AEP Generating Company — Moody's downgrades AEP, AEP Texas, Ohio Power and PSC of Oklahoma, outlooks stable
Rating Action: Moody’s downgrades AEP, AEP Texas, Ohio Power and PSC of Oklahoma, outlooks stable
Global Credit Research – 06 Aug 2020
Approximately $15 billion of debt and credit facilities affected
New York, August 06, 2020 — Moody’s Investors Service (Moody’s) downgraded the long-term ratings of American Electric Power Company, Inc. (AEP, senior unsecured to Baa2 from Baa1) and its subsidiaries AEP Texas Inc. (AEP Texas, senior unsecured to Baa2 from Baa1), Ohio Power Company (OPCo, senior unsecured to A3 from A2), and Public Service Company of Oklahoma (PSO, senior unsecured to Baa1 from A3). At the same time, Moody’s revised the outlooks for AEP, AEP Texas, OPCo and PSO to stable from negative. A complete list of rating actions is included below.
RATINGS RATIONALE
“The downgrades of AEP and utility subsidiaries AEP Texas, Ohio Power and Public Service of Oklahoma reflect weakened financial profiles that are being driven by large capital programs and an increased use of leverage”, said Laura Schumacher, Vice President — Senior Credit Officer. Although AEP’s most recent financing plan includes an additional $1.3 billion of equity to fund its acquisition of the $2 billion North Central Wind projects in 2021, prior acquisitions and ongoing capital spending have added debt to all of the companies’ balance sheets. While capital programs at the utilities remain primarily focused on growth in lower risk transmission and distribution networks and renewable generation, the subsidiaries cash flows continue to be negatively impacted by the accelerated return of deferred income taxes and the near-term inability to monetize production tax credits. At the same time, the consolidated organization is relying more heavily on debt than it had historically.
The downgrade of AEP Texas is driven primarily by the increase in leverage we expect will occur following the company’s 2020 general rate case decision. The authorization resulted in a $40 million annual revenue reduction ($170 million in year one), based on a 9.4% return on equity and a 42.5% equity layer rather than the 45% requested. Rates became effective in June. AEP now plans to increase leverage at AEP Texas to align more closely with its approved capital structure. The higher debt burden, when combined with the lower authorized revenues, will cause cash flow credit metrics to decline materially from their current levels. For example, the ratio of cash flow from operations excluding changes in working capital (CFO pre-WC) to debt will be in the range of 12-13% versus 18% for the twelve months ending March 2020, and 17% for 2019.
The downgrade of OPCo reflects a similarly weakened financial profile that is being driven by its ongoing elevated capital program and the loss of supplemental cash flow previously generated by Ohio regulatory commission approved transition riders. Going forward, we expect a significant portion of OPCo’s investment will be funded with debt, and that the utility’s credit metrics will remain under pressure. For example, we anticipate that OPCo will produce ratios of CFO pre-WC to debt that are in the mid-to-high teens as compared to ratios that, prior to 2019, were above 30%.
The downgrade of PSO considers the results of the company’s 2019 rate case decision, its planned acquisition of 45% of the North Central Wind projects, and ongoing financing strategies. While PSO’s earnings profile improved following the rate case outcome, its cash flows are being negatively impacted by the fairly rapid (over five years) return of excess deferred taxes and the inability to accelerate recovery of the Oklaunion coal-fired plant scheduled to close in October 2020. The acquisition of 675 MW of the North Central Wind projects has been authorized at the company’s current 9.4% earnings level and will be funded in line with the company’s approved capital structure, which includes about 48% equity. While the acquisition is accretive to earnings, given the long-lived nature of the assets, the need to defer production tax credits along with the balance of the company’s capital program, PSO’s cash flow based credit metrics will remain under pressure. For example, ratios of CFO pre-WC to debt will be in the mid-to-high teens rather than returning to a level above 19% that we had established as a threshold to maintain PSO’s prior A3 rating.
The downgrade of AEP considers the downgrades of these three utility subsidiaries and recognizes that its consolidated capital program, which includes the North Central Wind projects along with growth at its lower risk transmission and distribution networks, will be executed with significant use of leverage. In addition to increasing debt at its subsidiaries, AEP is also relying more heavily on parent level debt to support the equity needs of its operating utilities. Historically, AEP’s capital structure had incorporated a very limited amount of holding company debt, a key credit positive compared to many holding company peers. Currently, however, parent level debt represents about 20% of consolidated AEP debt, and the ratio will likely remain near this level.
Environmental, social and governance considerations incorporated into our credit analysis for AEP and its subsidiaries are primarily related to carbon regulations and social risks related to demographic and societal trends, as well as customer and regulatory relations. AEP has moderate carbon transition risk within the regulated utility sector as the majority of its energy is generated by fossil fuels. Although still heavily reliant on coal generation, AEP is focused on transitioning to a cleaner energy future. As of 2019, AEP’s consolidated 31,524 MW generating portfolio included about 45% coal-fired resources, versus about 66% in 1999, and about 17% in renewable generation, compared to around 4% in 2005. The North Central Wind projects will add close to 1,500 MW of wind generation bringing renewables to about 20% of the portfolio. From a governance perspective, financial strategy and risk management are key considerations.
