Fitch Affirms Pepco Holdings and Subs' Ratings; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'BBB' long-term Issuer Default Ratings (IDRs) of Pepco Holdings LLC (PH LLC, previously Pepco Holdings, Inc.), Potomac Electric Power Co. (Pepco) and Atlantic City Electric Co, (ACE) and the 'BBB+' IDR of Delmarva Power and Light Co. (DPL). The Rating Outlook for each entity is Stable. The rating action follows consummation of the merger between PHI and Exelon Corp. (EXC).

A full list of rating actions appears at the end of this release.

KEY RATING DRIVERS

Acquisition by Exelon Corp.: The merger between PH LLC and EXC provides a stronger, better capitalized parent company with far greater financial flexibility that supports current ratings. Post-closing, PH LLC became a second tier holding company of EXC and will remain the direct parent of Pepco and ACE. The ratings assume EXC will provide equity to support the minimum equity ratios allowed by the various state regulatory commissions. In addition, at maturity, Fitch expects PH LLC's long-term debt to be refinanced at EXC. PH LLC's long-term debt totals a modest $456 million, including $190 million maturing in 2016.

Regulated earnings contribution: PH LLC's ratings are supported by the predictable cash flows generated by its three regulated transmission and distribution utility subsidiaries. The three utilities are expected to provide approximately 98% of consolidated earnings over the next several years. The remaining earnings are generated by PH LLC's non-regulated subsidiary, Pepco Energy Services (PES), which provides energy management and underground and transmission construction services.

Predictable cash flows: The three operating utilities, Pepco, DPL and ACE have virtually no commodity price risk and limited volumetric exposure due to decoupling mechanisms in both Maryland and the District of Columbia (DC) covering approximately two-thirds of retail sales. In addition, the revenue mix is largely residential and commercial with a relatively small industrial customer base which tends to minimize the effect of economic downturns.

Regulatory Concessions: To gain merger approval, EXC agreed to a number of rate concessions in each of PH LLC's four regulatory jurisdictions aggregating an estimated $350 million - $400 million, including customer rate credits and deferral of rate increases and funding for a variety of customer investment funds largely related to energy efficiency, renewable energy programs and low income customer programs. Moreover the PH LLC utility subsidiaries deferred rate filings during the nearly two year merger review process that increased PHI leveraged and weakened its credit quality.

Regulatory Risk: Following two years of rate case avoidance, regulatory risk is heightened for PH LLC's three utility subsidiaries. Fitch expects the utilities to file rate cases shortly but to take a measured approach to cost recovery to avoid rate shock. The outcomes will be important to maintain credit quality.

Ring Fencing: The various utility commission's imposed several ring fencing provisions to protect the PH LLC utilities, but none are considered to be onerous or to impair EXC's credit quality. The requirements include:

--Pepco, DPL and ACE maintaining a rolling 48% equity ratio (no other dividend restrictions);

--Creation of a bankruptcy remote special purpose entity (SPE) to hold 100% of PH LLC equity;

--Maintenance of separate books and records;

--Pepco, DPL and ACE will maintain separate debt;

--The Board of Directors of the SPE will have four directors, one of which will be independent;

--The seven member PHI board will include one director from each of PH LLC's utility subsidiaries.

Corporate Structure: PH LLC will be structured as a subsidiary of EXC and the parent of its existing three regulated transmission and distribution utilities.

RATING SENSITIVITIES

Positive Rating Action: Positive rating action is not likely, but could occur if debt/EBITDAR and FFO lease adjusted leverage fall below 3.75x and 4.75x, respectively, on a sustainable basis and FFO coverage exceeds 4.5x.

Negative Rating Action: FFO lease adjusted leverage in excess of 5.0x on a sustained basis could result in lower ratings.

LIQUIDITY

A $1.5 billion unsecured credit facility provides ample liquidity for PHI and its utility subsidiaries. The borrowing sub-limit is $750 million for PH LLC and $250 million for each of the utility subsidiaries. The credit facility expires Aug. 1, 2018. The only financial covenant is a 65% debt/capital ratio, which is in line with industry standards and not expected to impact the company's ability to borrow. The credit facility supports commercial paper (CP) programs for each borrower.

Potomac Electric Power Co.

KEY RATING DRIVERS

Revenue Stability: Pepco's regulated electric transmission and distribution operations have minimal commodity, volumetric and environmental exposure. Regulators in both Maryland and DC implemented revenue decoupling mechanisms eliminating the revenue impact of weather and changes in usage patterns and permit full recovery of power procurement costs with a modest profit margin. Revenue stability is further enhanced by the significant presence of state and federal government customers which tends to reduce economic volatility in the service territory.

Challenging Regulatory Environment: Regulation in both Maryland and DC has historically been challenging. Both jurisdictions have relied on historical test years with limited forward adjustments and return on equity authorizations have generally been relatively low compared to the industry average, particularly in Maryland. Following two years of rate case avoidance, regulatory risk is heightened with potential rate shock a primary concern. Fitch expects Pepco to file rate cases regularly beginning in 2016 but to take a measured approach to cost recovery to avoid rate shock. The outcomes will be important to maintain credit quality.

