Fitch Affirms Oncor's IDR at 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed Oncor Electric Delivery Company LLC's (Oncor) long-term Issuer Default Rating (IDR) at 'BBB' and short-term IDR at 'F3'. The Rating Outlook is Stable.

Fitch sees no material contagion risk to Oncor from the ongoing bankruptcy proceedings of its indirect parent holding company, Energy Future Intermediate Holding Company LLC (EFIH), and its ultimate parent, Energy Future Holdings Corp. (EFH). Neither Oncor nor Oncor Electric Delivery Holdings Company LLC (Oncor Holdings), which holds 80% ownership in Oncor, is part of the Chapter 11 filings. Fitch continues to believe that Oncor is effectively ring-fenced and sees little risk of substantive consolidation during the bankruptcy proceedings of its indirect parent and affiliated entities.

The ongoing auction process for the sale of EFH's indirect ownership in Oncor could likely result in change of control for the company. Fitch expects uncertainty to prevail until a successful bidder emerges, the bankruptcy court approves the bid, and the transaction closes after the required approval by the Public Utility Commission of Texas (PUCT) for which the statutory time limit is six months. Oncor's Stable Outlook reflects Fitch's expectation that the PUCT will take steps to preserve the credit worthiness of the utility, which could include a continuation of the ring-fencing structure.

Fitch's updated financial analysis indicates a modest weakening of forecasted credit metrics for Oncor as the utility has significantly increased its capital expenditure estimates. Fitch has also moderately lowered its sales growth forecast for Oncor amidst the backdrop of slowing oil and gas activity in Texas. It is now Fitch's expectation that the return on equity (ROE) at Oncor could trail its authorized ROE of 10.25% by 2016 necessitating rate relief.

KEY RATING DRIVERS

Minimal Financial Contagion Risk: Fitch does not expect any material financial impact on Oncor as a result of bankruptcy filings of EFH and EFIH. The largest financial exposure to Oncor was the pre-petition account receivables and other contractual obligations from Texas Competitive Electric Holdings Company LLC (TCEH), which totaled $129 million. Oncor has since collected $127 million of the pre-petition amount. Several other steps taken by management in the past have significantly reduced Oncor's exposure to its distressed parent and affiliates, which include elimination of notes receivable from TCEH and limiting Oncor's exposure to EFH's pension and other retiree benefits. The unfunded pension liability for EFH's portion of EFH retirement plan, in which Oncor participates, stood at $30 million as of Dec. 31, 2014.

Adequate Liquidity: Oncor has adequate availability under the corporate revolver, which mitigates concerns regarding capital access in the midst of bankruptcy proceedings for EFH/EFIH. As of March 31, 2015, Oncor's $2.4 billion corporate revolving facility, due October 2016, had borrowings of $800 million and letter of credits outstanding of $7 million. The drawn balances are large and reflect a high capex spend; Oncor typically draws on its corporate revolver to fund capital work in progress and subsequently replaces the drawn balances with permanent financing and/or internally generated funds. Oncor can request the lenders to increase the borrowing capacity of the revolver by $100 million and to extend the maturity in two one-year increments. Under the terms of the corporate revolver, the lenders' commitments are several and not joint.

Oncor's large capex program over the next five years will be partially funded by debt requiring periodic access to the capital markets. Oncor raised senior secured notes totaling $725 million in March 2015 to repay borrowings under the revolver. The attractive yield on the new notes (2.95% on the 10-year notes and 3.75% on the 30-year notes) is an indication that capital markets remain open to Oncor.

Strong Financial Performance: Oncor's financial performance has benefited from a strong Texas economy. With the slowdown in oil and gas related activity, it is possible that Oncor's service territory may not grow as robustly as it has over the last few years. However, Fitch does not expect the growth rate to falter materially given the diversity of the industrial base and the positive impact of falling oil and gas prices on energy intensive industries based in Texas. Oncor derives only 7% of its revenues from West Texas, which has seen the most impact from the slowdown in oil drilling activity. In addition, approximately 47% of Oncor's revenues in West Texas (or 60% of industrial revenues) is covered via tracker mechanisms.

