Fitch Ratings has affirmed FirstEnergy Corporation's (FE) long-term
Issuer Default Rating (IDR) and revised the Rating Outlook to Positive
from Stable. Fitch has also affirmed FE's senior unsecured debt rating
at 'BB+/RR4' and short-term IDR of 'B'. The Positive Outlook considers
the filing by FE of a modified, proposed stipulation in FE's Ohio
utilities' Electric Security Plan IV (ESP IV) rate proceeding, including
an 8-year power purchase agreement (PPA). Operational changes
implemented in 2015 by incoming CEO Chuck Jones to de-risk FE's
competitive business and emphasize growth in regulated operations, as
well as improve consolidated earnings, cash flows and credit metrics,
are additional factors supporting the Positive Outlook. Given this shift
in management strategy and more credit-friendly business-risk profile,
Fitch believes that a debt-to-EBITDA ratio of 4.5x is more consistent
with a low investment-grade credit rating compared to the previous 4.0x
KEY RATING DRIVERS
--Recent and future rate case outcomes, especially FE's pending Ohio
--Strategic efforts to reduce risk at FE's competitive business and
focus future investment on transmission and distribution;
--High parent-only and consolidated debt;
--The extended downturn in U.S. power prices and its adverse effect on
--High capex directed primarily toward utility and transmission
--Relatively stable electric utility operations and cash flows.
Modified Stipulation Filed
The rating affirmation and Positive Outlook follow FE's announcement
that the company's Ohio operating utilities filed a modified stipulation
with the Public Utilities Commission of Ohio (PUCO) on Dec. 1, 2015.
Importantly, the modified stipulation includes the commission staff
among its 16 signatories. Staff had opposed the previous stipulation as
filed with the commission.
Economic Stability Plan
The modified, proposed stipulation in FE's Ohio utilities' ESP IV rate
proceeding includes an 8-year PPA. Under the PPA, FirstEnergy Solutions
(FES) will enter into a PPA with Ohio Edison Co., The Cleveland Electric
Illuminating Co., and The Toledo Edison Co. from June 1, 2016 through
May 31, 2024. The revised stipulation also extends the Ohio utilities'
distribution rate freeze through May 31, 2024.
PUCO Outcome Uncertain
Fitch believes that the support of the PUCO staff significantly improves
the stipulation's prospects for approval. Nonetheless, the stipulation
is highly controversial and PUCO approval is not assured. Judicial
review of the stipulation is a virtual certainty. A final PUCO decision
is expected in the first quarter 2016. The PUCO may adopt the
stipulation as proposed, adopt the stipulation with modification or
reject the proposed stipulation.
The stipulated agreement, if approved by the commission, would be a
significant positive event for FE's credit profile on both a
quantitative and qualitative basis. If approved by the PUCO as proposed,
Fitch estimates FE's EBITDA leverage would improve by nearly a turn in
2016 versus Fitch's previous expectations.
High Debt Levels
FE's consolidated debt is high with total debt approximating $23 billion
on a consolidated basis, including parent-only long-term debt of $4.2
billion as of Sept. 30, 2015. However, consolidated FE debt-to-EBITDA is
estimated by Fitch at 4.6x - 4.7x during 2016 - 2018 and FFO adjusted
debt 4.8x - 5.1x, levels that are consistent with a low investment-grade
credit rating given the company's improved business-risk profile.
De-Risking Competitive Operations
Operational changes implemented in 2015 by incoming CEO Chuck Jones to
de-risk FE's competitive business and emphasize growth in regulated
operations are meaningful positive developments from a credit
point-of-view. The competitive generation business is now managed more
conservatively, maintaining a long generation position for contingencies
and exiting more weather-sensitive and volatile sales channels. Fitch
believes this strategic change in how FE is managing its competitive
risk and the potential, incremental risk mitigation associated with the
modified stipulation (due to the 8-year PPA) meaningfully improve FE's
The proposed stipulation if approved by PUCO would provide a more
predictable stream of revenues for 3,244 mW of generating capacity
through June 1, 2024. In that scenario, approximately 42% of FE's
generation would be price regulated or under long-term contract.
