CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Ohio Valley Electric Corporation's (OVEC) Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'BBB-'. The Rating Outlook has been revised to Negative.
The Negative Outlook follows FirstEnergy Corp's (FE; IDR 'BBB-') announcement that it is reviewing strategic options for its merchant subsidiary FirstEnergy Solutions Corp (FES), including bankruptcy. FES currently holds a 4.85% entitlement in OVEC's intercompany power agreement (ICPA). A default at FES could subject OVEC to a permanent revenue shortfall given that sponsors are severally responsible for their shares of OVEC's operational and financial obligations under the terms of the ICPA.
OVEC has sufficient liquidity, in Fitch's opinion, to face a brief modest revenue shortfall. However, further negative rating actions are likely if there is a high probability that FES will reject its OVEC obligations under a bankruptcy proceedings and that OVEC will not be able to replace in a timely manner the loss of this sponsor, through substituting a new sponsor or establishing a reserve to offset the long-term revenue shortfall.
KEY RATING DRIVERS
ICPA Enforceability and Financial Strength of Sponsors
OVEC's credit profile is derived from the legal enforceability of the ICPA between OVEC and its sponsors as well as the credit profiles of its sponsors. Due to the diversity of the sponsor base, Fitch takes into consideration the average credit profile of the sponsors rather than tying OVEC's ratings to that of the lowest-rated sponsor. Sponsors are responsible to reimburse all of OVEC's expenditures, including debt service and capital improvements, irrespective of total electricity generated and supplied by OVEC. In accordance with its mandate, OVEC aims for profit neutrality and maintains minimal shareholder equity position.
Following approval by the Public Utility Commission of Ohio's of an eight-year power purchase agreement for Ohio Power Co's (IDR: 'BBB+') OVEC entitlements, sponsors representing nearly 80% of OVEC's generation capacity can recover their OVEC-related costs either through a regulatory construct or through sponsors' membership charter provisions. OVEC's variable energy costs compare favourably with wholesale energy prices in the PJM Interconnection, LLC (PJM) and Midcontinent Independent System Operator, Inc (MISO) regions. However, Fitch estimates that all-in costs exceed prevailing merchant prices, even when factoring in revenues from PJM's capacity market auctions. Thus, the continued ability of the sponsors to recover OVEC-related costs during the currently depressed wholesale market conditions is an important rating driver.
The ICPA restricts the transfer of sponsoring rights and obligations to entities with investment grade credit ratings; however, there is no provision if a sponsor fails to maintain an investment-grade credit profile. Three sponsors, collectively responsible for 12.76% of OVEC's financial obligations, have slipped to speculative credit profiles. In Fitch's opinion, the obligations held by FES and Allegheny Energy Supply Co (AES; 3.01% share) pose a greater concern given FE's plans to exit from the merchant power business. Fitch views as challenging the transfer of the rights and obligations under the ICPA to a new sponsor in an environment of low merchant power prices and secular trend toward lower-carbon generation capacity.
Fitch estimates FES and AES's combined share of the demand charges at less than $30 million annually while the short 15-day billing cycle for energy charges limits OVEC's credit exposure in the event of financial restructuring. OVEC has sufficient liquidity to meet a temporary revenue shortfall, with $115 million available under its revolving credit facility and $124 million in long-term financial investments at Sept. 30, 2016. However, OVEC does not have, in Fitch's opinion, the financial resources to absorb a permanent revenue shortfall. Thus, mitigating actions by shareholders or remaining sponsors would be required to maintain the current ratings.
Efficient Operating Performance
OVEC's coal plants maintain favorable availability factors and heat rates despite their age, averaging about 70% and 10,600 Mbtu/MWh respectively in 2013 - 2015. 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. The integration of OVEC's generation capacity into the PJM market, effective since May 2016, allows for economic dispatch of the individual generating units as well as participation in the capacity performance market. Management expects this will support higher capacity utilization over the medium-term.
Compliance with a stream of environmental regulation over the past decade has precipitated incremental capex and put upward pressure on demand costs. However, management forecasts modest environmental capex in 2017 - 2024, as the plants are currently compliant with MATS and CSAPR requirements. The impact of the Clean Power Plan currently falls outside the rating horizon. Nonetheless, Fitch will closely monitor the evolution of legislative challenges and compliance plans presented by Ohio and Indiana as these will influence OVEC's operating costs and capacity utilization over the long term.
Fitch's key assumptions within the rating case for OVEC include:
--Average usage factor of 75% in 2017-2019;
--Operating costs increasing by 1% annually;
--Debt repayments limited to amortization schedule.
Positive Rating Sensitivities
Fitch would affirm the ratings should the financially stressed sponsors transfer their obligations to entities with investment grade profiles. Modification of the ICPA, incremental contributions or other similar mitigating actions from remaining sponsors or shareholders to permanently offset the loss a sponsor could also stabilize the ratings. Ratings upgrade is unlikely given that OVEC's credit profile is constrained by its sponsors' credit ratings and increasingly stringent environmental emission mandates.
Negative Rating Sensitivities
Any attempt by a sponsor to terminate the ICPA would most likely lead to a negative rating action. Alternatively, prolonged revenue shortfall leading to a material deterioration of OVEC's liquidity and financial resources would likely result in negative rating actions. Although not contemplated at this time, failure to replace a defaulted sponsor or to establish a reserve to meet permanent recovery shortfalls could result in a more-than-one-notch downgrade. Fitch would also take a negative rating action if compliance with new environmental rules materially limits OVEC's ability to achieve a high capacity factor and render the ICPA very expensive for the sponsors.
At Sept. 30, 2016 OVEC had $160 million of available liquidity, including $45 million in cash and cash equivalents and $115 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. Unrestricted long-term investments, $124 million at Sept. 30, 2016, provide additional financial flexibility.
OVEC's debt maturity schedule is light over the next three years, mostly consisting of gradual amortization of long-dated bonds. $100 million of re-marketable securities were refinanced with a five-year bank loan in August 2016 and Fitch assumes the remaining re-marketable variable-rate bonds will be successfully refinanced through their contractual maturity dates.
Disclosure: There were no financial statement adjustments made that were material to the rating rationale outlined above.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Ohio Valley Electric Corporation
--Long-term IDR at 'BBB-';
--Senior unsecured debt and revenue bonds at 'BBB-'.
The Rating Outlook has been revised to Negative.
Additional information is available on www.fitchratings.com.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
Dodd-Frank Rating Information Disclosure Form
Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.