The Distribution Cost Recovery Factor (DCRF) available to Texas utilities per Senate Bill 1693 allows them to recover newly-incurred distribution capital costs on an interim basis, for a timely recovery of new investment. The DCRF rule allows a utility to change its rates between general rate cases (GRC), limited to one rate adjustment a year and not more than four times between two GRC applications. Oncor thus has the ability to recover its investments in a timely manner if electricity demand decline materially. Another significant driver of Oncor's financial performance has been growth in transmission investments, which still remain a focus area for the PUCT. Various tracker mechanisms allow Oncor to earn a return on transmission related capital investment with minimal regulatory lag.

Modest Regulatory Lag: Oncor is planning to spend more than $5.5 billion over 2015 to 2018 in capex, of which approximately 60% will be distribution related. The high level of distribution capex and no distribution rate increases since 2012 will cause Oncor to trail its authorized ROE by 2016, in Fitch's view. However, any general rate case filings are likely only after the change of control proceeding is complete. Fitch's financial projections incorporate a rate increase in 2017 that allows Oncor to earn an ROE closer to its currently authorized level.

Strong Credit Metrics: Fitch expects Oncor's Earnings before Interest, Depreciation and Taxes (EBITDA) to interest ratio to be above 5.0x over 2015-2018 and debt to EBITDA to be in the 3.3x-3.8x range. Fitch expects Oncor's funds flow from operations (FFO) metrics to moderate as benefits of bonus depreciation subside. Fitch expects FFO adjusted leverage to be in the 3.9x-4.3x range. The forecasted leverage ratios are moderately weaker than Fitch's last assessment, but remain robust for its rating category.

Relative to its peers, Oncor's equity funding is limited and the utility has replenished equity capital through reductions in dividend distributions. Oncor has been curtailing upstream dividends since 2011 in order to maintain equity to capital ratio within the 40% cap given its large capital spending plans. As of March 31, 2015, Oncor's regulatory capital structure was 59.8% debt and 40.2% equity. Fitch expects Oncor to continue to operate under the regulatory debt cap of 60% that limits the dividend that can be paid to the parent.

KEY ASSUMPTIONS

--Volumetric sales growth of 1% p.a. in 2015-2016 and 1.5% thereafter;

--O&M costs inflated at 3% annually;

--Rate increase in 2017 that allows Oncor to earn ROE close to its current authorized levels;

--Capex of $5.5 billion over 2015-2018; and

--Continuation of the existing ring-fencing provisions.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Future positive rating actions are unlikely unless there is clarity on change of control of Oncor's indirect majority owner and the requirements of PUCT approval are known. Oncor's current and forecasted credit metrics are solidly in line with the current rating level and the notching of the senior secured debt has been constrained to reflect ownership by a distressed parent.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Any potential change in ownership of Oncor would need to be evaluated in context of any existing or new ring-fencing arrangements implemented to preserve the credit quality of the company;

--Fitch continues to believe that the ring-fencing measures for Oncor are strong, and the assets and liabilities of Oncor should not be consolidated in the bankruptcy proceedings of EFH. Any decision to the contrary could lead to ratings downgrade for Oncor;

--Any unexpected regulatory developments such as adverse outcomes in future rate cases; and

--Sustained weakness in Total adjusted debt to EBITDAR measures above 4.5x and FFO lease adjusted leverage above 5.5x.

Fitch affirms Oncor's ratings as follows:

--Long-term IDR at 'BBB';

--Senior secured debt at 'BBB+';

--Short-term IDR and commercial paper at 'F3'.

The Rating Outlook is Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including short-Term Ratings and Parent Subsidiary Linkage' May 28, 2014;

--'Recovery Ratings and Notching Criteria for Utilities' (March 5, 2015);

--'Rating U.S. Utilities, Power, and Gas Companies' (March 11, 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=863298

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=984133

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Contacts

Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1 212-908-0351
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philip Smyth, CFA
Senior Director
+1 212-908-0531
or
Committee Chairperson
Peter Molica
Senior Director
+1 212-908-0288
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1 212-908-0351
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philip Smyth, CFA
Senior Director
+1 212-908-0531
or
Committee Chairperson
Peter Molica
Senior Director
+1 212-908-0288
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com