Fitch Rates Southern Company's Jr Sub Notes 'BBB '; Negative Watch
The debentures are junior and subordinated in right of payment and upon liquidation to all of Southern's senior indebtedness. Southern Company may defer interest payments on the debentures on one or more occasions for up to 10 consecutive years per deferral period.
The securities are eligible for 50% equity credit under Fitch's applicable criteria 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' dated Nov. 25, 2014. Features supporting the equity categorization of these debentures include their junior subordinate priority, the option to defer interest payments on a cumulative basis for up to 10 years on each occasion and a 60-year maturity.
KEY RATING DRIVERS
Rating Watch Negative: Fitch placed Southern's 'A' long-term Issuer Default Rating on Rating Watch Negative on Aug. 24, 2015 following the company's announcement that it would acquire AGL Resources (AGL, 'BBB+'/Rating watch Positive) for \\$8 billion in cash. Southern should benefit from the greater scale and diversity from the addition of AGL's predominantly low-risk natural gas distribution businesses. However, these benefits will be partially offset by the increase in the company's near-term leverage given the primarily debt driven acquisition financing and a measured pace of deleveraging through 2019.
Majority Debt Funding of the Acquisition: The proposed acquisition results in a meaningful increase in consolidated leverage compared to Southern's current and projected stand-alone financial condition. The rise in leverage is driven by the combination of the acquisition debt to be issued by Southern, the assumption of existing AGL consolidated debt and a measured pace of deleveraging to reach a permanent acquisition financing mix of 63% debt and 37% equity by 2019. Fitch expects consolidated cash flow leverage and fixed charge coverage measures of the combined entity to meaningfully weaken in the short to medium term compared with Southern's standalone credit profile. Based on preliminary analysis and excluding benefits of any potential synergies, Fitch forecasts pro forma adjusted FFO leverage to be in the 4.5x - 5.0x range and FFO fixed charge coverage in the 4.5x - 4.75x range over the forecast period.
Improved Business Profile: The acquisition of AGL meaningfully reduces Southern's risk profile, in Fitch's view. Fitch generally views gas distribution businesses as low risk and AGL's utilities are generally well managed with numerous supportive regulatory mechanisms in place. AGL's rising investments in inter-state pipelines carry moderately higher competitive market risks, but these are offset to a large extent by long-term offtake agreements with credit worthy counterparties. While the non-regulated retail and wholesale businesses of AGL are volatile, the exposure is somewhat contained given these will be a small part of the combined company.
Southern gains tremendous scale and geographic diversity with this acquisition and its inaugural pursuit of natural gas businesses can smooth out earnings and cash flow of its predominantly summer peaking electric utilities. The combination also lowers the contribution of its non-regulated, albeit conservatively managed, Southern Power Company in the overall business mix as well as that of its utility subsidiary, Mississippi Power Company, which is undergoing significant stress related to the construction cost overrun and inadequate rate recovery for the Kemper Integrated Gasification Combined Cycle (IGCC) project.
Other Capital Needs at Southern: The capital needs at Southern have increased since Fitch's last review. Its non-regulated subsidiary, Southern Power Company ('BBB+'/Outlook Stable), has announced the acquisition of three large projects that includes two solar and one wind projects. Southern Power typically funds its investments with 50% - 55% debt. The equity portion of the capex is generally funded by retained cash flows and/or equity infusion by the parent company. Separately, Mississippi Power has revised its in-service date for the Kemper IGCC project, which has now moved after April 19, 2015, forcing the company to return to the IRS approximately \\$234 million of Phase II investment tax credits that were received for the project. Southern is expected to support Mississippi Power to refund this amount.
Resolution of the Rating Watch: Fitch expects to resolve the Rating Watch either at or close to the transaction's completion, which will take approximately 12 months. The regulatory approval process and the pace of equity issuance by Southern will be the key data points to monitor. In parallel, Fitch will continue to track the progress of the Kemper IGCC project, which includes successful completion (currently estimated in first half of 2016) and operations of the plant, resolution of regulatory uncertainty in Mississippi (order on the permanent rate recovery for the in-service portion of the plant scheduled for early December 2015), and issuance of approximately \\$1 billion in securitization proceeds at Mississippi Power Company (Fitch's expectation is early 2017). Fitch will also track the construction program of the Vogtle 3 and 4 units by Georgia Power Company based on the current costs and schedule and continuation of regulatory support in Georgia as demonstrated through future Vogtle Construction Monitoring proceedings and the next general case to be filed in mid-2016.
Fitch's key assumptions within the rating case for Southern are as follows:
--No material retention of synergies from the AGL acquisition;
--Issuance of \\$3 billion in equity proceeds from 4Q2015 through 2019 in a ratable manner;
--At Alabama Power Company, modest increases in Rate Stabilization & Equalization (RSE) rates over 2015-2017, 1.5% increase under environmental rates in 2015 and 2.5% in 2016 and 0.5% increase in electricity sales in 2015 and 2016;
--At Georgia Power Company, 1.5% increase in electricity sales, rate increases as authorized in last base rate case, Nuclear Construction Cost Recovery (NCCR) tariff increases of 0.3% in 2015, and between 0.5%-1% over 2016-2017; and Vogtle 3 & 4 in-service in 2019 and 2020;
--At Gulf Power Company, a decline in sales by 1% in 2015, 0.5% growth in 2016 and 1% in 2017 and rate increase per the last rate order;
--At Mississippi Power Company, ROE of 9.7% for 2015-2017, 100% ownership of Kemper IGCC with 85% of the project recovered through regulated rates, Permanent rate recovery for in-service assets in-line with interim rates approved, securitization of \\$1 billion in January 2017, Kemper IGCC commercial operations date (COD) by June 2016 within the current budgeted costs, modest Performance Evaluation Plan (PEP) and Environmental Compliance Overview (ECO) rate increase over 2016 - 2017, and 1% electricity sales growth over 2015-2017;
--At Southern Power Company, growth projects as announced and balanced funding of growth capex.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Pace of deleveraging such that FFO adjusted leverage sustains at or below 4.0x;
--COD of Kemper without any further material escalation in currently projected capital costs followed by successful operational performance;
--Constructive outcome in Mississippi Power Company's pending rate filings;
--No material cost and/or schedule escalation for Vogtle units and any adjustments to the overall project costs deemed recoverable by the Georgia PSC;
--Continued regulatory support in Georgia regarding the VCM filings and next general rate case to be filed mid-2016.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Regulatory concessions in excess of those assumed in the financial forecasts or a reduction in planned equity issuance could have an adverse effect on ratings;
--Significant time/cost overrun at Vogtle and/or Kemper projects that are primarily debt financed and negative regulatory actions on the recovery of those costs;
--FFO adjusted leverage weakens to 4.5x or higher on a sustained basis.
At June 30, 2015, Southern and its subsidiaries had approximately \\$0.8 billion of cash and cash equivalents and approximately \\$5.1 billion of unused committed credit arrangements with banks. A portion of unused credit with banks is allocated to provide liquidity support to the utility subsidiaries' variable rate pollution control bonds and commercial paper programs. The amount of variable rate pollution control revenue bonds outstanding requiring liquidity support as of June 30, 2015 was approximately \\$1.9 billion. Approximately \\$1.2 billion of commercial paper borrowings and \\$717 million of short-term debt was outstanding as of June 30, 2015.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following rating:
--Junior subordinated notes 'BBB+' on Rating Watch Negative.