NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR) of WEC Energy Group, Inc. (WEC) at 'BBB+' and the Long-term IDRs of WEC's utility subsidiaries as follows: Wisconsin Electric Power Co. (WEPCO) at 'A'; Wisconsin Gas LLC (WI Gas) at 'A-' and Elm Road Generating Station Supercritical LLC (ERGSS) at 'A'.
Fitch has also affirmed the Long-term IDRs of WEC's wholly-owned intermediate holding company Integrys Holding, Inc. (Integrys) and Integrys' utility subsidiaries as follows: Integrys at 'BBB+'; Wisconsin Public Service Corp. (Wisconsin Public Service) at 'A'; Peoples Gas Light & Coke Co. (Peoples Gas) at 'A-'; and North Shore Gas Co. (North Shore Gas) at 'A'.
The Rating Outlook for all entities is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
WEC
Regulatory Diversification: WEC's credit profile benefits from regulatory scale and earnings and cash flow diversity provided by the ownership of seven regulated electric and natural gas utility businesses, including Integrys' five wholly-owned subsidiaries. The utilities operate in the relatively supportive regulatory jurisdictions of Wisconsin, Illinois, Michigan, Minnesota and the Federal Energy Regulatory Commission (FERC) via WEC's 60% ownership in American Transmission Co. (ATC; 'A'/Stable Outlook). Wisconsin is estimated to represent approximately 75% of WEC's rate base, with FERC and Illinois contributing about 11% and 12% of projected rate base, respectively. The smaller Michigan and Minnesota Integrys utilities are projected to represent a modest 2% of consolidated rate base.
The ownership of gas local distribution companies (LDCs) in Illinois, and on a smaller scale, LDCs in Michigan and Minnesota, provide cash flow stability and earnings growth through committed investments in upgrades of gas infrastructure over the next several years. Management estimates the proportion of gas utility in the earnings mix to grow to 26% from 17% pre-Integrys acquisition.
Furthermore, management expects investments in transmission rate base to continue to grow over the next few years, despite the anticipated reduction in the allowed ROE for Midcontinent Independent System Operator (MISO) transmission owners as a result of a complaint case pending before the FERC.
Balanced Regulatory Compact: Fitch views the Wisconsin regulatory compact as generally supportive of utility credit quality, as evidenced by the favorable rate decisions state utilities received in prior rate cases, including credit-supportive authorized ROEs. Constructive regulatory mechanisms include forward-looking test years, pre-approval of large projects, a partial cash return on construction work in progress (CWIP) for infrastructure investments, and annual fuel adjustments. The merger provisions, which include an earnings cap at WEPCO and WI Gas, are expected to remain manageable within the current financial profile.
In Illinois, the gas utilities benefit from constructive tariff mechanisms, including a purchased gas adjustment, decoupling, and riders for bad debt expense and manufactured gas plant remediation costs. Importantly, Peoples Gas can timely recover, via a rider, costs associated with its gas system modernization program in Chicago. The rider is in effect from 2014 through 2023 with annual review by the Illinois Commerce Commission (ICC).
High Parent Leverage: Combined parent-level debt represents approximately 30% of WEC consolidated debt. About 20% of parent debt is related to WEC. Management has indicated they intend to reduce parent debt over time but has not established specific targets. Fitch would view efforts of active deleveraging over the forecast period as supportive of credit quality.
Manageable Capex: Management plans to spend approximately $9.2 billion over the next five years on capex, including roughly 54% allocated toward the gas segment and 27% towards the electric segment, with the remainder consisting of generation. Capital investments associated with WEC's partial ownership of ATC are projected to total $933 million over 2016 - 2018, further supporting rate base growth. Utility capital investments will primarily be earmarked towards environmental upgrades, incremental generation, and enhancement of distribution networks and gas pipeline replacements.
