NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Ratings (IDR) of WGL Holding, Inc. (WGL) and Washington Gas Light (WG) at 'A' and 'A+', respectively, and has revised both companies' Rating Outlooks to Negative from Stable. Fitch has also affirmed WGL and WG's Short-Term Ratings at 'F1'. Approximately $1.7 billion of consolidated debt is affected by today's rating action. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
WGL
WGL Holdings, Inc.'s ratings reflect the predictable cash flows and strong credit metrics of Washington Gas Light Co., its wholly-owned regulated gas distribution utility subsidiary. WG remains the primary driver of consolidated earnings, accounting for more than 80% of consolidated EBITDAR for the latest-12-months (LTM) ending June 30, 2016. The Negative Rating Outlook primarily considers the increased business and execution risk, as well as higher leverage, associated with its growing midstream and relatively stable alternative energy business segments. Fitch expects WGL to fund its non-utility investments at the parent level, which will pressure leverage metrics.
WG's Negative Outlook reflects the operating utility's rating linkage with its corporate parent, WGL, and heightened parent company business risk. Fitch's assessment of WGL's group structure supports up to a one notch differential between the parent and its utility operating subsidiaries IDRs.
Leverage Pressured: Fitch expects WGL's large capex program to pressure leverage metrics over the next few years and projects WGL's funds from operations (FFO) adjusted leverage to increase and average 4.0x through 2020 due to increased investments in its midstream and alternative energy business segments. Fitch expects FFO coverage ratios at WGL to remain above 5.0x through the forecast period. WGL's FFO coverage ratio for the latest LTM period approximated 8.4x.
Increased Business Risk: Fitch expects WGL's business risk to increase through the forecast period due to expectations for strong growth in WGL's midstream and alternative energy business segments. If the proposed pipeline projects enter service as planned Fitch expects utility operations as a share of consolidated EBIT to decrease to significantly below the 84% level for 2015. A downgrade would be likely if unregulated operations account for greater than 25% of consolidated EBIT on a sustained basis.
WGL's midstream investments are focused on gas storage and pipeline investments that primarily move gas from the expanding Marcellus basin to consuming markets. WGL's commercial energy systems business segment invests in distributed generation assets including PV solar, combined heat and power plants, and natural gas fuel cells typically structured through purchase power agreement (PPAs) with an average term of 20 years.
Retail Energy Marketing Business: WGL has historically grown its unregulated investments primarily through Washington Gas Energy Services (WGES), its retail energy marketing subsidiary, which primarily services commercial customers. Going forward Fitch expects strong growth from WGL's other unregulated businesses and only modest growth at WGES. Consequently, Fitch expects WGES share of consolidated EBIT to fall to roughly 10% by 2020 from approximately 17% for 2015. Earnings at WGES can be volatile which highlights the increased risk of this business.
Significant Midstream Investments
WGL plans to spend approximately $600 million through 2017 - 2020 on new pipeline and storage investments to move gas from the expanding Marcellus basin to consuming markets in the Northeast and Mid-Atlantic region. WGL has entered into partnership agreements to invest in proposed pipeline projects including the Central Penn, Constitution, and Mountain Valley Pipelines. The projects are currently in the permitting phase and are not yet under construction with expected in service dates ranging from late 2017 to 2018, respectively.
WGL Midstream Becomes Supplier to Cove Point: WGL Midstream entered into a 20-year gas sale and purchase and capacity agreement with GAIL Global LNG LLC, a subsidiary of GAIL Limited (GAIL), to be their sole provider of natural gas to the Cove Point LNG facility for export to the growing Indian market. Under the agreement, WGL has agreed to sell up to 430,000 Dth/day of natural gas at Henry Hub linked prices commencing on the in-service date of the Cove Point LNG export facility in late 2017. The majority of natural gas would be purchased at Henry Hub linked prices through an existing arrangement with Antero Resources Corporation (Antero), helping to mitigate pricing risk. WGL is currently involved in ongoing arbitration proceedings with Antero regarding negotiations of a new contractual index price due to significantly lower natural gas prices in and around the delivery point specified in the agreement. Fitch expects the outcome of the arbitration proceedings will not have a material impact on the credit quality of WGL. Additionally, WGL Midstream acquired a 30% ownership interest in a 70-mile extension of the Stonewall gathering system for $89 million in February to support deliveries serving the Mid-Atlantic market.
WG
WG's Ratings reflects the strong credit quality and the predictable cash flows of its regulated gas distribution operations. Fitch notes that purchased gas cost recovery mechanisms in all of the company's service territories serve to limit cash flow volatility.
Solid Credit Metrics: Fitch expects WG's credits metrics to remain consistent with its rating level over the next few years, despite a large capex program that is expected to modestly pressure leverage. Fitch estimates debt/EBITDAR to approximate 3.0x through 2020, while FFO fixed-charge coverage is projected to remain above 5.0x through the forecast period.
IRMs Adopted in All Jurisdictions: The adoption of infrastructure recovery mechanisms (IRM) in Maryland, Virginia and Washington, D.C. is a constructive development and will allow for timely returns on capex and earnings growth between general rate case (GRC) proceedings.
Revenue Decoupling: In Maryland, a full revenue decoupling mechanism eliminates sales volume volatility due to weather and customer conservation. Similarly, in Virginia, a decoupling and weather normalization mechanism allows WG to recover costs related to customer conservation, energy efficiency and extreme weather. In the District of Columbia, WG's request for a full revenue decoupling mechanism is currently pending.