The rapid spread of the coronavirus outbreak, severe global economic shock, low oil prices and asset price volatility are creating a severe and extensive credit shock across many sectors, regions, and markets. The combined credit effects of these developments are unprecedented. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. However, we do not consider the impact of the coronavirus outbreak to be a material credit driver for AEP.
As events related to the coronavirus continue, we are taking into consideration a wider range of potential outcomes, including more severe downside scenarios. The effects of the pandemic could result in financial metrics that are weaker than expected; however, we see these issues as temporary and not reflective of the long-term financial or credit profile of AEP.
Outlook
The stable outlooks for AEP, AEP Texas, OPCo and PSO recognize that the companies continue to benefit from supportive regulatory frameworks that provide numerous riders and trackers to assure recovery of the investments the utilities are making to grow rate base. The outlooks consider that the sizable capital programs are focused on lower risk transmission and distribution networks and renewables, which facilitate the organization’s clean energy transition and reduce its carbon transition risk.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Factors that could lead to an upgrade
Upward ratings pressure could develop if there were to be an increase in cash flow, perhaps due to regulatory activity or load growth, or a reduction in leverage such that we could expect key financial credit metrics to strengthen. For example, at AEP a ratio of CFO pre-WC to debt sustained above 15%, at AEP Texas a ratio of CFO pre-WC to debt sustained above 15%, at OPCo a ratio of CFO pre-WC to debt sustained above 20%, and at PSO a ratio of CFO pre-WC to debt sustained above 20%. A reduction in parent leverage, such that the ratio of parent to consolidated debt moves closer to 10%, could put upward pressure on AEP’s rating.
Factors that could lead to a downgrade
There could be downward pressure on the ratings if a more contentious regulatory environment were to develop in any of AEP’s jurisdictions, if ongoing capital investments cannot be recovered on a timely basis, or if financial metrics deteriorate. For example, at AEP a ratio of CFO pre-WC to debt sustained below 13%, at AEP Texas a ratio of CFO pre-WC to debt sustained below 12%, at OPCo a ratio of CFO pre-WC to debt sustained below 16%, and at PSO a ratio of CFO pre-WC to debt sustained below 16%.
Downgrades:
..Issuer: American Electric Power Company, Inc.
….Senior Unsecured Regular Bond/Debenture, Downgraded to Baa2 from Baa1
….Junior Subordinated Regular Bond/Debenture, Downgraded to Baa3 from Baa2
….Senior Unsecured Shelf, Downgraded to (P)Baa2 from (P)Baa1
….Junior Subordinated Shelf, Downgraded to (P)Baa3 from (P)Baa2
..Issuer: Ohio Air Quality Development Authority
….Senior Unsecured Revenue Bonds, Downgraded to Baa2 from Baa1
..Issuer: Rockport (City of) IN
….Senior Unsecured Revenue Bonds, Downgraded to Baa2 from Baa1
..Issuer: AEP Texas Inc.
….Issuer Rating, Downgraded to Baa2 from Baa1
….Senior Unsecured Regular Bond/Debenture, Downgraded to Baa2 from Baa1
..Issuer: AEP Texas Central Company
….Senior Unsecured Regular Bond/Debenture, Downgraded to Baa2 from Baa1
..Issuer: Matagorda County Navigation District 1, TX
….Senior Unsecured Revenue Bonds, Downgraded to Baa2 from Baa1
….Underlying Senior Unsecured Revenue Bonds, Downgraded to Baa2 from Baa1
..Issuer: Ohio Power Company
….Issuer Rating, Downgraded to A3 from A2
….Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2
….Senior Unsecured Shelf, Downgraded to (P)A3 from (P)A2
..Issuer: Columbus Southern Power Company
….Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2 (Assumed by Ohio Power Company)
..Issuer: Public Service Company of Oklahoma
….Issuer Rating, Downgraded to Baa1 from A3
….Senior Unsecured Regular Bond/Debenture, Downgraded to Baa1 from A3
Affirmations:
..Issuer: American Electric Power Company, Inc.
….Commercial Paper, Affirmed P-2
Outlook Actions:
..Issuer: American Electric Power Company, Inc.
….Outlook, Changed To Stable From Negative
..Issuer: AEP Texas Inc.
….Outlook, Changed To Stable From Negative
..Issuer: Ohio Power Company
….Outlook, Changed To Stable From Negative
..Issuer: Public Service Company of Oklahoma
….Outlook, Changed To Stable From Negative
Headquartered in Columbus, Ohio, AEP is a large electric utility holding company with nine vertically integrated or retail transmission and distribution utility subsidiaries operating in eleven states. The company also operates transmission companies within the eastern and southwestern regions of the United States and owns a competitive generation and marketing business that is currently focused on growing its contracted renewable generation portfolio. AEP currently has a regulated rate base of around $46 billion and serves about 5.5 million customers.
The principal methodology used in these ratings was Regulated Electric and Gas Utilities published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1072530. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Laura Schumacher VP - Senior Credit Officer Infrastructure Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Michael G. Haggarty Associate Managing Director Infrastructure Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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