Fitch Ratings has upgraded FirstEnergy Corporation's (FE's) Long-Term
Issuer Default Rating (IDR) to 'BBB-' from 'BB+' and senior unsecured
ratings to 'BBB-' from 'BB+/RR4'. Fitch has also upgraded FE's
Short-Term IDR to 'F3' from 'B'. The Rating Outlook is Stable.
KEY RATING DRIVERS
--Relatively stable electric utility operations and cash flows.
--Credit supportive settlements in Pennsylvania and New Jersey rate
cases;
--Execution of FE's strategic exit from its competitive business;
--Uncertainty associated with potential insolvency at FE's competitive
operations;
--High FE parent-only and consolidated debt;
--High utility and transmission capex.
Support for Ratings
The ratings and Stable Rating Outlook reflect FE's strategic decision to
become a fully-regulated utility holding company, exiting its merchant
generation business within 18 months. The ratings and Stable Outlook
also consider equity issuance by FE of $2.4 billion during 2016- 2019,
credit supportive regulatory decisions in Ohio and recently settled rate
proceedings in Pennsylvania and New Jersey. Fitch estimates FE 2017-2019
debt/EBITDA of approximately 4.5x in each year and FFO-adjusted leverage
in the range of 4.5x-5.3x, excluding FirstEnergy Solutions. Rating
concerns for FE include execution risk in structuring a utility-only
holding company within 18 months, including a potential bankruptcy
filing at FirstEnergy Solutions (FES). Fitch believes efforts by
creditors of FES to extract value from FE, in a bankruptcy scenario, is
a primary source of uncertainty for FE creditworthiness. In Fitch's
estimation, FE's consolidated credit metrics excluding its competitive
business have headroom in its pro forma credit metrics that supports
FE's low investment grade rating.
Utility-Only Strategy
FE management announced its strategy to reposition FE within 18 months
so that it will be a pure, regulated utility holding company. FE
management intends to sell or deactivate its merchant generation assets
while working to maximize their value through legislative and regulatory
means in Ohio, Pennsylvania and West Virginia. Divestiture of FE's
competitive segment through asset sales, plant closures and, if
necessary, restructuring in bankruptcy resulting in permanent separation
of the competitive business would support a meaningfully improved
business risk profile. In this scenario, FE's improved business risk
profile would support EBITDA and FFO leverage of up to 5.5x each.
Focus on Regulated Assets
FE's focus on improving its regulated utility and transmission returns
while investing significant capital in these assets and exiting its
competitive business is credit supportive in Fitch's view. Distribution
and integrated utility capex is estimated at $1.3 billion each in 2016
and 2017. In addition FE is targeting 2017-2021 transmission capex of
$4.2 billion - $5.8 billion. FE invested approximately $2 billion in its
transmission business in 2014-2015 and is targeting another $1 billion
in 2016 with the majority of projects targeting FE's American
Transmission System, Inc. (ATSI) and moving east over time. FE recently
received approval from PA regulators to form Mid-Atlantic Interstate
Transmission Co. and filed with the Federal Energy Regulatory Commission
for formula rates. FE has identified up to $20 billion of post 2021
investment opportunities in its transmission business.
Supportive Regulation
Fitch believes that regulation across FE's service territory has
generally improved in recent years with constructive outcomes in PA, WV
and most recently OH. Recent settlement in PA of general rate case
filings by FE's four operating utilities in the state is a positive
credit development for FE. If the settlement agreements are approved by
the Pennsylvania Public Utility Commission (PUC) FE's PA rates would
increase $291 million per annum in aggregate; this compares to a
requested total increase of $439 million. The settlement proposes rates
effective Jan. 27, 2017 and is silent on return on equity. The
settlement also includes stay-outs through Jan. 27, 2019.
In New Jersey, Jersey Central Power and Light reached a settlement that
would increase rates $80 million, which compares to the $146.6 million
rate increase supported by the utility at the time of the settlement
filing. The effective date for the proposed rate increase under the
settlement is Jan. 1, 2017.
