Fitch Downgrades PPL Supply to 'BB' on Negative Watch & Affirms PPL Corp. on Spinoff Announcement

NEW YORK--()--Fitch Ratings has downgraded PPL Energy Supply's (Supply) long-term Issuer Default Rating (IDR) to 'BB' from 'BBB-' and the short-term IDR to 'B' from 'F3'. Fitch has also placed Supply's IDR on Rating Watch Negative. Prior to the announcement, Supply's Rating Outlook was Negative. Simultaneously, Fitch has affirmed the 'BBB' long-term IDRs of PPL Corp. (PPL) and PPL Capital Funding (PPL Funding). The Rating Outlooks for PPL and PPL Funding are Stable.

The ratings at PPL's domestic regulated utilities and their holding companies are not affected by this transaction. Fitch's current IDRs for these companies are as follows:

--Louisville Gas & Electric (LG&E) 'A-';

--Kentucky Utilities (KU) 'A-';

--PPL Electric Utilities 'BBB';

--LG&E and KU Energy LLC (holding company of LG&E and KU) 'BBB+'.

The rating actions taken today are prompted by PPL's announcement to spin off Supply and combine it with Riverstone Holding's (Riverstone) generation assets to form an Independent Power Producer (IPP), Talen Energy (Talen). The transaction is expected to close in Q1 or Q2 of 2015.

Upon closing, Supply will survive and become the second tier holding company under Talen and the direct parent of its existing subsidiaries and Riverstone's three operating units Raven, Jade and Sapphire. Supply will become the central financing entity at Talen. The existing debt at Riverstone will be refinanced at Supply and will be similar in terms and pari passu to Supply's existing senior unsecured debt obligations. This spinoff is expected to be tax free to PPL and its shareholders. PPL will have no ownership interest in Talen. PPL's shareholders will own 65% of Talen and Riverstone will own the remaining 35%.

KEY RATING DRIVERS:

PPL Energy Supply

The downgrade of Supply reflects the expected consolidated credit profile and business risks as a stand-alone IPP once the transaction is completed. Fitch has previously indicated that PPL's ownership and on-going support are crucial to maintaining Supply's investment grade rating. Without such support, Supply would have been a relatively weak 'BB+' credit.

Upon Fitch's preliminary assessment, this transaction will likely further weaken Supply's credit profile by adding highly levered Riverstone assets, partially offset by the estimated synergy savings, which will not likely be fully achieved until the 2016-2017 time frame.

Talen's proposed capitalization (Debt/EBITDA ratio of approximately 4.0x for 2015 including synergy) is indicative of a weak 'BB' profile for an IPP. Management's comments indicate a bias towards acquisitions to pursue growth, which could be primarily debt financed. In addition, the ratings reflect the additional financial risk of management's intention to operate a portfolio that has a much shorter duration and more open exposure.

The transaction does not materially change the fuel mix or geographic concentration of the fleet. Supply currently owns nearly 10GW of generation capacity, which is comprised of 41% coal. Post closing, the coal generating capacity is relatively unchanged at 40%. The Raven portfolio of three coal plants (2.65GW) were acquired from Exelon Corp. (EXC, IDR 'BBB+', Rating Watch Negative) for $400 million in 2012 in conjunction with Exelon's acquisition of Constellation Energy Group. Although there is no substantial environmental capex required in the foreseeable future (management estimates that approximately $118 million will be spend on major environmental mandates, 85% of which will be spent on Supply's fleet and remaining on the Raven fleet), Fitch consider the Raven assets to have relatively high risk of incurring sizeable future compliance costs as Maryland has a history of imposing stringent environmental mandates.

Combined generation fleet will continue to be concentrated in PJM. Approximately 86% of Talen's total capacity will be located in PJM and 55% of the capacity will be base load coal and nuclear assets in PJM. Though PJM's capacity market lends some stability in earnings and cash flow by providing visibility to capacity revenues three years in advance, the auction results have been unpredictable. Evolving rules regarding demand supply resources and on capacity imports from other regions, along with attempts by participating states such as Maryland and New Jersey to subsidize new generation could drive down auction results.

Fitch will resolve the Negative Watch upon closing after completing a detailed assessment of the financial and operating statistics of the combined fleet, the expected synergy benefits, the impact of possible divestitures needed to mitigate market power concerns, and the forecasted credit profile of the new entity.

PPL and PPL Funding

Although the spinoff of Supply is a credit positive event for PPL and PPL Funding, as PPL will become a fully regulated utility holding company, it is not sufficient to raise PPL's 'BBB' IDR at this time. The 'BBB' IDR already incorporates the expected decline in Supply's contribution to the consolidated PPL, which was expected to be 15% of total consolidated EBITDA in the next two years. PPL's current and forecasted credit metrics are weak for its 'BBB' IDR compared to its peers with similar operating risks. The weakness was a combination of expected debt financed equity infusion to fund the large utility capital spending program, the relatively higher leverage at PPL's UK operations and to a lesser degree, the expected decline in Supply's earnings.

Pro forma for the announced transaction, Fitch expects PPL's total adjusted Debt to EBITDAR to approximate 4.4x during 2015-2017, which remains modestly weak for a fully regulated BBB issuer. Fitch expect PPL's credit metrics to align with a solid 'BBB' rating level of 4.0x to 4.2x as the utility spending moderates in the 2018-2019 time frame.

RATING SENSITIVITIES:

PPL Supply

Positive and Negative:

Fitch does not anticipate any positive actions for Supply. Fitch will resolve the Rating Watch Negative after completing a detailed assessment of the financial and operating profile of the new entity. A total adjusted debt/EBITDAR of 3.5x - 4.0x and FFO adjusted leverage of 4.0 - 4.5x will be needed to stabilize Supply's IDR at the 'BB' level.

PPL

Positive:

--Unlikely given the large capital spending program.

Negative:

--PPL's ratings could be downgraded if total adjusted debt/ EBITDAR remains above 4.5x, beyond the heavy utility spending period, on a sustained basis.

--Any material adverse development in the regulatory framework in U.S. or in U.K. that PPL's regulated utilities operate in, such as changes in commodity cost and environmental cost recovery.

Fitch downgrades and places the following ratings on Rating Watch Negative:

PPL Energy Supply, LLC.

--Long-term IDR to 'BB' from 'BBB-';

--Senior unsecured debt to 'BB' from 'BBB-';

--Short-term IDR to 'B' from 'F3';

--Commercial paper to 'B' from 'F3'.

Fitch affirms the following ratings with a Stable Outlook:

PPL Corp

--Long-term IDR at 'BBB';

--Short-term IDR at 'F2'.

PPL Capital Funding Inc.

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB';

--Junior subordinated notes at 'BB+';

--Short-term IDR at 'F2'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 5, 2013);

--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 13, 2013);

--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2013);

--'Rating U.S. Utilities, Power and Gas Companies', (March 9, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Utilities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722085

Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=834195

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Contacts

Fitch Ratings
Primary Analyst
Julie Jiang
Director
+1-212-908-0708
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Robert Hornick
Senior Director
+1-212-908-0523
or
Committee Chairperson
Shalini Mahajan
Senior Director, CFA
+1-212-908-0581
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Julie Jiang
Director
+1-212-908-0708
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Robert Hornick
Senior Director
+1-212-908-0523
or
Committee Chairperson
Shalini Mahajan
Senior Director, CFA
+1-212-908-0581
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com