Fitch Affirms Oncor at 'BBB'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed Oncor Electric Delivery Company LLC's (Oncor) Long-Term Issuer Default Rating (IDR) at 'BBB' and Short-Term IDR at 'F3'. The Rating Outlook is Stable. Fitch's rating case does not include the sale of Oncor to a consortium of investors led by Hunt Consolidated Inc. and the conversion into a Real Estate Investment Trust (REIT). Even though the Public Utility Commission of Texas (PUCT) recently approved the change of control, some of the conditions laid out are onerous and cast considerable uncertainty around the ultimate closing of the transaction.
The buyer consortium plans to convert Oncor into a Lessee-Lessor structure, whereby the operating assets will be separated from real property. Oncor AssetCo (the Lessor) will own the real property i.e. the transmission and distribution assets and lease it to Oncor Electric Delivery Co. (OEDC, the Lessee). The ultimate parent company, Ovation Acquisition 1, would hold 100% indirect ownership in Oncor Electric Delivery Holdings Company LLC (Oncor Holdings) and elect to be taxed as a REIT. OEDC will be wholly owned by the Hunt family.
Fitch generally views the REIT structure for a utility parent holding company to be weaker in credit quality. The requirement for a REIT to distribute at least 90% of its taxable income to shareholders diminishes its financial flexibility, the continuous reliance on external capital to fund growth capex and distribution subjects the REIT to vagaries of the capital markets, and the still untested regulatory treatment of such structures including lease terms and sharing of tax benefits lead to significant regulatory overhang. While the strong ring-fencing provisions in PUCT's conditional approval are supportive of Oncor AssetCo's credit quality and could effectively insulate its credit from a weaker ultimate parent, the potential sharing of tax benefits with customers could be material and, if so, will affect its profitability and cash flow. Hence, if the proposed transaction did close, Fitch anticipates negative rating pressure for Oncor AssetCo.
KEY RATING DRIVERS
Strong Ring Fencing Provisions: Fitch continues to believe that Oncor is effectively ring-fenced from its indirect parent holding company, Energy Future Intermediate Holding Company LLC (EFIH), and its ultimate parent, Energy Future Holdings Corp. (EFH). Fitch is encouraged to see the PUCT's intent to preserve the strong ring-fencing and, hence, protect the credit quality of Oncor as demonstrated by the conditions laid out in their order conditionally approving the change of control. The PUCT order mandates several strong governance provisions at Oncor AssetCo and Oncor Holdings, restrictions on affiliate transactions as well as distribution restrictions at Oncor AssetCo if the combined leverage of Oncor AssetCo, OEDC and Oncor Holdings exceeds the regulatory approved ratio or if Oncor AssetCo's credit ratings fall to below investment grade.
Regulatory Overhang: The buyer consortium initiated tariff proceedings this week to establish the initial lease terms between Oncor AssetCo and OEDC. The PUCT must rule on the initial rates and tariffs of Oncor AssetCo before August 5th, or the order to purchase and restructure Oncor expires.
In parallel, the PUCT intends to conduct a rulemaking to address the appropriate tax expense to use in setting rates for TX utilities even though the amount of tax sharing for a restructured Oncor shall be addressed in its next rate case. There is no definitive timeline for this rulemaking to be completed and may extend beyond November 30th, which is the date when the PUCT's conditional approval expires. The possibility of sharing the tax savings resulting from the REIT structure with customers was the key basis for the PUCT determination that the transaction is in public interest.
Separately, it is likely that certain TX cities could initiate a rate case against Oncor in the near-term. Fitch's earlier expectations were that any general rate case proceedings will likely take place after the change of control is implemented. In its order, the PUCT requires Oncor AssetCo and OEDC to file a rate case by July 1, 2017.
Strong Operational Performance: Oncor's operational performance continues to be robust. Weather-adjusted residential sales and large commercial and industrial (C&I) sales continue to be strong despite the slowdown in oil and gas related activity. Residential customer base grew 1.5%, and large C&I GWH sales increased 1.8% in 2015. Fitch believes this is driven by the diversity of the industrial base and the positive impact of falling oil and gas prices on energy intensive industries based in Texas. Another significant driver of Oncor's performance has been growth in transmission investments, which still remain a focus area for the PUCT.
Strong Credit Metrics: For the last twelve months ending Dec. 31, 2015, Oncor reported Earnings before Interest, Depreciation and Taxes (EBITDA) to interest ratio of 5.5x and debt to EBITDA of 3.6x. Oncor is planning to spend approximately $1.4 billion in capex in 2016 and could potentially spend more than $1.5 billion annually over 2017 - 2021. Various tracker mechanisms allow Oncor to earn a return on transmission related capital investment with minimal regulatory lag. But absence of distribution rate increases since 2012 may cause Oncor to trail its authorized ROE by 2016, in Fitch's view. The timing of the next rate case remains uncertain. While Oncor is likely to file a general rate case only after the change in ownership is effective, it is likely that certain TX cities could initiate a rate proceeding sooner. Fitch's financial projections for Oncor on a stand-alone basis incorporate a rate increase in 2017 that allows Oncor to earn an ROE closer to its currently authorized level. In such a scenario, Fitch estimates Oncor's EBITDA to interest ratio to sustain above 5.0x over 2016 - 2018 and debt to EBITDA to approximate 3.8x over the same period.
Fitch's key assumptions within the rating case for Oncor include:
--The sale of Oncor to the buyer consortium led by the Hunt Consolidated Inc. does not go through;
--Volumetric sales growth of 1% p.a. in 2016 and 1.5% thereafter;
--O&M costs inflated at 3% annually;
--Rate increase in 2017 that allows Oncor to earn ROE close to its current authorized levels;
--Capex of $4.4 billion over 2016-2018; and
--Continuation of the existing ring-fencing provisions.
Positive: Future positive rating actions are unlikely unless there is clarity regarding the ultimate indirect ownership of Oncor, the nature of ring-fencing arrangements, and the regulatory treatment in subsequent rate proceedings. Oncor's current and forecasted credit metrics are comparable with those of its peer T&D utilities in Texas, which Fitch rates one-notch above Oncor's IDR. The notching of the senior secured debt at Oncor has been further constrained to reflect ownership by a distressed parent.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Ownership by a weak ultimate parent;
--Weak ring-fencing provisions that lead to a close rating linkage between Oncor and its ultimate parent;
--Material amount of debt above Oncor Holdings with limited visibility on deleveraging;
--Adverse outcomes in future rate cases such as significant sharing of tax benefits or material reduction in authorized ROEs; and
--Sustained weakness in total adjusted debt to EBITDAR measures above 4.5x.
Oncor has adequate availability under the corporate revolver. As of Dec. 31, 2015, Oncor's $2.0 billion corporate revolving facility, currently due October 2017, had borrowings of $840 million and letter of credits outstanding of $7 million. The drawn balances are large and reflect a high capex spend; Oncor typically draws on its corporate revolver to fund capital work in progress and subsequently replaces the drawn balances with permanent financing and/or internally generated funds. Oncor can request the lenders to increase the borrowing capacity of the revolver by $100 million and to extend the maturity in two one-year increments. Oncor exercised one of the two one-year extensions in October 2015. Under the terms of the corporate revolver, the lenders' commitments are several and not joint.