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.
Environmental Regulations
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.
KEY ASSUMPTIONS
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.
RATING SENSITIVITIES
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.
LIQUIDITY
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.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Additional Disclosures
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015029
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https://www.fitchratings.com/regulatory
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