NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded Exelon Corp.'s (EXC) Issuer Default Rating and senior unsecured debt ratings to 'BBB' from 'BBB+ and the junior subordinated debt rating to 'BB+' from 'BBB-'. The commercial paper (CP) rating is affirmed at 'F2'. The ratings are removed from Rating Watch Negative where they were placed in April 2014 following the announcement of an agreement to acquire Pepco Holdings, Inc. (PHI) in an all-cash transaction. The Rating Outlook is Stable. The ratings of EXC's four operating subsidiaries are unaffected by this rating action.
The downgrades reflect the increased consolidated leverage that results from the PHI acquisition and to a lesser extent the weak operating environment of its competitive generation business. The higher leverage is a product of the acquisition financing, which included approximately 65% debt and consolidation of the more levered PHI. The rise in leverage is softened by a modest reduction in business risk from the increase in regulated earnings. Post-merger regulated earnings are expected to account for roughly 65% of 2017 consolidated earnings compared to an estimated 55% without the acquisition.
KEY RATING DRIVERS
Increased Leverage: The acquisition results in a meaningful increase in consolidated leverage compared to EXC's current and projected stand-alone financial condition. Fitch estimates adjusted debt to EBITDAR will approximate 4.25x - 4.5x in the first full year after the merger compared to about 3.0x - 3.5x on a stand-alone basis. The rise in leverage is driven by the combination of the acquisition debt to be issued by EXC and the assumption of existing PHI consolidated debt. Funding for the $6.9 billion acquisition plus fees, integration costs and regulatory commitments includes approximately $4.2 billion of EXC corporate debt and $1 billion of mandatory convertible debt (issued in 2014). Under Fitch criteria the convertible debt issued by EXC, in the form of equity units, receives no equity credit. The remainder of the acquisition financing consisted of common stock and proceeds from asset sales. In addition, EXC will assume approximately $6 billion of PHI consolidated debt.
Regulatory Concessions: To gain merger approval, EXC agreed to a number of rate concessions in each of PHI's four regulatory jurisdictions aggregating to an estimated $350 million - $400 million, including customer rate credits and deferral of rate increases and funding for a variety of customer investment funds largely related to energy efficiency, renewable energy programs, and low-income customer programs. Moreover the PHI utility subsidiaries deferred rate filings during the nearly two-year merger review process that increased PHI's leverage and weakened its credit quality.
Ring Fencing: Each of the utility commissions imposed several ring-fencing provisions to protect the PHI utilities, but none are considered to be onerous or to impair EXC's credit quality.
The requirements include:
--Potomac Electric Power Co. (Pepco), Delmarva Power & Light Co. (DPL) and Atlantic City Electric Co. (ACE) maintaining a rolling 48% equity ratio (no other dividend restrictions)
--Creation of a bankruptcy-remote special purpose entity (SPE) to hold 100% of PHI equity
--Maintenance of separate books and records
--Pepco, DPL and ACE will maintain separate debt
--The Board of Directors of the SPE will have four directors, one of which will be independent
--The seven-member PHI board will include one director from each of PHI's utility subsidiaries
Corporate Structure: PHI will be structured as a subsidiary of EXC and the parent of its existing three regulated transmission and distribution utilities.
Utility Earnings Contribution: The acquisition furthers EXC's goal of increasing regulated earnings and lowering business risk. Post-merger regulated earnings are expected to account for roughly 65% of consolidated earnings from its six regulated utilities compared to an estimated 55% - 60% without the acquisition. Even without the PHI acquisition the regulated earnings contribution was expected to increase due to significant amount of planned utility investment, particularly at Commonwealth Edison Co (ComEd).
Competitive Generation Business: The operating environment for EXC's competitive generation business is expected to remain challenging with sluggish demand and low natural gas and power prices expected by Fitch to persist for several years. Favorably, the business is well capitalized and the credit profile has stabilized during a low point in the commodity cycle. In addition, management employs a three-year hedging strategy that moderates earnings and cash flow volatility.
--Relatively flat load growth
--Each of the PHI subsidiaries file rate cases in 2016 and every 12-15 months thereafter
--Commonwealth Edison Co. formula rate plan updated annually
--$1 billion in cash from the remarketing of junior subordinated debt in 2017
--Henry Hub Natural gas prices as of Dec. 31, 2015
--Nihub and PJM forward power prices as of Dec. 31, 2015
Positive Rating Action: An upgrade seems unlikely over the next few years given the rise in leverage associated with the PHI acquisition, but could occur if on a sustained basis debt/EBITDAR is reduced below 3.5x while lease-adjusted FFO leverage is below 4.25x.
Negative: Ratings could be lowered if lease adjusted FFO leverage exceeds 4.5x on a sustained basis. A renewed emphasis on non-regulated investments could also have an adverse effect on ratings.
Cash flow from operations, CP borrowings and committed bank credit facilities provide ample liquidity. EXC and each of its operating subsidiaries maintain separate credit facilities and CP programs. Syndicated credit facilities aggregate to $8 billion (excluding minority and community banks) and bilateral agreements an additional $400 million. The syndicated facilities include $500 million at EXC, $5.3 billion at Exelon Generation Co., LLC (Exgen), $1 billion at ComEd and $600 million each at PECO Energy Co. (PECO) and Baltimore Gas and Electric Co. (BGE). The syndicated facilities support CP programs of equal size and have five-year terms.
EXC also operates a corporate money pool with subsidiaries Exgen and PECO. EXC can lend to the money pool, but not borrow from the pool. ComEd and BGE are excluded from the money pool due to ring fencing measures.
Fitch has downgraded the following ratings:
--Long-term IDR to 'BBB' from 'BBB+';
--Senior unsecured debt to 'BBB' from 'BBB+';
--Junior subordinated debt to 'BB+' from 'BBB-'.
Fitch has affirmed the following ratings:
--Commercial paper at 'F2;
--Short-term IDR at 'F2'
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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