Fitch Downgrades Central Hudson's IDR to 'BBB+'; Outlook Revised to Stable

NEW YORK--()--Fitch Ratings has downgraded Central Hudson Gas & Electric Co.'s (CHG&E) long-term Issuer Default Rating (IDR) to 'BBB+' from 'A-' and revised the Rating Outlook to Stable from Negative. In addition, Fitch has downgraded CHG&E's senior unsecured debt to 'A-' from 'A'. Fitch has also affirmed CHG&E's short-term IDR at 'F2'.

The ratings downgrade is driven by Fitch's expectation of continued deterioration of CHG&E's financial profile over the next several years, despite the beneficial impact of the recently approved multi-year rate plan. Based on Fitch's forecast, projected credit metrics are not supportive of an 'A' utility credit profile. The downtrend is largely due to incremental debt financings required to fund persistently elevated capex through 2019 and to the deferral of projected manufactured gas plant clean-up costs. The deferred costs result in a significant build-up of regulatory assets and generate lag in cash recovery.

The revision to a Stable Outlook reflects Fitch's expectations that CHG&E will operate its low-risk transmission and distribution (T&D) utility business in a conservative manner through cost control and commitment to maintain a balanced capital structure.

KEY RATING DRIVERS

Rising Capex: Management plans to spend approximately $790 million in capital investment over 2015-2019, an increase of nearly 65% compared with the $481 million spent over the previous five years. The high capex will require significant external funding that Fitch anticipates will pressure operating cash flows. Capital spending is primarily allocated toward the upgrade of T&D infrastructure, advanced grid initiatives, and heating oil to natural gas conversions. Capex also reflects accelerated investments in cast iron pipeline replacement projects. Fitch projects CHG&E's internally generated cash flows to fund on average 60% of capex requirements over the next five years, with the balance funded primarily with long-term debt issuances, and manage to a 50%-50% debt equity mix.

Relatively Balanced Rate Order: The recent order that results in the establishment of a three-year rate plan for CHG&E's electric and gas businesses is consistent with Fitch's prior rating case expectations and provides regulatory predictability through June 2018. The utility will continue to benefit from timely and full recovery of commodity costs and a revenue decoupling mechanism that insulates net margins from variation in sales, weather, and energy efficiency and conservation. In addition, the NYPSC approved the use of a storm reserve that will allow CHG&E to recover incremental storm-related costs on a timelier basis.

Under the multi-year plan, CHG&E will receive aggregate base rate increases for combined electric and gas service of approximately $56 million over the period July 1, 2015 through June 30, 2018. However, the benefit of tariff increases will be largely offset by the NYPSC's use of approximately $31 million of existing regulatory liabilities as one-time bill credits to moderate the immediate impact of the rate increase. The reliance on balancing accounts for rate setting protects earnings but does not provide immediate cash flows.

In addition, the 9% ROE authorized by the NYPSC is significantly below what was granted, on average, to utilities nationwide in 2014, and the multi-year plan does not include a tracker that accounts for the possibility of a future rise in interest rates.

Decline in Credit Metrics: Credit metrics are currently sound but are projected to weaken materially through the forecast period to levels that are more consistent with a 'BBB' utility credit profile. Fitch's rating case projects FFO lease-adjusted leverage to weaken by almost a full turn in 2015 to 4.2x and be above 4.5x in 2016 and beyond. Adjusted debt/EBITDAR is forecasted to remain near 4x while FFO fixed charge coverage is expected to be below 4x from 2015 to 2019. For the LTM period ended March 31, 2015, FFO adjusted leverage stood at 3.4x, adjusted debt/EBITDAR, 4x, and FFO fixed charge coverage, 4.7x.

REV-based Regulation: The future implementation of the 'Reforming the Energy Vision' (REV) initiative spearheaded by the NYPSC appears to be credit neutral at this time. Under a REV framework, rate plans that span over multiple years and provide long-term rate visibility could be favorable to utilities, in Fitch's view.

Furthermore, a successful penetration of distributed energy resources, one of REV's key objectives, could lead to reduced peak energy demand and allow utilities to scale back capital spending on costly infrastructure-related projects. This is particularly relevant in the case of CHG&E given its large capex cycle and funding requirements.

CHG&E has proposed four demonstration projects before the NYPSC that focus on investments in community solar, micro-grid, demand side management, and smart meters. Those projects, whose funding was determined as part of the 2015 rate order, must be approved by the NYPSC Staff.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case are as follows:

--Tariff increases per the 2015 rate order;

--Capital spending of approximately $790 million over 2015-2019 excluding any REV-related investments;

--Core O&M kept relatively flat.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

Given the current downgrade, any positive rating action is unlikely in the near term. However, adjusted debt/EBITDAR below 3.5x on a sustained basis could lead to positive rating actions.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

Negative regulatory developments including the inability to timely recover commodity costs or the termination of the revenue decoupling mechanism.

Sustained FFO adjusted leverage greater than 4.75x and adjusted debt/EBITDAR greater than 4.1x.

LIQUIDITY AND CAPITAL STRUCTURE

Fitch assesses CHG&E's ratings on a stand-alone basis under the Fortis corporate umbrella. The utility maintains a separate board, has its own bank credit facility, and can issue long-term debt on its own. The Fortis ownership does provide the utility with some financial flexibility with respect to parent equity infusions or upstream dividends. Fitch expects upstream dividend distributions to be relatively modest over the next five years during the high capex cycle.

Fitch considers liquidity to be adequate. CHG&E has access to a total capacity of $150 million under a bank credit facility that expires in October 2016. At March 31, 2015, there was $10 million of borrowings outstanding under the facility and $34 million of cash and cash equivalents. Long-term debt maturities are considered to be manageable with $8 million due in 2016, $33 million due in 2017, and $30 million due in 2018.

FULL LIST OF RATING ACTIONS

Fitch has taken the following rating actions on CHG&E:

--Long-term IDR downgraded to 'BBB+' from 'A-';

--Senior unsecured debt downgraded to 'A-' from 'A';

--Short-term debt affirmed at 'F2'.

The Outlook is revised to Stable from Negative.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Utilities (pub. 05 Mar 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863298

Additional Disclosures

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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987378

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987378

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Contacts

Fitch Ratings
Primary Analyst
Philippe Beard
Director
+1-212-908-0242
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Rob Hornick
Senior Director
+1-212-908-0523
or
Committee Chairperson
Philip W. Smyth
Senior Director
+1-212-908-0531
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Philippe Beard
Director
+1-212-908-0242
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Rob Hornick
Senior Director
+1-212-908-0523
or
Committee Chairperson
Philip W. Smyth
Senior Director
+1-212-908-0531
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com