CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of American Transmission Co. LLC's (ATC), including its Long-term Issuer Default Rating (IDR) at 'A'. The Rating Outlook is Stable. A detailed list of rating actions follows at the end of this release.
The affirmation and Stable Outlook reflects Fitch's belief that ATC's credit protection measures will remain consistent with the current rating level despite a potential reduction in the Federal Energy Regulatory Commission (FERC)-authorized return on equity (ROE) on its transmission assets. Using the administrative law judge's (ALJ) recommendation of a base ROE of 9.7% in the most recent ROE challenge as the base-case scenario, Fitch expects adjusted debt/EBITDAR of 4.5x to 4.6x in 2018 - 2019. While the financial leverage is elevated for an 'A' rated utility, the ratings also consider the stable earnings and cash flow profile of ATC stemming from the forward-looking FERC-approved formula rate plan and low risk nature of the transmission business.
KEY RATING DRIVERS
Challenges to FERC-authorized ROE
In its September 2016 decision to the first challenge (case EL14-12) to the ROE of transmission owners in the Midcontinent Independent System Operator, Inc (MISO) region, FERC sided with the ALJ's assessment of anomalous capital market conditions and established a base ROE of 10.32% applicable to the period of the complaint, November 2013 to February 2015, as well as all future billings. In a separate proceeding, ATC has been allowed a 50bp adder for belonging to a regional transmission organization (RTO) effective Jan. 2015. The 140bp ROE reduction (10.3% base ROE plus 50bp adder compared with 12.2% previously) results in roughly $40 million revenue requirement attrition for ATC. FERC's revenue formula and true-up mechanisms provide little flexibility to offset the lowered revenue requirement thus resulting in an equal-sized EBITDA reduction.
A second challenge (case EL15-45), covering the period of February 2015 to May 2016, remains pending. While a decision is not expected until mid-year 2017, the ALJ's recommendation points to an incremental 50bp reduction in the authorized base ROE to 9.7%. Fitch uses a base ROE of 9.7%, plus a 50bp adder for participation in a RTO, as its base-case scenario. Although not contemplated at this time, any further reduction in the base ROE from the base-case scenario would likely result in a one-notch downgrade of ATC's ratings.
The regulatory proceedings are causing unusual volatility to ATC's credit protection measures since fourth-quarter 2014. While the ROE-related reserves have become material, Fitch is not adjusting ATC's reported EBITDA and FCF to remove the impact of the reserves. The agency focuses instead on projected credit protection measures in 2018 - 2019, after the ROE challenges have been resolved and refunds have been disbursed. Under its base case scenario, Fitch expects adjusted debt/EBITDAR to stabilize at 4.5x to 4.6x in 2018 - 2019.
Large Capex Program
The elevated capex plan poses a modest credit concern, in Fitch's view, as ATC's rate structure allows for contemporaneous returns on investments, which lessens the stress on its credit metrics from the elevated investments. Furthermore, ATC has received regular equity investments from its owners to maintain a debt/capital ratio below its 55% regulatory maximum. Fitch anticipates ATC will continue to rely on a balanced mix of debt and equity to fund its FCF shortfall though 2019.
ATC projects close to $1.5 billion in capex in 2016 - 2018, compared with $1.0 billion invested in 2012-2015. Two larger projects are under construction, Badger Coulee and Bay Lake, in addition to numerous smaller initiatives. The Bay Lake project, valued at $447 million, spans across Michigan and Wisconsin, with the Michigan portion completed in August 2016 and the Wisconsin segment on track for a late 2018 in-service date. The Badger-Coulee line began construction in early 2016 and is expected to be in service in 2018. The $580 million project is co-developed with Northern States Power Company - Wisconsin (IDR 'A-'/Stable Outlook), a subsidiary of Xcel Energy Inc. (IDR 'BBB+'/Stable Outlook). ATC is also pursuing the construction of the Cardinal-Hickory Creek line, a multi-value project developed jointly with ITC Midwest LLC (not rated) and Dairyland Power Coop (not rated). The $500 million project ($225 million for ATC's 45% share) has a tentative start of construction date on 2019.
Supportive Regulatory Environment
ATC operates under a FERC-approved tariff structure that ensures cash flow stability with automatic annual updates to forward-looking rates, subject to an annual true-up; inclusion of construction work in progress and expensing of pre-certification costs; and a fixed ROE using a 50/50 long-term debt/equity capital structure. ATC's business model entails no material volume, commodity or weather sensitivity.
Nonetheless, the numerous challenges to FERC-authorized ROEs are clouding earnings visibility. The approved ROEs still compare favourably with state commission-approved ROEs, but this is partly driven by FERC's assessment of anomalous market conditions. While currently favourable, the concept of anomalous conditions adds ambiguity to the rate-making process, in Fitch's opinion, as its definition and application is up to FERC's discretion.
Ownership and Corporate Structure
WEC Energy Group, Inc. (WEC 'BBB+') holds a 60% economic interest in ATC following its acquisition of Integrys Energy Group Inc. However, WEC does not exercise control because its voting interest is capped at 34% for most matters. Thus, the credit profiles and ratings of ATC and WEC remain independent.
The planned creation of ATC Holdco LLC to develop and own transmission projects located outside of the MISO region is credit neutral in Fitch's view, as this will not affect ATC's portfolio of operating assets, its projects under construction within MISO or its capital structure. Furthermore, ATC Holdco LLC will have no financial ties to ATC except for shared investors.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for ATC include:
--Authorized ROE of 10.2%, including 50bp adder, effective January 2015;
--Operating expenses growing by 3% annually;
--Capital expenditures totalling $1.8 billion in 2016 - 2019;
--Cash shortfall funded with a mix of debt and equity contributions to maintain a debt-to-capitalization ratio below 55%.
RATING SENSITIVITIES
Positive Rating Action: A positive rating action is unlikely at this time given the pressure on the credit protection measures stemming from the reductions in FERC-approved ROE. The ratings assume an authorized ROE of 10.2% (including adders), in-line with the ALJ's recommendation for case EL15-45.
Negative Rating Action: A reduction in the FERC-authorized ROE and/or other actions resulting in adjusted debt/EBITDAR leverage metrics materially exceeding 4.5x for a sustained period could lead to a downgrade. Fitch estimates that an authorized ROE materially less than 10.2%, inclusive of adders, would likely result in a rating downgrade.
LIQUIDITY
Fitch's views ATC's liquidity position to be sufficient, based upon $136 million availability under its $400 million revolving credit facility as of June 30th, 2016. The credit facility, maturing in June 2020, provides backstop support for the company's commercial paper program. Liquidity was bolstered in October 2016 with the issuance of $150 million senior notes, inclusive of $75 million with delayed-draw into early 2017.
ATC's debt maturity schedule is light over through 2020, with $200 million of senior notes due in 2018 and $150 million due in 2019.
Fitch affirms the following:
American Transmission Co. LLC
--Long-term IDR at 'A';
--Senior unsecured debt at 'A+';
--Short-term IDR at 'F1';
--Commercial Paper Program at 'F1'.
Disclosure: There were no financial statement adjustments made that were material to the rating rationale outlined above.
Date of Relevant Rating Committee: Nov. 4, 2016
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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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014368
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https://www.fitchratings.com/regulatory
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