Fitch Affirms Ohio Valley Electric Corp.'s IDR at 'BBB-'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the ratings on Ohio Valley Electric Corporation (OVEC), including the long-term Issuer Default Rating (IDR) at 'BBB-' and the senior unsecured debt rating at 'BBB-'. The senior secured debt rating was withdrawn, as it was unused. The Rating Outlook is Stable.

The rating affirmation and Stable Outlook reflect OVEC's modest business risk profile, underpinned by the legal enforceability of the intercompany power agreement (ICPA) and the solid credit profiles of its sponsors. While presenting a long-term risk, the Clean Power Plan's (CPP) carbon emission reduction target is not explicitly factored into our ratings given the lack of visibility on state implementation plans, the long implementation horizon, and pending legal challenges.

KEY RATING DRIVERS

ICPA Enforceability Is Key: The legal enforceability of the ICPA, a contractual obligation of sponsors to pay demand charges and pro rata share of capital investments, is the basis for Fitch assigning OVEC's IDR. Under the ICPA, OVEC bears no volumetric or commodity risk. Sponsors are responsible to reimburse for all of OVEC's expenditures, including debt service and capital improvements, irrespective of total electricity generated and supplied by OVEC. The ICPA is set to expire in 2040, which coincides with the end of the operating life of the plants, based on an independent engineering report. Thus, Fitch considers OVEC's profile closer to that of a regulated utility than of a merchant generator. Any attempt by a sponsor/off-taker to terminate the contract would be negative for OVEC's IDR.

Off-Takers' Ability to Recover Costs: The majority of sponsors/off-takers can recover OVEC-related costs either through a regulatory construct or through sponsors' membership charter provisions. Fitch has assumed continued recovery of OVEC-related costs regardless of wholesale market conditions. In addition, the Public Utilities Commission of Ohio (PUCO) is reviewing stipulations by Ohio Power Company and FirstEnergy Solutions for eight-year power purchase agreements (PPAs) that include their share of OVEC-related power costs. Fitch believes that the support of the PUCO staff significantly improves the prospects of approval. Nonetheless, the stipulations are highly controversial with PUCO approval not assured and judicial review a virtual certainty. A final PUCO decision is expected in first quarter 2016, and a positive outcome would be supportive of OVEC's credit profile.

Strength of Sponsors' Credit Profile: Sponsors are severally responsible for OVEC's operating and financial obligations, irrespective of total electricity generated and supplied by OVEC. The sponsors/off-takers are very stable, with only two additions in the past decade. Nearly all have investment-grade credit profiles and the ICPA restricts transfer of ownership in OVEC only to an investment-grade entity. Due to the diversity of the sponsor base, Fitch does not directly tie OVEC's ratings to that of the lowest rated sponsor.

Numerous New Environmental Regulations: OVEC has retrofitted its coal-fired plants over the past decade to meet numerous new environmental regulations, including Mercury Air Toxics Standards (MATS) and the Cross-State Air Pollution Rule (CSAPR). Management plans further capital spend, concentrated in 2019-2022, to meet recent regulation surrounding cooling water intake management (Clean Water Act) and wastewater and land management (mainly dry fly ash conversion, wastewater treatment and ash pond modifications). While the impact of the Clean Power Plan (CPP), mandating gradual CO2 emission reductions starting in 2022, currently falls outside the rating horizon, Fitch will monitor the evolution of state compliance plans and legal challenges as these will influence OVEC's operating costs and capacity utilization over the long term.

Efficient Operating Performance: OVEC's coal plants maintain favourable availability factors and heat rates despite their age, averaging respectively 75% and 10,600 Mbtu/MWh in recent years. OVEC's role as an energy supplier to the Department of Energy resulted in sustained elevated maintenance investments throughout the plants' lives. Cost reduction initiatives and pro-active management of coal supplies resulted in reduction in energy costs since 2013, with electricity charges expected to remain below $30/MWh over the medium term.

Back-Dated Debt Maturities: OVEC's debt structure is heavily weighted toward long-term maturities with about $200 million expected to be retired in 2016-2019, compared with $1.5 billion in outstanding debt at the end of Sept. 30, 2015. Furthermore, environmental expenditures planned for 2020-2022 will likely require incremental debt financing. While Fitch recognizes the shorter-term benefits of the debt amortization schedule on OVEC's liquidity position and demand charges, the current amortization schedule will also result in a large back-ended demand charges for debt service.

KEY ASSUMPTIONS

Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:

--Average capacity factor of 80%;

--Operating costs increasing by 2% annually;

--Debt repayments limited to amortization schedule.

RATING SENSITIVITIES

Positive Rating Sensitivities:

A positive rating action is unlikely at this time given that the credit profile is constrained by the sponsors' credit profiles and increasingly stringent environmental emission mandates.

Negative Rating Sensitivities:

Amendments to the ICPA and/or severe decline in creditworthiness of sponsors would result in a negative rating action. Fitch would also take a negative rating action if compliance with new environmental rules materially limit OVEC's ability to achieve a high capacity factor and render the ICPA very expensive for the sponsors/off-takers, thus constraining their ability to recover these costs either through regulatory mechanisms or in wholesale power markets.

LIQUIDITY

Adequate Liquidity Position: At Sept. 30, 2015, OVEC had $193 million of available liquidity, including $13 million in cash and cash equivalents and $180 million available under its $200 million revolving credit facility (expiry on Nov. 17, 2019). OVEC primarily uses its revolving facility to support letters of credit as well as for general corporate purposes. Semimonthly settlement of accounts receivable from sponsors/off-takers reduces OVEC's working capital needs.

Extended Debt Maturity Profile: OVEC's debt maturity schedule is light over the next three years, mostly consisting of gradual amortization of long-dated bonds. Fitch expects OVEC to use excess cash flows to modestly reduce debt in 2016-2018. Fitch assumes re-marketable variable-rate bonds will be successfully refinanced through their contractual maturity dates, thus excludes them from short-term maturities.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings with a Stable Outlook:

OVEC

--Long-term IDR at 'BBB-';

--Senior unsecured debt at 'BBB-'.

Fitch has withdrawn the following ratings:

OVEC

--Senior secured debt withdrawn.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=996918

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=996918

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Maude Tremblay, CFA
Director
+1-312-368-3203
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Philip W. Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Maude Tremblay, CFA
Director
+1-312-368-3203
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Philip W. Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com