Fitch Ratings has taken the following rating actions on Pinnacle West Capital Corp. (PNW) and its subsidiaries:
–Long-term Issuer Default Rating (IDR) upgraded to ‘BBB’ from ‘BBB-‘;
–Short-term IDR affirmed at ‘F3’;
–Commercial paper affirmed at ‘F3’.
–Long-term IDR upgraded to ‘BBB’ from ‘BBB-‘;
–Short-term IDR affirmed at ‘F3’;
–Senior unsecured upgraded to ‘BBB+’ from ‘BBB’;
–Commercial paper affirmed at ‘F3’.
PVNGS II Funding Corp.
–Secured lease obligation bonds upgraded to ‘BBB+’ from ‘BBB’.
The Rating Outlook is Stable. Approximately $3.7 billion of debt is affected by the rating action.
PNW is a parent holding company whose ratings reflect the stable earnings and cash flows of its core operating subsidiary, APS, a regulated vertically integrated electric utility subsidiary where substantially all of the consolidated long-term debt resides. APS accounts for virtually all consolidated revenues, assets, earnings, and cash flows. The upgrades reflects strong performance in 2011 and the constructive outcome of APS’ recently settled 2010 General Rate Case (GRC), which will provide a tailwind for improved earnings and credit ratios in 2012 and 2013. The ratings also consider APS’ solid liquidity position, manageable debt maturities, low leverage, and the financial support from its corporate parent, PNW, including anticipated equity infusions agreed to in APS’ settlement of its 2008 GRC.
COVERAGE MEASURES EXPECTED TO IMPROVE
APS’ credit metrics remain stable despite residential housing weakness in its service area and ahead of new rates effective July 1, 2012 as per the recently settled 2010 General Rate Case (GRC). EBITDA-to-interest was stable at 5.2x for the 12-month (LTM) period ended March 31, 2012 as compared to 5.1 for 2011. Similarly, funds from operations (FFO) coverage was 5.3x and 5.0x, respectively over the same time periods. Leverage for the 12-month (LTM) period ended March 31, 2012, as measured by Debt to EBITDA, was low at 3.0x. Fitch expects EBITDA coverage to improve to approximately 5.6x in 2013, in part reflecting the full-year impact of higher revenues from the 2010 GRC settlement. Credit metrics compare well to ‘BBB’ guideline ratios as well as peers.
FFO coverage in 2013 is likely to be flat in the absence of bonus depreciation. Going forward, Fitch expects EBITDA and FFO coverage measures to remain less than 6.0x through 2015.
GENERAL RATE CASE SETTLEMENT
On May 15, 2012, the ACC approved the regulatory settlement agreement as proposed by APS and other parties in APS’s 2010 GRC without material modifications. The ACC approved an increase in non-fuel base rates of $116.3 million, which represented roughly 60% of APS requested amount based on an authorized return on equity (ROE) of 10%. The settlement is consistent with Fitch’s modeling forecasts and supports Fitch’s projection of improved coverage measures.
The 2010 GRC settlement includes provisions for partial revenue decoupling, post-test year plant additions, future property tax deferrals, and generation and environmental compliance tracking mechanisms. In addition, the Power Supply Adjustor (PSA) was expanded to recover 100% of fuel and purchased power expense from the current 90% level. The adoption of these proposals by the ACC is a constructive development for APS and PNW’s creditworthiness as these mechanisms ameliorate regulatory lag and improve their business risk profiles. In Fitch’s view, the issuance of the final order by the ACC at roughly 10 months following certification is considered constructive. Additionally, per the terms of the settlement, APS agreed to a 4 year stay-out and is prohibited from filing its next rate case before May 31, 2015 for rates effective on or after July 1, 2016, at the earliest. Going forward, controlling operating costs will be key to maintaining credit quality.
Fitch expects capex projects to be funded with a balanced mix of debt and equity. As part of the 2008 GRC settlement, APS’ parent, Pinnacle West Capital Corp. (PNW; IDR ‘BBB’, Stable Outlook) is required to make $447 million of equity injections into APS before the end of 2014. Fitch expects PNW to issue equity during 2013 – 2014.
As of March 31, 2012, PNW had total consolidated liquidity available of $1 billion including $20.7 million of cash and cash equivalents. PNW maintains liquidity through a $200 million unsecured credit facility which matures in November 2016. APS maintains liquidity through two $500 million unsecured credit facilities which mature in February 2015 and November 2016, respectively. Additionally, PNW and APS can upsize their $200mm and $500 million credit facilities to $300 million and $700 million with consent of the lenders. The credit facilities are subject to a maximum debt to capitalization covenant of 65%, and as of March 31, 2011 both PNW and APS were in compliance with debt to capitalization ratios of 51.5% and 49.7%. PNW’s revolving credit facility contains cross-default provisions to APS, while APS’ revolving credit facilities do not contain cross-defaults to PNW. As of March 31st 2012, PNW and APS were in compliance with all financial covenants under these facilities.
Long-term debt maturities are expected to be manageable and include no parent company debt through 2014. On Feb. 23, 2011, PNW entered into a $175 million term loan facility that matures in February 2015 and used the proceeds to repay $175 million of maturing parent company debt. As of Dec. 31, 2011 $125 million was outstanding under the term loan.
Improved Nuclear Performance: On the operating front, APS’ generating facilities exhibited solid operating performance in 2011 with meaningful improvement achieved at the Palo Verde Nuclear Generating Station (PVNGS). In 2011, the PVNGS successfully refueled units 1 and 2, and recorded its best generation year ever producing over 31 million megawatt-hours, with an overall capacity factor of 90.7%, materially up from 79% in 2007.
Fitch expects capex ($885 million in 2011) to increase over the next couple of years. The increase reflects the purchase of Southern California Edison Company’s interest in units 4 and 5 at the Four Corners coal generating facility for $294 million by 2013 and related emissions control upgrades. Additionally, APS is also increasing its renewable generation capacity to meet Renewable Portfolio Standard targets in the state. Going forward, Fitch projects capex to average $1.1 billion through 2014.
PNW is a parent holding company that derives substantially all of its revenue from its wholly-owned operating subsidiary, APS. APS is a vertically integrated regulated electric utility that accounted for virtually all consolidated PNW revenues, earnings, and total assets. For 2011, 2010, 2009, and 2008, APS approximated 100%, 97%, 99%, and 97% of PNW’s consolidated revenues, respectively. APS is the largest electric utility in Arizona, serving 1.1 million customers in a 34,646 square mile service territory.