Fitch Ratings – New York – 04 May 2021: Fitch Ratings has assigned a ‘BBB+’ rating to AEP Texas Inc.’s (AEPTX) offering of series J senior notes. The net proceeds from the sale of the senior notes will be used for the repayment of advances from affiliates and for […]
Fitch Ratings - New York - 04 May 2021: Fitch Ratings has assigned a 'BBB+' rating to AEP Texas Inc.'s (AEPTX) offering of series J senior notes. The net proceeds from the sale of the senior notes will be used for the repayment of advances from affiliates and for other general corporate purposes relating to AEPTX's utility business. As of April 29, 2021, AEPTX had approximately $320 million in advances from affiliates outstanding. The notes are unsecured and rank equally with all of AEPTX's other unsecured and unsubordinated indebtedness. The Rating Outlook on AEPTX's 'BBB' Long-Term Issuer Default Rating is Stable. AEPTX is a subsidiary of American Electric Power Company, Inc. (AEP, BBB+/Negative).
KEY RATING DRIVERS
Low-Risk Business Profile: AEPTX owns and operates regulated electricity T&D networks located in the Electric Reliability Council of Texas (ERCOT). The Public Utility Commission of Texas (PUCT) sets rates on a cost-of-service basis with the opportunity for capital recovery outside of base rate proceedings through annual or semi-annual clause mechanisms. AEPTX does not have direct exposure to commodity prices. AEPTX had no material impact from the market disruptions due to the February 2021 winter storm; however, it is unknown at this time if the company will be affected longer term from any potential changes in ERCOT market structure or PUCT regulation.
2020 Base Rate Proceeding: AEPTX concluded in April 2020, as per the settlement, its first base rate proceeding since 2006. The approved settlement resulted in a $40 million revenue decrease based on a 9.4% ROE, 42.5% hypothetical equity capital structure and 2018 test year. The lower equity capitalization further pressures metrics already affected by significant capex spend. In addition to traditional rate case issues, the somewhat contentious proceedings included a return of excess federal income taxes collected, due to the Tax Cuts and Jobs Act of 2017 (TCJA), implementation of ringfencing measures, inclusion in base rates of amounts previously recovered under rate riders, and consolidation of rate structures of AEPTX's two predecessor entities.
Energy Industry Exposure: AEPTX's service territory encompasses the Eagle Ford and Permian shale gas basins, which have experienced an uptick in economic activity. AEPTX's weather-normalized kWh sales increased 1.3% in 2020 versus 2019, despite the pandemic. The company forecasts total weather-normalized kWh sales to increase by 2.7% in 2021, with industrial sales up 10.4%.
Pressured Credit Metrics: As a result of AEPTX's lower equity capitalization and continued regulatory lag due to the service territory's high growth, AEPTX's FFO leverage has declined significantly versus prior periods and is expected to exceed 6.0x over the forecast period. The company's 2021-2023 capex forecast of almost $3.4 billion is flat versus the prior three-year forecast, but still at an elevated level. Fitch expects parent AEP will only make equity infusions to maintain the regulatory capital structure as authorized, which will result in credit metrics lower than most 'BBB' rated utilities. However, Fitch considers the low risk nature of the T&D companies in Texas an offsetting factor to support the current rating.
Parent-Subsidiary Rating Linkage: AEP and its regulated subsidiaries have operational, financial and functional ties, resulting in moderate ratings linkage. The treasury function is centrally managed and all regulated subsidiaries depend on AEP for short-term liquidity and participate in AEP's money pool. The money pool allows the utilities to manage working capital needs and provides short-term financing. Legal ties are weak, as the parent does not guarantee the debt obligations of its regulated subsidiaries.
AEP and most of its subsidiaries have limitations on capital structure from covenants in the bank credit agreement (debt/total capitalization that does not exceed 67.5%) and from regulatory requirements to maintain a specific equity ratio. No cross-default provisions exist among AEP and its subsidiaries. Due to these linkages, Fitch typically limits the notching difference between AEP and its subsidiaries to one to two notches. Fitch applied a bottom-up approach in rating AEP's utility subsidiaries, including AEPTX.
AEPTX's credit metrics are significantly weaker compared with its peer T&D utilities in Texas, which include CenterPoint Energy Houston Electric, LLC (CEHE; IDR BBB+/Stable) and Oncor Electric Delivery Company (BBB+/Stable). AEPTX's FFO leverage for YE 2020 was 8.9x, compared with 5.3x for CEHE and 4.6x for Oncor. Both AEPTX and CEHE received rate orders in 2020 that lowered allowed ROEs for each company to 9.4% and equity capitalization to 42.5%. Oncor, which is expected to file a rate case in October 2021, currently has rates sent based upon a 9.8% ROE and 42.5% equity capitalization. With approximately one million customers, AEPTX serves significantly fewer customers than Oncor (3.7 million) or CEHE (2.6 million) and has a larger geographic and less populated service territory.
Fitch's Key Assumptions Within its Rating Case for the Issuer Include:
--Capex of $3.4 billion over 2021-2023;
--10% rate base growth;
--Dividend policy managed to maintain authorized capital structures.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Sustained FFO leverage at or below 5.0x;
--Continued balanced jurisdictional rate regulation.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Sustained FFO leverage exceeding 6.5x on a sustained basis;
--Unexpected regulatory development.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: AEP has a $4.0 billion committed revolving credit facility maturing in March 2026 and a $1 billion committed facility maturing in March 2023, both of which serve as a backstop for AEP's CP program and LOC. AEP must maintain a ratio of debt/total capitalization that does not exceed 67.5% under the covenants to its credit agreement. This contractually defined percentage was 59.5% as of March 31, 2021. Additionally, to address the near-term cash flow impacts resulting from the severe weather impact in some of AEP's service territories, AEP entered into, and drew the full amount of, a $500 million 364-day term loan in March 2021. As of March 31, 2021, AEP had $3,126 million available on its revolving credit facilities (after giving effect for CP issuance of $1,874 million) and cash of $273 million.
AEP's regulated subsidiaries use a pool of corporate borrowing to meet short-term funding needs. The money pool operates according to regulators' approved terms and conditions, and includes maximum authorized borrowing limits for individual companies. Under the money pool terms and conditions, the maximum borrowing limit for AEPTX is $500 million. AEPTX has long-term debt maturities over the rating horizon as follows: $625 million in 2022 and $185 million in 2023. Fitch expects AEPTX will be able to refinance any maturing debt at competitive rates.
SUMMARY OF FINANCIAL ADJUSTMENTS
As of Dec. 31, 2020, Fitch has made the following adjustments: $493 million of securitized debt has been removed from Fitch's AEPTX debt calculation.
DATE OF RELEVANT COMMITTEE
07 April 2021
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
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