Significant projects include the upgrade of Wisconsin Public Service's aging infrastructure, a $220 million investment from 2014 - 2018 with a proposed $200 million extension for 2018 -2021, and Peoples Gas' gas system modernization program, a $250 million to $280 million average annual investment.
To address reliability needs in the Upper Peninsula of Michigan, WEC is proposing to build approximately 170 MW of natural gas-fired generation. The estimated $255 million investment will be made by Upper Michigan Energy Resources Corp. (UMERC), a newly formed utility that would include WEPCO and Wisconsin Public Service's electric and gas distribution assets in the Peninsula. WEC has reached an uncontested settlement agreement with the Michigan Public Service Commission staff, the Michigan Attorney General (AG) and other interveners, approving the formation of UMERC. WEC expects the utility to commence operation on Jan. 1, 2017. The incremental generation is targeted to come online in 2019, which would subsequently allow for the retirement of the Presque Isle Power Plant.
Fitch expects capex to be financed in a conservative manner, with a balanced mix of internally generated cash flows and debt.
Adequate Credit Metrics: Fitch projects consolidated FFO-adjusted leverage and adjusted debt/EBITDAR to average 4x and 3.8x, respectively, over 2016 - 2020. As of TTM Q216, FFO and EBITDAR leverage ratios were 3.7x and 4x, respectively.
WEPCO
Low-Risk Business Model: WEPCO's ratings reflect the low-risk business profile of its regulated utility businesses that operate in what Fitch considers to be constructive regulatory frameworks across the regulatory jurisdictions of Wisconsin and Michigan. Wisconsin is the largest contributor to WEPCO's electric revenues at 83% in 2015, while Michigan accounts for approximately 5%.
Balanced Regulatory Compact: Fitch views the Wisconsin regulatory framework to be generally supportive of credit quality. Constructive regulatory mechanisms include forward-looking test years; a partial CWIP for infrastructure investments; annual fuel rate adjustments; bad debt escrow accounting; and credit-supportive ROEs. WEPCO's authorized ROE of 10.2% is above the 9.58% national average ROE recorded for electric utilities in 2015.
Sustained Elevated Capex: Management plans to spend approximately $1.70 billion on utility capex over 2016 - 2018 compared with approximately $1.56 billion over the previous three years. Capex is earmarked primarily toward the upgrade of WEPCO's electric and gas base infrastructure. Projects are smaller in scope relative to the large renewable generation and environmental capital spending of prior years. Fitch has assumed capex will be funded in a manner consistent with the authorized regulatory capital structure, reflecting a 51% common equity ratio.
Stable Credit Metrics: WEPCO's credit metrics are sound for the current rating category. Adjusted debt/EBITDAR is projected to be in the mid to high 3x, while FFO-adjusted leverage is expected to be in the high 3x to low 4x. Fitch's projections assume rate relief after 2017. As of TTM Q216, FFO and EBITDAR leverage ratios were 3.8x and 3.5x, respectively.
Regulatory Concessions and Savings: Fitch believes merger concessions are manageable within WEPCO's financial profile. Concessions include a three-year earnings cap and sharing mechanism, effective in 2016, under which 50% of the first 50bps of earnings above the 10.2% authorized ROE would be shared with ratepayers and used to reduce the utility's transmission escrow. All additional earnings above the first 50bps will be used to pay down the transmission escrow. Merger savings, including reductions in staffing levels and consolidation of IT infrastructure across the corporate family, allowed WEPCO to avoid the filing of a Wisconsin base rate case in 2016.
WI Gas
Constructive Multi-Year Rate Plan: WI Gas operates in the second year of its two-year rate plan, which provided base rate increases of $17.1 million in 2015 and $21.4 million in 2016. The rate relief allows for timely recovery of spending on the Western Gas Lateral project, which was completed in 2015. Under WI Gas' earnings sharing mechanism effective in 2016, 50% of the first 50bps of earnings above the 10.3% authorized ROE would be shared with ratepayers and used to reduce the costs of the Western Gas Lateral recovered from customers. All additional earnings above the first 50bps will be used towards reducing the costs recovered from customers.
Capex Trending Down: Fitch forecasts capex to amount to approximately $460 million over 2016 - 2018 compared with $526 million over the prior three years. The lower projected capex primarily reflects the completion of the Western Gas Lateral project in 2015 for approximately $130 million. Future capex is primarily earmarked toward upgrade of gas infrastructure. Fitch has assumed capex will be funded in a manner consistent with the authorized regulatory capital structure, reflecting a 48.91% common equity ratio.
Adequate Credit Metrics: Fitch projects WI Gas' adjusted debt/EBITDAR to average roughly 3.6x over 2016 - 2020, while FFO-adjusted leverage is expected to hover in the low 4x. As of TTM Q216, FFO and EBITDAR leverage ratios were 2.9x and 3.3x, respectively.
ERGSS
The ratings of ERGSS reflect the credit quality of WEPCO. ERGSS services its debt obligations with the rental payments it receives from WEPCO related to the lease of the Power the Future (PTF) generating plants.
Integrys
WEC Ownership: Ownership by WEC provides Integrys with enhanced financial flexibility to manage its capital structure, and expands earnings and cash flow capabilities through increased FERC exposure and potential long-term operational efficiencies provided by a larger group with complementary businesses.
Conservative Business Model: Integrys' ratings reflect the stable and predictable operating cash flows derived from its ownership of five low-risk regulated electric and gas utilities that operate in balanced regulatory jurisdictions of Wisconsin, Illinois, Michigan, and Minnesota. Wisconsin is the primary driver of earnings with Wisconsin Public Service representing approximately 44% of Integrys consolidated EBITDA as of the TTM Q2 2016. Integrys' financial profile further benefits from operating two LDCs in Illinois, which are estimated to represent nearly 43% of Integrys EBITDA on a TTM basis, primarily contributed by Peoples Gas. The Michigan and Minnesota utilities' earnings contributions are not estimated to be significant. The sale of the unregulated compressed natural gas business in the first quarter of 2016 further supports Integrys' low business risk.
Elevated Capex: Integrys plans on spending nearly $1 billion annually on capital investments, which is higher than historical norms. Capex is primarily driven by investments in environmental control, electric base infrastructure and gas main replacement. Fitch expects utilities to fund capex in a manner that is consistent with their authorized regulatory capital structures, using a balanced mix of internal cash flows, debt, and parent cash infusions as needed.
Solid Credit Metrics: Fitch estimates FFO-adjusted leverage and adjusted debt/EBITDAR to average 3.3x and 3.5x, respectively, over 2016 - 2020. As of TTM Q216, FFO and EBITDAR leverage ratios were 3.3x and 3.8x, respectively.
Wisconsin Public Service
Low-Risk Business Model: Wisconsin Public Service's ratings reflect the low-risk business profile of its utility businesses that operate in what Fitch considers to be constructive regulatory frameworks in Wisconsin and Michigan. Wisconsin is the largest contributor to electric revenues, at approximately 82% in 2015. Wisconsin rate design features timely recovery of fuel and commodity costs, and a gas cost recovery mechanism that stabilizes earnings and cash flows.
Balanced Rate Order: Fitch considers Wisconsin Public Service's last rate order in Wisconsin to be relatively balanced, despite the utility receiving rate reductions in its electric and gas businesses. The utility was required to reduce electric and gas retail rates by $7.9 million and $6.2 million, respectively, effective Jan. 1, 2016. The rate reductions primarily resulted from updates to fuel and purchased power expenses, which are almost entirely passed through to ratepayers.
