL Capital Funding may defer interest payments on the notes on one or more occasions for up to 10 consecutive years per deferral period.
The notes are eligible for 50% equity credit under Fitch's applicable criteria 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' dated Dec. 13, 2012. Features supporting the equity categorization of these notes include their junior subordinate priority, the option to defer interest payments on a cumulative basis for up to 10 years on each occasion and a 60-year maturity.
Key Rating Drivers:
PPL's ratings and Outlook reflect its transformation from a company heavily reliant on commodity sensitive businesses to one that is highly regulated with substantially less business risk. Driven by the acquisitions of Central Networks in April 2011 and LG&E and KU Energy, LLC (LKE) in November 2010, regulated operations are expected by Fitch to provide approximately 75% of consolidated EBITDA by 2013. By comparison regulated operations accounted for approximately 30% of EBITDA prior to the two acquisitions. The proposed ratings also reflect credit metrics that are generally consistent with the rating and lower risk profile.
Rising capital expenditures in PPL's regulated segment pose a potential credit risk. PPL is investing heavily in its regulated businesses and expects to grow the regulated rate base by approximately 7.6% annually over the next five years. The investments will require on-going rate increases in both Kentucky and Pennsylvania and equity support from PPL. Expenditures in Kentucky are primarily to install environmental upgrades to comply with new Environmental Protection Agency (EPA) standards. In Pennsylvania the new investments are largely to replace aging infrastructure and for transmission upgrades. The risk associated with the magnitude of the capital expenditure program is mitigated by regulatory provisions that provide near real time cost recovery of invested capital for about two-thirds of projected expenditures, including FERC jurisdictional transmission in Pennsylvania, environmental compliance in Kentucky and all capital investments in the UK.
In PPL's merchant power generation segment, a weak power price environment is the primary challenge in the next two to three years. Additionally, several unplanned plant outages due to hardware failure adds more downward pressure and raise concern with regard to the chronic nature of these incidents. However, Fitch believes that the weak performance in this business segment is manageable for PPL as the segment becomes less critical to PPL's consolidated financial strength going forward.
Historically, PPL positions well within the rating category. Over the last three years, on average, it produced funds from operations (FFO)/debt of 19.8% and FFO interest coverage of 4.6x. Going forward, Fitch expects these metrics to decline while remaining in line with its rating, with average FFO/debt in mid-teens and FFO interest coverage of 4x. Fitch's projection has taken into consideration the mandatorily convertible debt issued in 2010 and 2011 of approximately $1.2 billion and $1 billion which currently receive 100% equity credit.
--PPL's ratings could be downgraded if capital resources are allocated disproportionally in the relatively weak unregulated business, resulting in increasing leverage and FFO to debt below 16% and Debt to EBITDA above 4x beyond the heavy utility spending period;
--Any material adverse development in the regulatory framework in the states or in U.K. that PPL's regulated utilities operate in, such as change in commodity cost recovery provisions in Pennsylvania.
--Unlikely given the large capital spending program.
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);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);
--'Recovery Ratings and Notching Criteria for Utilities' (May 3, 2012);
--'Rating North American Utilities, Power, Gas and Water Companies' (May 16, 2011).
Applicable Criteria and Related Research
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies