NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Rating (IDR) and senior unsecured debt rating of WGL Holdings, Inc. (WGL) to 'A' from 'A+' and affirmed the IDR of Washington Gas Light Co. (WG), its primary utility subsidiary at 'A+'. The Rating Outlook for both companies is Stable. The downgrade reflects a change in financial strategy at WGL, including the planned issuance of parent level debt and a planned share repurchase program, and growing investments in natural gas pipelines and alternative energy projects. Going forward, Fitch expects investments associated with WGL's non-regulated business will be at least partially financed with parent level debt which results in greater leverage than previously anticipated.
KEY RATING DRIVERS
The ratings of WGL primarily reflect the predictable cash flows and strong credit metrics of WG, a regulated gas distribution utility subsidiary and also incorporate the risk and volatility of WGL's retail marketing business. For the latest 12 months (LTM) period ending June 30, 2014, WG comprised 76.7% of consolidated funds from operations (FFO).
The Stable Outlook reflects the solid operating performance of the company's regulated and non-regulated operations, and the expectation that the company will continue to effectively manage the risks associated with its modestly growing non-regulated businesses.
Solid Financial Performance: Credit quality measures at both WGL and WG are expected to be commensurate with their current rating levels over the forecast period. For the 12-month period ended June 30, 2014, WGL's EBITDAR to interest coverage and debt to EBITDAR ratios were 6.0 times (x) and 3.3x, respectively. For the same period, WG's EBITDAR coverage and debt to EBITDAR metrics were 7.7x and 2.3x, respectively. For the LTM period, WG has benefited from a combination of higher rates in the District of Columbia and Maryland, modest customer growth and lower interest expense. Going forward, Fitch estimates leverage, as measured by debt to operating EBITDAR, will approximate 3.4x at WGL, and 3.0x at WG, which remains consistent with Fitch's target ratios for their current rating levels.
Share Repurchase Program: On Aug. 7, WGL's board of directors authorized a $150 million share buyback program over a two year period.
Increased Capex Needs: WGL plans to spend $2.2 billion on capital expenditures through 2018, an average of approximately $500 million per annum, levels significantly higher than previous years. The capex program is primarily focused on system rehabilitation and maintenance at WG, and to a lesser extent, unregulated alternative energy and midstream pipeline investments, which will pressure credit metrics. Going forward, Fitch expects the majority of capex will be covered by operating cashflows, however, both WGL and WG will be moderately free cash flow (FCF) negative net of dividends. Notably, the recent adoption of Infrastructure Recovery Mechanisms (IRM's) in Maryland and Virginia is a constructive development for WG and will allow for timely recovery on invested capital in between GRC proceedings.
Volatile Retail Business: WGL has grown its unregulated investments primarily through Washington Gas Energy Services (WGES), its retail energy marketing subsidiary which primarily services residential and commercial customers. Revenues at WGES have been growing steadily for the last six years at a 2% compound annual growth rate (CAGR) through fiscal 2013 before a drop-off in 2014 when gross margins from electric sales were adversely affected by higher capacity and ancillary service charges from PJM and lower realized margins from large commercial customers due to cooler than normal winter weather during the polar vortex. Consequently, contributions from WGES declined to 36.5% of consolidated net income for the LTM ending June 30, 2014 compared to 41.1% in fiscal 2013. Going forward, Fitch expects new commercial customers to drive modest growth. WGES entered the Pennsylvania electric market in 2010 and currently operates in Washington D.C., Maryland, Virginia, Delaware, and Pennsylvania.
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 customer growth of 1% annually.
Decoupling: In Maryland, a full revenue decoupling mechanism mitigates sales volume volatility due to weather variability and customer conservation. In Virginia, a decoupling mechanism allows WG to recover costs related to conservation and energy-efficiency programs. Additionally, WG also operates under a weather normalization mechanism in Virginia. WG's request for a weather normalization adjustment mechanism filed in November 2013 in the District of Columbia is currently pending. Natural gas sales delivered approximated 48.6%, 34.5%, and 16.9% in Maryland, Virginia, and Washington, D.C., respectively, for the year ended Sept. 30, 2013.
MD 2013 GRC Settled: On Nov. 22, 2013, the Public Service Commission of Maryland (PSC of MD) approved an $8.9 million rate increase for WG based on a 9.5% return on equity (ROE), which represented 31.4% of the revised requested amount for rates effective forthwith.
MD STRIDE: Maryland's Strategic Infrastructure Development and Enhancement Program (STRIDE) program allows WG to implement an IRM to accelerate repair and replacement of its natural gas distribution system. On May 6, 2014, the PSC of MD approved $200 million of infrastructure investments under the STRIDE program during the next five years as part of a 22-year long-term plan with a Jan. 1 start date. In July, the PSC of MD allowed WG to collect associated revenues over the next five month period through December 2014. The Maryland Office of People's Counsel filed an appeal of the PSC of MD's May 6, 2014 order with the Circuit Court for Baltimore City. The appeal is currently pending.
DC GRC Settled: On May 15, 2013, the PSC of DC approved an $8.4 million rate increase for WG, predicated on a 9.25% ROE, which represented 29% of the requested amount, for rates effective June 4, 2013. WG plans to spend roughly $22 million per annum over the next five years related to its accelerated infrastructure replacement program and filed for an IRM with the PSC of DC. On March 31, 2014, the PSC of DC approved WG's infrastructure replacement program, contingent on submitting an implementation plan by the end of April. WG filed the implementation plan and sought reconsideration on several issues in the order. The PSC of DC granted final approval of WG's infrastructure replacement program on Aug. 21 and established a procedural schedule for expedited review of the proposed IRM.
VA GRC Settled: On July 2, 2012, the Virginia State Corporation Commission (SCC of VA) approved a $20 million rate increase for WG, which represented 70.2% of the requested amount, based on a 9.75% ROE. On Jan. 31, 2011, WG requested a $28.5 million revenue increase predicated on a 10.5% ROE for rates effective October 2011, subject to refund. On July 24, 2012, the SCC of VA finalized its July 2, 2012 order. On Nov. 15, 2012, the SCC of VA approved WG's application to increase its Steps to Advance Virginia's Energy Plan (SAVE) expenditures to $191.4 million over a five-year period beginning Jan. 1, 2013. Costs associated with this accelerated infrastructure replacement program are recovered through a SAVE rider that is subject to commission approvals and annual true-ups.
New Midstream Investments
Constitution Pipeline: In May, WGL Midstream entered into $72 million equity investment in the Constitution Pipeline Company, LLC for a 10% share in the proposed 121-mile long pipeline. The pipeline project is designed to transport at least 650,000 dekatherms of natural gas per day from the Marcellus region in northern Pennsylvania to major northeastern markets. Construction of the pipeline is expected to begin in the third quarter of 2014 and is scheduled to be in service by second quarter of 2016. WGL Midstream joins Williams Partners L.P. ('BBB'/Outlook Stable) (41% share), Cabot Oil and Gas Corporation (25% share) and Piedmont Natural Gas (24% share) in the project.
Central Penn Line Pipeline: In February 2014, WGL Midstream, formed Meade LLC with COG Holdings LLC, Vega Midstream MPC LLC and River Road Interests LLC to partner with Transcontinental Gas Pipeline Company, LLC (Transco; 'BBB+'/ Outlook Stable) to invest in the Central Penn Pipeline. The Central Penn Pipeline, as part of Transco's Atlantic Sunrise project, will be an approximately 177-mile pipeline originating in Susquehanna County, Pennsylvania that is designed to transport up to approximately 1.7 million dekatherms per day of natural gas to a delivery point into Transco's mainline in southeast Pennsylvania. The Central Penn Line currently has a projected in-service date in the fourth quarter of 2017. WGL Midstream plans to invest an estimated $410 million for a 55% interest in Meade and Meade will invest an estimated $746 million for an approximate 39% interest in the Central Penn Line.
Sufficient Liquidity: As of June 30, 2014, WGL had total consolidated available liquidity of $575 million under their credit agreements including $13 million of cash and cash equivalents. WGL and WG can upsize their $450 million and $350 million senior unsecured credit facilities, which mature in April 2017, 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%. As of June 30, there were no direct borrowings under the facilities and WGL had $237.5 million of commercial paper outstanding.
Manageable Debt Maturities: Long-term debt maturities over the next five years are modest and as follows: $20 million in 2015, $25 million in 2016, none in 2017 and 2018, and $50 million in 2019.
What Could Lead To A Credit Rating Upgrade?
--No positive rating actions are anticipated in the near term.
What Could Lead To A Credit Rating Downgrade?
--WGL: A marked increase in the risk profile of its retail marketing operations or other non-regulated businesses could lead to negative rating actions. Sustained debt to EBITDAR leverage metrics above 3.65x and/or FFO fixed charge coverage below 5.0x over the forecast period could cause negative rating actions.
--WG: 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.
--A downgrade at WGL could trigger negative rating actions.
Fitch takes the following rating actions:
WGL Holdings, Inc.
--Long-term IDR downgraded to 'A' from 'A+';
--Senior unsecured debt downgraded to 'A' from 'A+';
--Short-term IDR affirmed at 'F1';
--Commercial paper affirmed at 'F1'.
Washington Gas Light
--Long-term IDR affirmed at 'A+';
--Senior unsecured notes affirmed at 'AA-';
--Preferred stock affirmed at 'A';
--Short-term IDR affirmed at 'F1';
--Commercial paper affirmed at 'F1'.
Both Rating Outlooks are Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Utilities, Power and Gas Companies (March 11, 2014);
--'Corporate Rating Methodology' (May 28, 2014);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)