On a credit positive note, the utility received a 10% authorized ROE and was permitted to increase the fixed monthly charge for its residential customers to $21 from $19. As a result of the WEC acquisition, The Public Service Commission of Wisconsin (PSCW) also revised the dividend restrictions established in the utility's prior rate case. Wisconsin Public Service cannot upstream dividends in the event that its common equity ratio falls below the authorized level of 51% on a financial basis. Fitch considers the dividend restrictions to be supportive of credit quality.
High Capex: Management estimates capital spending to total approximately $932.5 million over 2016 - 2018. By contrast, the utility spent roughly $929 million over 2013 - 2015, and a materially lesser amount of $358 million over 2010 - 2012. Capex is earmarked toward the installation of pollution-control equipment at the Weston Unit 3 generating facility. The environmental upgrade at the Weston plant is projected by management to cost approximately $345 million and to be completed in 2016. Wisconsin Public Service is allowed to defer costs that are above the originally authorized $275 million level through 2017, and the utility will be required to obtain a separate approval for collection of these deferred costs.
Capex is also driven by the upgrade of the utility's transmission and distribution infrastructure through its System Modernization and Reliability Project, which includes converting more than 1,000 miles of overhead distribution power lines to underground in Northern Wisconsin and adding distribution automation equipment on 400 miles of lines. Capital investments on the project amount to approximately $135 million over 2016 - 2018. Fitch expects Wisconsin Public Service to fund capex using a balanced mix of internal cash flows, debt, and equity contributions from Integrys.
Adequate Credit Metrics: Fitch projects Debt/EBITDAR and FFO-adjusted leverage to average 3.4x and 3.6x, respectively, over 2016 - 2020. As of TTM Q216, FFO and EBITDAR leverage ratios were 3.7x and 4.1x, respectively.
Peoples Gas
Balanced Regulation: Peoples Gas benefits from credit-supportive regulatory mechanisms, including a purchased gas adjustment clause that allows for full and timely recovery of gas commodity costs, riders for gas pipeline replacement and bad debt expenses and a decoupling mechanism that breaks the link between sales and margins. Peoples Gas' last rate order was constructive, with the utility receiving approximately 70% of its revised rate request.
Base Rate Freeze: Fitch does not expect the two-year base rate freeze to bear a material impact on the utility's financial profile. The earnings and cash flow benefit from the last rate order and efficient cost control should support a sound credit profile in 2016.
High Capex: Management projects to spend approximately $1.09 billion over 2016 - 2018, compared with $923 million over the prior three years. The primary driver of capex is the 20-year gas system modernization program to modernize natural gas infrastructure in Chicago. Peoples Gas expects to invest between $250 million to $280 million annually over the next three years. Favorably, the utility benefits from the Qualified Infrastructure Plant (QIP) rider, which provides near-immediate cash return on capital investments in gas pipeline replacement.
Investigation Settlement: The $18.5 million settlement agreement reached by Peoples Gas with the ICC and state AG related to investigations of the utility's past management of the infrastructure replacement program is manageable within the existing credit profile. Importantly, it alleviates concerns of event risk and sizeable fines that could have resulted from the investigations. The proceedings followed allegations from consumer groups and the AG of mismanagement and improprieties by the utility's past management in its handling of the program, which led to material cost overruns.
Sound Credit Metrics: Fitch expects FFO and EBITDAR leverage metrics to be range bound at 3.5x to 4x over 2016 - 2020. As of TTM Q216, FFO and EBITDAR leverage ratios were 4.1x and 3.1x, respectively.
North Shore Gas
Balanced Regulation: North Shore Gas benefits from credit-supportive regulatory mechanisms, including a purchased gas adjustment clause that allows for full and timely recovery of gas commodity costs, riders for environmental remediation and bad debt expenses and a decoupling mechanism that breaks the link between sales and margins. The last rate order was relatively balanced, with the utility receiving about 55% of its revised rate request.
Base Rate Freeze: Fitch does not expect the two-year base rate freeze to bear a material impact on the utility's financial profile. The earnings and cash flow benefit from the last rate order and efficient cost control should support the utility's sound credit profile in 2016.
