NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A-' long-term Issuer Default Rating (IDR) and debt instrument ratings of Central Hudson Gas & Electric Co. (CHG&E) and revised the Rating Outlook to Negative from Stable.
The Negative Outlook reflects the expected deterioration in CHG&E's leverage metrics primarily driven by projected capital spending that is greater than Fitch's prior expectations and will require incremental debt financing. Fitch's main concern is the regulatory lag given the two-year rate freeze that is in place through June 30, 2015. The company is not able to earn a return on ongoing capital investments until new rates are implemented.
KEY RATING DRIVERS
Rising Capex: Management plans to spend approximately $700 million in capital investment over the next five years, an increase of nearly 50% compared with approximately $469 million spent over the previous five years. Capital spending is primarily allocated toward the upgrade of transmission and distribution (T&D) infrastructure, and heating oil to natural gas conversions. Capex also reflects accelerated investments in cast iron pipeline replacement projects. Fitch expects CHG&E to finance capex using a mix of internally generated cash flows and long-term debt issuances, and manage to a 50%-50% debt equity mix. Fitch views CHG&E's ability to receive adequate and timely recovery of capex in its next rate proceeding as critical to the ratings.
Upcoming Rate Case Proceeding:
Management plans on filing a rate case in mid-2014 with new rates to be effective mid-2015. As per the terms of the Fortis merger approval, CHG&E is in the second year of a two-year distribution rate freeze that expires June 30, 2015. During the rate freeze, CHG&E continues to operate under the terms of its 2010 rate order, which features the full and timely recovery of fuel and commodity costs, the use of tracking mechanisms for certain operating expenses, and a revenue decoupling mechanism.
Fitch's financial projections reflect a multi-year rate plan for CHG&E with an authorized ROE of 9.25%, which is in line with ROEs most recently granted to other New York utility peers. CHG&E was authorized a 10% ROE in its previous rate order. Timely and full recovery of invested capital is the primary credit concern, given the relatively large revenue requirement associated with the capital investments, as well as the potential impact of $15 million of remaining positive benefit adjustments (PBAs) that are currently recorded as a regulatory liability on CHG&E's balance sheet and available as rate moderators. The PBAs were part of regulatory concessions CHG&E and Fortis agreed to in order to consummate the merger. In addition, CHG&E's inability to secure a multi-year plan in lieu of frequent rate filings could lead to regulatory fatigue.
Weakening Credit Metrics: Credit measures are currently sound, but are expected by Fitch to weaken for the remainder of 2014 and beyond due to the base rate freeze and incremental debt financings to fund the growing capex. As expected, cash flow is also adversely affected by the expiration of bonus depreciation and other tax credits. Fitch estimates FFO-lease adjusted leverage to average above 4x and debt/EBITDAR near 3.8x over the five-year forecast period.
Ownership by Fortis: CHG&E operates as a stand-alone entity under Fortis ownership. Fitch believes Fortis' ownership provides CHG&E with some financial flexibility with respect to parent equity infusions or upstream dividends. Favorably, Fitch expects CHG&E's upstream dividend distributions to be minimal over 2015-2017 at the peak of capital spending.
Low-Risk Business Model: CHG&E operates a low-risk transmission and distribution regulated utility business, which bears no commodity price risk. The New York regulatory compact features balanced tariff mechanisms, including a revenue decoupling mechanism that insulates CHG&E from changes in sales volume due to energy conservation and efficiency, customer demand and weather. Other rate design features include forward-looking test years and use of trackers for certain operating expenses.
Adequate Liquidity: The company has access to a total capacity of $150 million under a multi-year bank credit facility that expires in October 2016. At March 31, 2014, there was $10 million of borrowings outstanding under the facility. CHG&E had $4.4 million of cash and cash equivalents and no restricted cash. Long-term debt maturities are considered to be manageable with $7 million due in 2014, $0 million in 2015, $8 million due in 2016, $33 million due in 2017, and $30 million due in 2018.
Stable Outlook: Future developments that may, individually or collectively, lead to a Stable Outlook include:
--A constructive multi-year rate order that provides regulatory predictability and allows CHG&E to recover capex on a timely basis while mitigating the impact of PBAs on rates;
--Parental support by Fortis in the form of downstream equity infusions that results in lower projected leverage at CHG&E;
--If FFO lease-adjusted leverage maintains in a range between 3.75x-4.25x and adjusted debt/EBITDAR between 3.25x and 3.75x on a sustained basis.
Future developments that may, individually or collectively, lead to a negative rating action include:
-An unfavorable decision in CHG&E's pending rate case that precludes full and timely recovery of invested capital and other operating costs;
--FFO-lease adjusted leverage greater than 4.25x and adjusted debt/EBITDAR greater than 3.75x on a sustained basis;
-A deterioration of the New York regulatory compact that provides revenue decoupling, forward-looking test years, and use of trackers for certain operating expenses.
Fitch has affirmed the following ratings and revised the Rating Outlook to Negative from Stable:
--Long-term IDR at 'A-';
--Senior unsecured debt at 'A';
--Short-term debt at 'F2'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'Rating U.S. Utilities, Power and Gas Companies' (March 11, 2014).
Applicable Criteria and Related Research:
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage