NEW YORK–(BUSINESS WIRE)–Fitch Ratings has upgraded the Issuer Default Rating (IDR) of Tucson Electric Power Company (TEP) one-notch to ‘BBB-‘ from ‘BB+’ with a Stable Rating Outlook.
The short-term IDR and securities ratings were also upgraded one-notch, as follows:
–First mortgage bonds to ‘BBB+’ from ‘BBB’; –Secured bank facility to ‘BBB+’ from ‘BBB’; –Unsecured industrial revenue bonds to ‘BBB’ from ‘BBB-‘; –Unsecured pollution control revenue bonds to ‘BBB’ from ‘BBB-‘; –Unsecured notes to ‘BBB’ from ‘BBB-‘; –Short-term IDR to ‘F3’ from ‘B’.
Approximately $1.6 billion of debt securities are affected by the rating action. TEP is a wholly-owned subsidiary of UNS Energy.
Key rating drivers include: –Stable earnings and cash flows –Pending 2012 GRC with the ACC; –Nearing the end of a five-year non-fuel base rate freeze; –Adoption of a more flexible leverage covenant in bank agreement; –High leverage (including capital lease obligations); and –Exposure to changes in environmental rules and regulations;
The ratings upgrade and Stable Outlook reflects TEP’s relatively strong performance at the end of its five-year non-fuel base rate freeze ending this year. Fitch assumes a reasonable outcome in the utility’s pending 2012 GRC which will provide a tailwind for increased earnings in 2013 and 2014. A constructive outcome in TEP’s pending 2012 General Rate Case (GRC) should permit an adequate rate of return on investment on recent rate base additions and recovery of higher operating expenses incurred over the last few years.
TEP’s capital structure remains burdened by high levels of debt and a large capital expenditure program affords little opportunity to decrease leverage. However, TEP has made progress in improving its debt profile as it has reduced its exposure to variable rate debt. For the LTM ending June 30, 2012, TEP’s variable rate debt comprised 15.9% of total long-term debt, as compared to 26% for 2010, including capital lease debt.
2012 GRC filed; Partial Decoupling Requested: On July 2, 2012 TEP filed its 2012 GRC with the ACC and requested a nonfuel base rate increase of $128 million dollars predicated on an 10.75% ROE for rates effective no later than Aug. 1, 2013. Notably, TEP’s filing includes a request for a Lost Fixed Cost Recovery (LFCR) mechanism and an Environmental Compliance Adjustor (ECA). The LFCR is a partial revenue decoupling mechanism which is designed to recover non-fuel costs associated with the implementation of energy efficiency or distributed generation programs. The ECA is a recovery mechanism designed to recover compliance costs associated with environmental regulations, primarily for pollution control upgrades on TEP’s coal fired generation fleet. Fitch notes that the LFCR is not weather normalized and expects a decision by August of next year.
Solid Operating Performance: For the LTM period ending June 30, 2012 TEP’s EBITDA coverage ratios trended flat at 4.0x as compared to 4.1x for 2011. Similarly, TEP’s FFO coverage ratios approximated 3.9x and 3.8x over the same time periods. Leverage for the LTM ending June 30, 2012, as measured by Debt to EBITDA, was high at 4.4x.
Coverage Metrics Expected to Improve: Over a five-year forecast period, Fitch projects that TEP’s EBITDA coverage ratios could reach 5.9x reflecting rate base additions and new rates. In the intermediate term, TEP is forecasted to be modestly Free Cash Flow negative due to increased capital spending needs associated with emissions compliance and transmission investments. Going forward, leverage ratios are also expected to show modest improvement as TEP amortizes its capital lease obligations. Debt to total capitalization is expected to decline to 58% in 2014 from 65% currently. Fitch includes capital lease obligations in its debt leverage calculations; approximately two-thirds of TEP’s capital lease obligations mature by 2015.
Increased Capital Expenditure Needs: TEP plans to spend $1.8 billion on capital expenditures through 2016, and capital expenditures are expected to average $350 million per annum. Capital expenditures associated with environmental compliance investments and transmission projects account for the bulk of increased capital spending levels. Additionally, capital expenditures for solar projects are expected to average $30 million per annum. Going forward, the majority of capital expenditures are covered by operating cash flows and Fitch projects TEP to be modestly FCF negative.
Manageable Maturities: Debt maturities at TEP are manageable and mainly consist of capital lease obligations. As of June 30th 2012, TEP had $365 million of capital lease obligations on the balance sheet of which $258 million amortizes by 2015.
Sufficient Liquidity: TEP’s $386 million secured bank facility includes a $200 million revolving credit facility used to meet day-to-day working capital requirements and a $186 million secured letter-of-credit facility that supports outstanding tax-exempt bonds. TEP’s secured bank facility matures in November 2016 and is secured by a First Mortgage Bond indenture. As of June 30, 2012, TEP had total available liquidity of $82 million including $32 million of cash and cash equivalents and $50 million of available borrowing capacity under its secured revolving credit facility.
In November of 2011, TEP amended its $200 million secured credit agreement and extended the maturity by two years to 2016. TEP’s revolving credit facility contains a maximum debt to capitalization covenant ratio of 70%, and as of June 30, 2012 TEP was in compliance with a debt to capitalization ratio of 65.1%. Fitch notes that TEP has limited headroom in their capital structure under their leverage covenant.
What could lead to a credit rating upgrade? –None anticipated in the near term.
What could lead to a credit rating downgrade? –An outcome in the 2012 GRC which limits TEP’s ability to earn an adequate and timely return on invested capital.