Manageable Capex: Management plans on spending between $25 million and $30 million annually on capital investments over 2016 - 2018, compared with $96 million spent over the prior three years. Capex is primarily earmarked for the upgrading of the natural gas pipe distribution system. The utility expects to fund capex with a mix of internal cash flows, debt and parent equity infusions.
Sound Credit Metrics: FFO and EBITDAR leverage ratios are projected to average roughly 3.6x over 2016 - 2020. As of TTM Q216, FFO and EBITDAR leverage ratios were 2.5x and 2.3x, respectively.
Small Size within Corporate Structure: North Shore Gas is one of the smallest utilities in the WEC family, representing approximately 2% of consolidated EBITDA at year-end 2015. As a result of its size, the utility does not rely on a corporate credit facility or CP market to fund liquidity requirements. It relies on intercompany borrowings from WEC and sister affiliate Peoples Gas for its liquidity, which leaves it exposed to the credit quality of those entities. However, given the strong financial profiles of both WEC and Peoples Gas, Fitch does not consider access to liquidity a material credit concern for North Shore Gas at this time.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case are as follows:
WEPCO
--No base rate increase through 2017;
--Retail sales growth of 0.5% annually;
--$1.7 billion capex 2016 - 2018;
--$40 to $50 million annual ATC cash distributions 2016 - 2020.
WI Gas
--Base rate increases per the last rate order;
--Retail sales growth of 0.5% annually;
--$460 million capex 2016 - 2018.
Wisconsin Public Service
--Rate relief per 2016 rate order;
--Retail Sales growth of 0.5% annually;
--$932.5 million capex 2016 - 2018.
Peoples Gas
--Base rate freeze through 2017;
--QIP rider increases 2016 - 2020;
--$18.5 million fine due to settlement;
--$1.09 billion capex 2016 - 2018.
North Shore Gas
--Base rate freeze through 2017;
--$25 to $30 million per annum capex 2016 - 2018.
RATING SENSITIVITIES FOR WEC
Positive: Future developments that may, individually or collectively, lead to a positive action include:
Deleveraging efforts that result in FFO lease-adjusted leverage to improve to near 3.5x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--A more aggressive financial management policy that results in incremental parent leverage;
--Unfavorable regulatory developments that lead to a deterioration of utilities' financial profiles;
--FFO lease-adjusted leverage ratio between 5x to 5.2x on a sustained basis.
RATING SENSITIVITIES FOR WEPCO
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given current rating levels and a sustained elevated capex program over the forecast period, positive rating actions are unlikely in the near term.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Although not anticipated by Fitch, deterioration of the regulatory compact could lead to negative rating actions;
--Adjusted debt/EBITDAR over 4x on a sustained basis.
RATING SENSITIVITIES FOR WI GAS
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given current rating levels and elevated capex over the forecast period, positive rating actions are unlikely in the near term.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Although not anticipated by Fitch, deterioration of the regulatory compact could lead to negative rating actions;
--Adjusted debt/EBITDAR over 4x or FFO lease-adjusted leverage over 4.5x on a sustained basis.
RATING SENSITIVITIES FOR INTEGRYS
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given comparable credit profiles, a positive action at WEC;
--Deleveraging efforts that result in FFO lease-adjusted leverage to improve to near 3.5x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Unfavorable regulatory developments in Wisconsin or Illinois that lead to a deterioration of utilities' financial profiles;
--FFO lease-adjusted leverage between 5x to 5.2x on a sustained basis;
--A more aggressive financial management policy from WEC that creates added financial pressure on Integrys to upstream dividends.
RATING SENSITIVITIES FOR WISCONSIN PUBLIC SERVICE
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given current rating levels and elevated capex over the forecast period, positive rating actions are unlikely in the near term.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Unfavorable regulatory developments;
--Adjusted debt/EBITDAR over 4x or FFO lease-adjusted leverage above 4.5x on a sustained basis.