Neither the PUC nor the New Jersey Board of Public Utilities are bound
by the respectively proposed settlements in Pennsylvania and New Jersey.
In Oct. 2016, the Ohio PUC issued an order in FE's electric security
plan IV rate case approving a distribution modernization rider (DMR)
that facilitates collection of $204 million per annum for a three-year
period, with a possible two-year extension. Revenue from the rider will
be excluded from the significantly excessive earnings test for the
initial three-year period. Fitch believes adoption of the DMR is credit
supportive for FE.
Competitive Challenges
FE's competitive business has struggled for years with the prolonged
downturn in power prices driven by a surfeit of natural gas supply in
turn driven by advances in drilling technology, strong reserve margins,
and sluggish residential demand. Low natural gas and power prices are
expected to continue to pressure margins and cash flows at FE's merchant
operations. With low prospects for a rebound in power prices in the
near- to intermediate-term, FE has decided exit this underperforming
business segment to focus on regulated growth opportunities. While the
competitive generation business is expected to be cash flow positive
through 2018, low power prices, increasing collateral postings due to
credit ratings downgrades, scheduled debt maturities, and an adverse
outcome in rail arbitration could trigger insolvency.
Parallel Paths
FE intends to seek to maximize the value of the competitive business's
generation assets through regulatory and legislative initiatives in OH,
PA and WV as it engages in negotiations with interested parties to sell
its 13,000-MW of coal, nuclear and natural gas fired generating assets.
If generating assets cannot be sold, FE is likely to restructure its
competitive business in bankruptcy.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for FE include:
--Exit from the competitive business within 18 months.
--No major clawbacks associated with a potential FES insolvency.
--Equity issuance of approximately $2.4 billion 2016 - 2019.
--Implementation of PUCO approval of FE's ESP IV, including the
commission-approved $204 million distribution modernization rider.
--Inclusion of jurisdictional rate changes authorized by FERC and state
regulatory commissions in Ohio, Pennsylvania, West Virginia and New
Jersey, including recently announced general rate case settlements in
Pennsylvania and New Jersey.
--Balanced outcomes in future rate case proceedings.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a
positive rating action include:
--Rating upgrades are not anticipated in the near term, given today's
upgrade, which assumes a path to a utility-only FE business risk profile
in 18 months. However, continued rate base growth along with
constructive regulatory outcomes could result in future credit upgrades
in the intermediate- to long-term. These factors along with improvement
in debt/EBITDA to better than 4x could lead to credit rating upgrades.
Future developments that may, individually or collectively, lead to a
negative rating action include:
--Larger than expected FE exposure to creditor clawbacks in a FES
bankruptcy scenario could result in credit rating downgrades.
--Significant deterioration in regulatory compacts across FE's six-state
service territory could result in credit rating downgrades.
--These or other factors resulting in debt/EBITDA leverage of greater
than 5x could lead to future credit rating downgrades.
LIQUIDITY
Fitch believes FE's consolidated liquidity position is solid. As of
Sept. 30, 2016, FE had approximately $3 billion of liquidity available
under its consolidated $6 billion of revolving credit facilities and
$551 million of cash.
FULL LIST OF RATING ACTIONS
Fitch has upgraded the following ratings:
FirstEnergy Corp.
--Long-Term IDR to 'BBB-'from 'BB+';
--Senior unsecured debt to 'BBB-' from 'BB+/RR4';
--Short-term IDR to 'F3' from 'B'.
The Rating Outlook is Stable.
SUMMARY OF FINANCIAL ADJUSTMENTS: Fitch adjusts FE's financials for
impacts related to outstanding securitization debt.
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
Recovery Ratings and Notching Criteria for Utilities (pub. 04 Mar 2016)
https://www.fitchratings.com/site/re/878227
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014673
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014673
Endorsement Policy
https://www.fitchratings.com/regulatory
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