Modest Customer Growth: WG operates in an attractive service territory in the metropolitan Washington, D.C. area, one of the stronger residential markets in the country, and forecasts modest annual customer growth of 1% through 2016, increasing to 2% in 2017 through 2020.
D.C. 2016 GRC Filed: WG filed its 2016 general rate case (GRC) with the District of Columbia Public Service Commission in February 2016 and is currently requesting a rate increase of $17.3 million predicated on a 10.25% return on earnings (ROE). The requested revenue increase includes $4.5 million associated with its natural gas pipeline replacement program that was previously approved by the commission. Notably, WG has applied for a full revenue decoupling mechanism, which would be a credit positive if approved. If the full rate increase is authorized, a typical customer's monthly bill is expected to increase approximately 9.6%. Fitch expects a final decision by March 2017.
VA 2016 GRC Filed: WG filed its 2016 GRC with the Virginia State Corporation Commission in June 2016 and is requesting a rate increase of $45.6 million predicated on a 10.25% ROE. The requested revenue increase includes $22.3 million associated with its natural gas pipeline replacement program that was previously approved by the commission. If the full rate increase is authorized a typical customer's monthly bill is expected to increase modestly by approximately 4.6%. WG plans to implement interim rates in December 2016, subject to refund by the commission, and Fitch expects a final decision in July 2017.
Large Capex Program: WGL expects to spend approximately $2.6 billion on capital expenditures through 2017 - 2020, levels approximately 36% higher than the previous four years. The capex program is primarily focused on utility investments at WG (61% of total) and growing unregulated midstream pipeline and alternative energy investments, which will pressure credit metrics. Fitch expects WGL's capex levels to peak in 2017 and 2018 at $810 million and $710 million, respectively, due to increased midstream investments and then taper off and average $525 million through the balance of the forecast period. Fitch expects that both the midstream and utility business segments will be moderately free cash flow (FCF) negative though the forecast period and will need equity support from the parent to help maintain balanced capital structures. Fitch expects WGL to fund the deficit by a roughly 50% mix of debt and equity. Notably, accelerated pipe replacement investments at the utility average under 30% of total capex through 2020, subject to recovery under Infrastructure Recovery Mechanisms (IRMs) in MD, VA, and Washington DC, will provide for a timely return on investments.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for WGL and WG includes:
--Constructive outcomes in pending GRC's in D.C. and VA;
--Proposed Pipeline investments enter service during late 2017 to 2018;
--Utility rate base CAGR of 9% through 2020;
--Large capex program totalling $2.6 billion through 2017 - 2020;
--Manageable maturities including $250 million in 2018, $50 in 2019 and $150 million in 2020;
--Equity issuances as needed to maintain balanced capital structures at WGL and WG.
RATING SENSITIVITIES
WGL
Positive Rating Sensitivities
--Given the Negative Outlook no positive rating actions are anticipated in the near term; however, unexpected developments resulting in sustained FFO adjusted leverage metrics lower than 3.5x through the forecast period could result in a Stable Rating Outlook.
Negative Rating Sensitivities
--An increase in unregulated operations resulting in greater than 25% of sustained consolidated EBIT and sustained FFO leverage metrics above 4x and/or FFO fixed charge coverage below 5.x over the forecast period could cause a rating downgrade.
WG
Positive Rating Sensitivities
--Fitch would stabilize the Rating Outlook at WG concurrent with that of WGL. Given Fitch's preference to keep the IDRs of WGL and WG one notch apart, we do not see any future positive rating actions for WG.
Negative Rating Sensitivities
--A downgrade at WGL could trigger negative rating actions.
--A greater than expected increase in leverage to fund the large capex program coupled with adverse regulatory outcomes which limits WG's ability to earn an adequate return on invested capital. Sustained EBITDAR leverage above 3.25x and/or FFO fixed charge coverage below 5.0x could trigger a downgrade.
LIQUIDITY
WGL maintains sufficient liquidity with $511 million of consolidated liquidity available under its credit agreements as of June 30 including $17 million of unrestricted cash and cash equivalents. WGL and WG can upsize their $450 million and $350 million senior unsecured credit facilities, which mature in December 2019, to $550 million and $450 million, respectively, with consent of the lenders. The credit facilities backstop the companies' commercial paper programs and contain a maximum debt-to-capital covenant of 65%. Both WGL and WG were in compliance with all financial covenants under the credit facilities as of June 30, with debt-to-capitalization ratios of 52% and 45%, respectively. Management has a common equity ratio target of 50% at WGL and 53% at WG.
Long-term debt maturities are manageable over the next five years and are modest and as follows: none in 2016 and 2017; $250 million in 2018; $50 in 2019 and $150 million in 2020. Fitch expects maturing debt to be refinanced in a timely manner.
FULL LIST OF RATING ACTIONS
Fitch affirms the following with Negative Rating Outlooks:
WGL Holdings, Inc.
--Long-Term IDR at 'A';
--Senior unsecured debt at 'A';
--Short-Term IDR at 'F1';
--Commercial Paper at 'F1'.
Washington Gas Light
--Long-Term IDR at 'A+';
--Senior unsecured notes at 'AA-';
--Preferred stock at 'A';
--Short-Term IDR at 'F1';
--Commercial Paper at 'F1'.
Date of Relevant Rating Committee: October 13, 2016.
Disclosure: There were no financial statement adjustments made that were material to the rating rationale outlined above.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
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