The proposed stipulation includes an economic stability program that
includes the 8-year PPA and a retail rate stability rider (RRS). Under
the terms of the stipulation, FE's Ohio operating utilities would pay
FES a cost-based rate for power, including a 10.38% PPA return on
equity. The utilities would sell the power acquired from FES via the PPA
in wholesale markets. When wholesale market revenues exceed cost,
customers receive a credit to their monthly bill. Conversely, when
wholesale market revenues are less than cost, customers pay a charge. If
approved as proposed, the PPA is estimated by FE to save Ohio ratepayers
$560 million over its 8-year term.
The proposed stipulation extends the utilities' distribution rate freeze
through May 31, 2024, contains guaranteed credits to customers of $10
million beginning in year five, increasing to $40 million in year eight.
The stipulation also extends increases to the distribution capital rider
(DCR) cap through May 31, 2024. Under the terms of the stipulation, FE
will pursue carbon reduction through investment in grid enhancement,
including smart meters and battery technologies, fuel diversity and
other means. The stipulation calls for timely cost recovery of future
investment through specific riders. This alignment of utility strategy
with Ohio energy policy is, in our opinion, credit supportive for FE's
Focus on Regulated Assets
FE's focus on improving its regulated utility and transmission returns
while investing significant capital in these assets and de-risking its
competitive business is credit supportive in Fitch's view. FE is in the
midst of a $4.2 billion transmission buildout 2014 - 2017 with the
majority of projects targeting FE's American Transmission System, Inc.
(ATSI). Recent rate case decisions with the exception of the March 2015
$34 million rate decrease for Jersey Central Power and Light have been
generally supportive from a credit point of view. Earlier this year,
regulators in West Virginia and Pennsylvania approved settlement
agreements authorizing rate increases and the Federal Energy Regulatory
Commission (FERC) approved ATSI's settlement of its transmission rate
filing in October 2015. The FERC order authorizes use of a forward test
year in formula rates and a 10.38% return on equity.
Low Power Prices
FE's ratings and Stable Outlook reflect the prolonged downturn in power
prices driven by a surfeit of natural gas supply, strong reserve
margins, and sluggish residential demand. Low, albeit gradually
improving, power prices are expected by Fitch to continue to constrain
margins and cash flows at FE's merchant operations.
Fitch's key assumptions within the rating case for FE include:
--PUCO approval of FE's ESP IV stipulation as filed.
--Incorporate jurisdictional rate changes authorized by FERC and state
regulatory commissions in Pennsylvania, West Virginia and New Jersey and
assume balanced future rate case outcomes.
--PJM capacity auction results included in estimates.
--Continued equity issuance of approximately $100 million per annum.
--Effective tax rate of 36% - 38%.
Future developments that may, individually or collectively, lead to a
positive rating action include:
--Approval of FE's ESP IV as proposed or with minor modification;
--Improvement in debt-to-EBITDA to 4.5x and FFO adjusted leverage of
5.5x or better;
--Continued management commitment to de-risking and deleveraging FE's
Future developments that may, individually or collectively, lead to a
negative rating action include:
--Lower than expected margins and volumes and continued high leverage at
FE and its competitive business;
--An unsupportive final decision in FE's pending ESP IV filing in Ohio;
--Weakening of FE's FFO adjusted leverage to 6.5x or worse on a
Fitch believes FE's consolidated liquidity position is solid. As of
Sept. 30, 2015, FE had approximately $4 billion of liquidity available
under its consolidated $6 billion of revolving credit facilities and $59
million of cash.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following:
--IDR at 'BB+';
--Senior unsecured debt at 'BB+/RR4';
--Short-term IDR at 'B.
The Rating Outlook is revised to Positive from Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Utilities (pub. 05 Mar 2015)
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