NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has assigned an Issuer Default Rating (IDR) of 'A' to Southern Electric Generating Company (SEGCO). The Rating Outlook is Stable. Fitch expects to assign an 'A+' rating to SEGCO's proposed offering of $100 million series 2013A 2.200% senior notes due Dec. 1, 2018. The notes are fully and unconditionally guaranteed by Alabama Power Company (Alabama Power; IDR 'A'). The net proceeds from the offering will be used by SEGCO for general corporate purposes, including the pay down of a portion of short-term debt that stood at approximately $90.8 million as of Nov. 15, 2013, and for the company's continuous construction program.
KEY RATINGS DRIVERS
The ratings of SEGCO are supported by a joint ownership by Georgia Power Company (Georgia Power) and Alabama Power, both of which carry an 'A' IDR by Fitch and are, in turn, wholly owned subsidiaries of Southern Company (IDR 'A'). SEGCO's debt is fully and unconditionally guaranteed by Alabama Power, which, in turn, has an indemnification from Georgia Power to cover 50% of SEGCO's debt repayment in case of a default by SEGCO.
SEGCO's primary asset consists of 1,020 MWs of coal-fired units, which have a power purchase agreement (PPA) with Alabama Power and Georgia Power under which each utility is entitled to 50% of the capacity and energy from the units. Alabama Power manages the operation of the units and provides fuel to the units. The PPA provides SEGCO with sufficient payment to cover its operating expenses, taxes, interest expense and an 11% return on equity (ROE). The terms of the PPA extend automatically for two-year periods, subject to either party's right to cancel upon two years' written notice. Both Alabama Power and Georgia Power recover the capacity and energy purchased from SEGCO through their own capacity and purchased power clauses.
SEGCO has $75 million of committed credit arrangements expiring during 2014 and $25 million of committed credit arrangements expiring in 2015. As of Nov.r 15, 2013, there were no outstanding borrowings under the credit arrangements. SEGCO can also meet short-term cash needs through a Southern Company subsidiary organized to issue and sell commercial paper. Proceeds from such issuances are loaned directly to SEGCO. As of Nov. 15, 2013, SEGCO had $90.8 million of commercial paper outstanding. SEGCO has been authorized by the Alabama Public Service Commission (PSC) through 2015 to issue up to $150 million of long-term securities and to have outstanding up to $150 million of short-term borrowings, including borrowings from Alabama Power and Georgia Power.
Alabama Power's ratings reflect Fitch's view that the utility will continue to generate strong credit metrics over the next three years driven by a gradual improvement in industrial sales and rate increases under the Rate Stabilization & Equalization (RSE) mechanism and environmental cost recovery clauses. Alabama Power enjoys a constructive regulatory environment and has consistently earned more than 13% ROE over the last five years. Cost-of-service recovery mechanisms provide timely recovery of all prudent costs through various rates/cost trackers, such as those incurred for fuel, purchased power, storm costs, environmental expenditures and new generation facilities.
Alabama Power recently received a favorable outcome from the Alabama PSC regarding review of its RSE mechanism. The PSC voted to replace the current ROE range of 13%-14.5% and allowed equity ratio of 45% with a weighted cost of equity (WCE) provision. The WCE range was established by the PSC at 5.75%-6.21% with an adjusting point of 5.98%, which is modestly lower than the implied WCE range under current rates of 5.85%-6.53% with an adjusting point of 6.19%. In addition, Alabama Power will be eligible for a performance-based adder of 0.07% if it is rated 'A' by at least one of the major credit rating agencies or is in the top one-third in customer satisfaction survey. The resolution of the RSE review was in line with Fitch's expectation and removes a key source of regulatory uncertainty for Alabama Power.
Rating concerns for Alabama Power include a high reliance on the industrial sector, which makes up for 37% of its total MWH sales. The dominant industrial customers in its service territory comprise chemicals, pipelines, primary metals and pulp and paper. Fitch sees enough room in the credit metrics to absorb a prolonged period of economic slowdown in Alabama Power's service territory; this was demonstrated during the stressed economic conditions of the year 2009. Fitch expects adjusted debt to EBITDA ratio to be approximately 3.2x over the next three years. Funds from operations (FFO) to adjusted debt is expected to moderate to 22% by 2015 after the benefit of bonus depreciation recedes.
Other rating concerns include Alabama Power's large coal mix (about 55% of total generation), which leaves the utility exposed to potential higher environmental expenditures. While Alabama Power has an environmental clause that allows for recovery of all prudent and mandated expenditures, the retail electricity rates would rise, reducing the flexibility for Alabama Power to increase the base rates to earn an attractive ROE.
Weak Industrial Sales: Sharp industrial slowdown in Alabama Power's service territory that depresses margins as well as curtails its flexibility to continue to earn attractive ROEs would lead to downward rating actions.
Unexpected negative regulatory developments that cause a mismatch between incurrence and recovery of capital and operating expenses could lead to unfavorable rating actions.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 5, 2013;
--'Parent and Subsidiary Rating Linkage', Aug. 5, 2013;
--'Short-Term Ratings Criteria for Non-Financial Corporates', Aug. 5, 2013;
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', Dec. 13, 2012;
--'Recovery Ratings and Notching Criteria for Utilities', Nov. 19, 2013;
--'Rating North American Utilities, Power, Gas and Water Companies', May 16, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies
- Investment & Company Information
- Alabama Power
- Fitch Ratings
- Georgia Power
Shalini Mahajan, CFA
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Brian Bertsch, +1-212-908-0549 (New York)