NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A-' rating to the Southern Company's new issuance of senior notes. The notes are being offered in multiple tranches maturing in two, three, five, seven, 10, 20 and 30 years. The notes will rank equally with all other senior unsecured debt and will be senior in right of payment to all subordinated debt. The Rating Outlook is Stable.
The net proceeds from the notes will be primarily used to fund the pending acquisition of AGL Resources Inc. (AGL, 'BBB+'/Stable) and for other corporate purposes, including retiring a portion of short-term debt. The issuance is, however, not conditional upon completion of the merger with AGL. If the merger is not consummated by February 23, 2017, Southern Company can redeem the notes, with the exception of 2026 fixed rate notes, at 101 plus accrued and unpaid interest.
Last week, Fitch downgraded the Long-Term Issuer Default Rating (IDR) of Southern Company to 'A-' from 'A'. The downgrade reflects the expected degradation in Southern Company's credit metrics following the closing of the predominantly debt-financed acquisition of AGL Resources Inc. (AGL, 'BBB+'/Stable). Fitch expects the acquisition to close in the second half of 2016. The transaction has been approved by AGL shareholders and the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act expired on December 4, 2015. State regulatory approvals have been received from Maryland, Georgia, California and Virginia. The companies have entered into merger settlements with key intervenors in both Illinois and New Jersey.
KEY RATING DRIVERS
Meaningful Increase in Leverage: The proposed $8 billion cash acquisition of AGL, which is largely funded by debt, results in a meaningful increase in consolidated leverage compared to Southern Company's current and projected stand-alone financial condition. The combination of acquisition debt and the assumption of existing AGL consolidated debt ($4.3 billion at March 31, 2016) will cause consolidated FFO adjusted leverage and FFO fixed charge coverage of the combined entity to meaningfully weaken in the short- to medium-term. Excluding benefits of any potential synergies, Fitch forecasts pro forma adjusted FFO leverage to jump to 5.1x in 2017 and gradually improve to 4.7x by 2019. Pro forma FFO fixed charge coverage is expected to be in the 4.5x - 5.0x range over 2016 - 2019. Fitch would like to see the FFO adjusted leverage improve and sustain below the 4.5x level before considering any upward migration of ratings.
Improved Business Profile: The acquisition of AGL meaningfully improves Southern Company's risk profile, in Fitch's view. Fitch generally views gas distribution businesses as low risk and AGL's utilities are generally well managed with numerous supportive regulatory mechanisms in place. AGL's rising investments in inter-state pipelines carry moderately higher competitive market risks, but these are offset to a large extent by long-term offtake agreements with creditworthy counterparties. While the non-regulated retail and wholesale businesses of AGL are volatile, the exposure is somewhat contained given these will be a small part of the combined company. Southern Company gains tremendous scale and geographic diversity with this acquisition and its inaugural pursuit of natural gas businesses can smooth out earnings and cash flow of its predominantly summer-peaking electric utilities. The combination also lowers the contribution of its non-regulated, albeit conservatively managed, Southern Power Company in the overall business mix as well as that of Mississippi Power Company, which is undergoing significant stress related to the construction cost overrun for the Kemper IGCC project.
Execution Risk of Two Large Construction Projects: Fitch's rating concerns for Southern Company include significant construction and regulatory risks associated with the two large baseload projects under construction, namely the 2,200 MW Vogtle nuclear units 3 and 4 at Georgia Power Company and the 580 megawatt (MW) Kemper IGCC plant at Mississippi Power. The risks related to Vogtle 3 and 4 nuclear units have abated somewhat with the October resolution of the pending litigation between Vogtle owners and the EPC contractors, changes in the EPC agreement, and the contractor changes. The modified EPC agreement confirmed the in-service dates as June 30, 2019 for Unit 3 and June 30, 2020 for Unit 4. Ongoing proceedings with the Georgia Public Service Commission (GPSC) Staff could result in a favorable outcome that provides more certainty regarding the recovery of costs currently not included in the existing $6.1 billion cost certification and would be credit positive.