Credit Metrics: Credit quality measures are moderately weak for the current rating level following two-years of rate case avoidance, but should improve as the company implements its strategy of annual rate filings. Initially, the expected improvement will be hindered by rate concessions agreed to as part of the merger approval process. Fitch expects equity support from EXC to fund the rate concessions and to maintain a balanced capital structure.

Key Assumptions

--Annual rate filing beginning in 2016;

--Annual customer growth of approximately 1% annually;

--O&M increases of about 2% annually;

--Capex funded in a manner to preserve existing capital structure.

Rating Sensitivities

Positive Rating Action: Positive rating action is not expected in the near term, but could occur if debt to EBITDAR falls below 3.75x on a sustainable basis and lease adjusted leverage is maintained below 4.75x.

Negative Rating Action: FFO leverage above 5.0x and FFO fixed charge coverage below 4.5xsustainable basis could result in lower ratings. or FFO coverage below 4.5x on a sustained basis could result in lower ratings.

Delmarva Power and Light Co.

Key Rating Drivers

Low Risk Operations: Ratings benefit from the absence of commodity price risk and the associated cash flow volatility. DPL retains the provider of last resort obligation for customers that do not choose an alternative energy provider, but recovers its' electric and gas supply costs from customers through a fuel adjustment mechanisms.

Decoupling: In Maryland, which accounts for about 35% of retail sales, DPL operates with a Bill Stabilization Adjustment (BSA) that reduces volumetric exposure and stabilizes revenue. The BSA provides for a fixed distribution charge per customer rather than a charge based on usage. Any deviation from the approved charge is either recovered from or credited to customers effectively decoupling revenue from sales.

Credit Metrics: Credit quality measures are moderately weak for the current rating level following two-years of rate case avoidance, but should improve as the company implements its strategy of annual rate filings. Initially, the expected improvement will be hindered by rate concessions agreed to as part of the merger approval process. Fitch expects equity support from EXC to fund the rate concessions and to maintain a balanced capital structure.

Key Assumptions

--Annual rate filing beginning in 2016;

--Annual customer growth of approximately 0.5% annually;

--O&M increases of about 2% annually;

--Capex funded in a manner to preserve existing capital structure.

RATING SENSITIVITIES

Positive Rating Action: Positive rating action is not likely in the near term, but could occur if debt/EBITDAR falls below 3.6x on a sustainable basis.

Negative Rating Action: Lease adjusted FFO leverage above 4.5x and/or FFO fixed charge coverage below 4.7x on a sustained basis could result in lower ratings.

Atlantic City Electric Co.

KEY RATING DRIVERS

Low business risk: ACE's ratings and Stable Outlook are supported by low business risk and predictable cash flows generated by its regulated electric transmission and distribution operations. ACE bears no commodity risk. However, ACE does face timing mismatch in recovering the power costs associated with three power purchase contracts with non-utility generators (NUG).

Credit Metrics: Credit quality measures are generally consistent with the current ratings despite two-years of rate case avoidance. Fitch expects the company to implement its rate strategy of annual rate filings beginning in 2017. Fitch also expects equity support from EXC to fund the rate concessions and to maintain a balanced capital structure.

Key Assumptions

--Annual base rate filings beginning 2016;

--Declining sales growth of about 0.5% and customer growth of about 0.5%;

--O&M increases of 2% annually;

--Capex funded in a manner to preserve existing capital structure.

Positive Rating Action: Positive rating action is not likely in the near term, but could occur if, on a sustainable basis, debt/EBITDAR falls below 3.75x, lease adjusted FFO leverage is at or below 5.0x and FFO coverage exceeds 4.5x.

Negative Rating Action: Lease adjusted FFO leverage above 5x on a sustained basis could result in lower ratings.

Fitch affirms the following ratings with a Stable Outlook:

Pepco Holdings, Inc.

--Long-term IDR at 'BBB';

--Senior unsecured notes at 'BBB';

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

Potomac Electric Power Company

--Long-term IDR at 'BBB';

--Secured debt at 'A-';

--Short-term IDR/commercial paper at 'F2'.

Delmarva Power & Light

--Long-term IDR at 'BBB+';

--Secured debt and PCRBs at 'A';

--Senior unsecured notes at 'A-';

--Short-term IDR/commercial paper at 'F2'.

Atlantic City Electric Company

--Long-term IDR at 'BBB';

--Secured debt at 'A-';

--Senior unsecured notes at 'BBB+';

--Short-term IDR/commercial paper at 'F2'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Hornick
Senor Director
+1-212-908-0523
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Daniel Neama
Associate Director
+1-212-908-0561
or
Committee Chairperson
Philip Smyth
Senior Director
+1-212-908-0531
or
Media Relations
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Hornick
Senor Director
+1-212-908-0523
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Daniel Neama
Associate Director
+1-212-908-0561
or
Committee Chairperson
Philip Smyth
Senior Director
+1-212-908-0531
or
Media Relations
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com