Narragansett Electric Company -- Moody's places NECO's Baa1/Baa3 ratings on review for upgrade

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Rating Action: Moody's places NECO's Baa1/Baa3 ratings on review for upgradeGlobal Credit Research - 18 Mar 2021London, 18 March 2021 -- Moody's Investors Service (Moody's) has today placed on review for upgrade the Baa1 long-term issuer and senior unsecured ratings of Narragansett Electric Company (NECO), and the Baa3 rating of its preferred stock securities. Concurrently, Moody's has changed NECO's issuer outlook to ratings under review from stable. NECO, which is ultimately owned by National Grid plc (National Grid, Baa2 stable), is a retail distribution company providing electric and gas services to customers in Rhode Island, where it also owns electricity transmission assets.The rating review was prompted by the 18 March announcement [1] that National Grid and PPL Corporation (PPL, Baa2 positive) have agreed that NECO will be sold to PPL following the purchase of PPL's UK regulated assets by National Grid.RATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe asset sale, if concluded, will remove an existing cap on NECO's Baa1 ratings. Moody's currently views the consolidated credit quality of the National Grid group, commensurate with a Baa1 rating, as a constraint in its assessment of NECO. The review will consider NECO's likely future credit quality in the context of its membership of the PPL group. In particular, it will consider whether NECO will maintain financial metrics consistent with an A3 rating with cash flow from operations pre-working capital (CFO pre-WC) to debt of at least 18%, including after the primary term of its current distribution rate plans has expired.The current constraint on NECO's rating as part of the National Grid group reflects the substantial additional debt at the parent holding companies, National Grid USA (Baa2 stable) and National Grid North America Inc. (NGNA, Baa2 stable), and the absence of significant ring-fencing provisions. NECO's dividend lock-up only applies if its debt to capitalization will exceed 70% - a level much higher than for the group's New York utilities (in the mid-50s in percentage terms). Although National Grid manages its financing and liquidity on a group basis, Moody's considers the linkages for US subsidiaries to be greater than for those in the UK. None of the group's US operating subsidiaries, for example, have revolving credit facilities in their own names. Short-term liquidity requirements are managed via the group's regulated money pool.NECO's financial profile has been supported by the continued strong performance of its transmission operations, which account for around 30% of its rate base, with achieved return on equity (ROE) over 11% in each of the last ten years. This high level reflects base ROE above those of state regulated utilities (currently 10.57%, in line with that for other transmission owners in New England), despite many changes in the regulator's (FERC) ROE methodologies and complaints on allowed returns in recent years, and the support provided by incentive adders. The company's financial profile has also benefitted from the improved performance of its distribution businesses, whose rate base is split broadly equally between electricity and gas, under the current three-year rate plans which took effect in September 2018. These plans include de-risking provisions that improve the likelihood and timing of cost recovery.Under the agreement between National Grid and PPL, PPL will assume NECO's outstanding debt, $1,396 million, at 31 December 2020, and pay National Grid $3.8 billion for NECO's equity upon successful completion of the transaction. There are several steps to the announced deal, which also involves National Grid acquiring PPL's UK electricity distribution assets (the Western Power Distribution group), but all the customary approvals pertaining to NECO are expected to be received no later than March 2022.Based on previous precedent, the Rhode Island regulator (the Public Utilities Commission, PUC) may, as a condition of approving the change in ownership, require PPL to stay-out from making a fresh rate case filing for NECO's distribution operations for a pre-defined period. If the stay out period (1) does not contain any mechanisms for increasing revenues to reflect increasing operating costs or cost pressure from a growing rate base; and (2) is for several years, NECOs ability to maintain a financial profile commensurate with an A3 rating may be dependent on PPL's ability to realise operational efficiencies.Rates for NECO's transmission operations are set based on a formulaic, forward-looking rate-setting mechanism, under an indefinite rate plan so it would only be if the FERC applies its revised ROE methodology to all transmission companies, rather than just in the MISO region that there would be cut in authorized ROE.NECO's ratings are supported by the diversification of its revenues across distribution and transmission, its stable and predictable cash flows, and the generally supportive regulatory environment in Rhode Island. Moody's views the regulatory framework for its electricity transmission operations, which accounts for around 30% of the rate base, as particularly supportive to credit quality, given the well-established and transparent framework and a tariff formula that allows for timely recovery of operating and capital spending.The ratings could be upgraded if it appears likely that, following successful completion of the asset sale, NECO will maintain CFO pre-WC/debt of at least 18%.The ratings could be confirmed if it appears likely that NECO's CFO pre-WC/debt will fall below 18% or there was a deterioration in the supportiveness of the regulatory frameworks that govern NECO's businesses.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.The National Grid group owns a range of largely regulated businesses focusing on the electricity and gas transmission networks in the UK and transmission and distribution utilities in the US. The company reported total revenue of GBP14.5 billion in 2019-20 and total regulated and other assets of GBP45.2 billion as of 31 March 2020. NECO's rate base of around $2.6 billion as of 31 March 2020 is broadly equally distributed across electricity distribution and transmission, and gas distribution and represents around 10% of National Grid's rate base in the US.REGULATORY DISCLOSURESFor 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_1243406.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.REFERENCES/CITATIONS[1]https://otp.tools.investis.com/Utilities/PDFDownload.aspx?Newsid=1461911Please 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. Philip Cope Asst Vice President - Analyst Infrastructure Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Neil Griffiths-Lambeth Associate Managing Director Infrastructure Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. 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