RATING SENSITIVITIES FOR PEOPLES GAS
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given high projected capex, a positive rating action is unlikely in the near-term. However, FFO lease-adjusted leverage below 3.5x or adjusted debt/EBITDAR below 3.2x on a sustained basis could trigger positive actions.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Unfavorable regulatory developments;
--FFO lease-adjusted leverage over 4.5x on a sustained basis.
RATING SENSITIVITIES FOR NORTH SHORE GAS
Positive: Future developments that may, individually or collectively, lead to a positive action include:
--Given current rating levels, no positive rating action is likely in the near term.
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--Deterioration of the regulatory compact;
--Inability to receive short-term funding from Integrys or Peoples Gas in the event of a liquidity crisis;
--FFO lease-adjusted leverage over 4x on a sustained basis.
LIQUIDITY
At June 30, 2016, WEC and its subsidiaries had approximately $32 million of cash and cash equivalents and approximately $1.55 billion of unused committed credit arrangements with banks. The unused credit capacity is allocated to provide liquidity support to the group's CP programs. Approximately $928 million of CP borrowings were outstanding at June 30, 2016.
Each utility within the combined group has access to their own unsecured credit facility except smaller entities: North Shore Gas, Michigan Gas Utilities (MGU), and Minnesota Energy Resources (MER), who meet their short-term liquidity needs through intercompany borrowings with the parent company. North Shore Gas can borrow up to $50 million with Integrys and up to $50 million with sister affiliate Peoples Gas. In addition, Peoples Gas can borrow up to $150 million from Integrys and up to $50 million from North Shore Gas.
Financial covenants include maintaining a debt-to-total capitalization ratio no greater than 65% for WEPCO, WI Gas, Integrys, Wisconsin Public Service, and Peoples Gas. WEC must maintain a debt-to-total capitalization ratio that is no greater than 70%. At June 30, 2016, all entities were in compliance with the covenants.
FULL LIST OF RATING ACTIONS
Fitch affirms the following ratings with a Stable Outlook:
WEC
--Long-term IDR at 'BBB+';
--Short-term IDR at 'F2';
--Commercial Paper at 'F2';
--Senior unsecured debt at 'BBB+';
--Junior subordinated notes at 'BBB-'.
WEPCO
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Commercial Paper at 'F1';
--Senior unsecured debt at 'A+';
--Preferred stock at 'A-'.
WI Gas
--Long-term IDR at 'A-';
--Short-term IDR at 'F2';
--Commercial Paper at 'F2';
--Senior unsecured debt at 'A'.
ERGSS
--Long-term IDR at 'A';
--Senior unsecured debt at 'A+'.
Wisconsin Energy Capital Corp.
--Senior unsecured debt at 'BBB+'.
Integrys Holding
--Long-term IDR at 'BBB+';
--Short-term IDR at 'F2';
--Commercial Paper at 'F2';
--Senior unsecured debt at 'BBB+';
--Junior subordinated notes at 'BBB-'.
Wisconsin Public Service
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Commercial Paper at 'F1';
--Senior unsecured debt at 'A+';
--Preferred stock at 'A-'.
Peoples Gas
--Long-term IDR at 'A-';
--Short-term IDR at 'F2';
--Commercial Paper at 'F2';
--Senior secured debt at 'A+'.
North Shore Gas
--Long-term IDR at 'A';
--Senior secured debt at 'AA-'.
SUMMARY OF FINANCIAL ADJUSTMENTS
-WEPCO adjusted debt: Fitch has adjusted the debt by treating a percentage of the present value of the on-balance sheet capital lease obligation to affiliate We Power, LLC (We Power) as a debt equivalent in calculating WEPCO leverage metrics. The adjustment reflects the high level of regulatory recovery associated with the lease payments to We Power.
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
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014453
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014453
Endorsement Policy
https://www.fitchratings.com/regulatory
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