The construction costs and expected commercial operations date (COD) for the Kemper IGCC plant continue to show modest escalation as the project enters its critical start-up phase. While the 3-0 PSC vote on the $126 million permanent rate increase order in December 2015 for the in-service portion of the Kemper plant is encouraging, significant regulatory uncertainties remain for the recovery of the remainder of the project costs in rates. We believe the plant may need to demonstrate a successful start-up and sustained operating performance before Mississippi Power can file for the next rate proceeding.
Significant Growth at Southern Power: Fitch views Southern Power's fast-growing renewable business as neutral to ratings at this time. The extension of bonus depreciation and federal subsidies for wind and solar projects and a strong interest from both utility and non-traditional offtakers is expected to result in a significant growth of renewable power generation in the U.S. Southern Power has made several project acquisitions in recent months and, combined with a placeholder capex, could potentially invest approximately $5 billion over 2016 - 2018. Long-term contracts with creditworthy counterparties, a balanced mix of debt and equity to finance the growth capex and management's current intent to limit the earnings contribution from Southern Power to approximately 10% of the combined entity mitigate any rating pressure at this time.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case are as follows:
--At Alabama Power Company, modest increases in Rate Stabilization & Equalization (RSE) rates over 2016 - 2018; no increases under CNP C (environmental) rates over 2016 - 2018; and 0.5% increase in electricity sales over 2016 - 2018
--At Georgia Power, 1% increase in electricity sales over 2016 - 2018; $140 million rate increase effective Jan. 1, 2016; Nuclear Construction Cost Recovery (NCCR) tariff increases of 0.5% - 1% over 2016 - 2018; and Vogtle 3 & 4 units in-service in 2019 and 2020
--At Gulf Power Company, sales growth of 0.5% in 2016 and 1% in 2017 and 2018 and rate increases per the last rate order
--At Mississippi Power, ROE of 9.87% for 2016 - 2018, 9.2% for Kemper rates from 2016 - 2020; 100% ownership of Kemper IGCC with 85% recovered through regulated rates; securitization of $1 billion million in 2H17; Kemper IGCC COD by September 2016 and additional Kemper rates before the end of 2017; modest Performance Evaluation Plan (PEP) and Environmental Compliance Overview (ECO) rate increase over 2016 - 2018; and 1% electricity sales growth over 2016 - 2018
At Southern Power, growth projects as announced, funding of growth capex at approximately 55% debt and 2016 - 2018 FFO ratios include ITCs for the solar projects during construction
At Southern Company, AGL acquisition closes in 2H 2016, no material retention of synergies from the AGL acquisition and future capital needs funded in a balanced manner
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Enhanced pace of deleveraging such that FFO adjusted leverage sustains at or below 4x;
--Commercial operations at Kemper without any further material escalation in capital costs followed by satisfactory operational performance;
--No material cost and/or schedule escalation for Vogtle units and any adjustments to the overall project costs deemed recoverable by the Georgia PSC.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Significant time/cost overrun at the Vogtle and/or Kemper projects that are primarily debt financed and negative regulatory actions on the recovery of those costs;
--Primarily debt-financed growth strategy at Southern Power;
--Failure to bring down the FFO adjusted leverage to below 4.7x by 2019.
LIQUIDITY
At March 31, 2016, Southern and its subsidiaries had approximately $0.8 billion in cash and cash equivalents and approximately $6.4 billion of unused committed credit arrangements with banks. This excludes the $8.1 billion bridge loan entered into in September 2015 as a backstop for AGL acquisition financing. A portion of unused credit with banks is allocated to provide liquidity support to the utility subsidiaries' variable rate pollution control bonds and CP programs. The amount of variable rate pollution control revenue bonds outstanding requiring liquidity support as of March 31, 2016 was approximately $1.8 billion. Approximately $782 million of CP borrowings were outstanding as of March 31, 2016.
Date of Relevant Rating Committee: May 12, 2016
Additional information is available at '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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