Fitch Rates Pepco's FMBs 'A-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch rates Potomac Electric Power Co.'s (Pepco) new $200 million issue of first mortgage bonds (FMBs) 'A-'. The Rating Outlook is Stable. The net proceeds will be used to repay outstanding commercial paper and for general corporate purposes.

KEY RATING DRIVERS

Revenue Stability: Pepco's regulated electric transmission and distribution operations have minimal commodity, volumetric and environmental exposure. Regulators in both Maryland and the District of Columbia implemented revenue decoupling mechanisms eliminating the revenue impact of weather and changes in usage patterns and permit full recovery of power procurement costs with a modest profit margin. Revenue stability is further enhanced by the significant presence of state and federal government customers which tends to reduce economic volatility in the region.

Significant Capital Program: Pepco is in the midst of a significant capital program of approximately $3.4 billion over 2015-2019. A large portion of the expenditures are to address reliability issues that have in the past been a point of contention with Maryland regulators. The large capex budget is particularly challenging given the rate lag issues and relatively low authorized returns on equity (ROE).

Challenging Regulatory Environment: Earnings and cash flow measures have been constrained by a string of restrictive rate decisions in Maryland dating back to 2007. The two most recent cases were based on ROE of 9.62% and 9.36%, respectively, which are among the lowest in the industry. Particularly troubling is the Maryland Public Service Commission's (MPSC) reluctance to permit forward adjustments to address regulatory lag which will likely prevent Pepco from earning its allowed ROE.

Credit Metrics: Following two years of improvement, credit metrics will be pressured in 2015 as the company avoids base rate filings during the regulatory review of the pending merger between Pepco's parent Pepco Holdings, Inc. (PHI) and Exelon Corp. (EXC). Fitch anticipates funds from operation (FFO) adjusted leverage and debt/EBITDAR to both approximate 4.4x in 2015 and then improve to about 4.0x by 2017. FFO fixed charge coverage is expected to approximate 4.5x in 2015 improving to about 4.75x in 2017.

Exelon Merger: The pending merger between PHI and EXC has no direct impact on Pepco's credit quality, but does provide a stronger, better capitalized parent company with far greater financial flexibility. Moreover, Fitch anticipates Pepco to benefit from improved operating efficiency and lower costs as a result of the merger. Nonetheless, rate case avoidance and a likely package of rate payer benefits will adversely affect cash flow in the near term.

KEY ASSUMPTIONS

--Sales Growth of -0.2% per annum through 2017.

--Customer Growth of 0.7% per annum through 2017.

--O&M growth of 2.5% per annum through 2017.

--Approximately $2.1 billion of capex through 2017.

RATING SENSITIVITIES

Positive Rating Action: Positive rating action is not expected, but could occur if debt/EBITDAR and FFO leverage fall below 3.75x and 4.25x on a sustainable basis and FFO coverage is maintained at 4.5x or better.

Negative Rating Action: FFO leverage above 4.25x or FFO coverage below 4.5x on a sustained basis could result in lower ratings.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology - Including Short-term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'Recovery Ratings and Notching Criteria for Utilities' (March 5, 2015);

--'Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)' (March 11, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Utilities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863298

Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980989

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Fitch Ratings
Primary Analyst
Robert Hornick
Senor Director
+1 212-908-0523
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Daniel Neama
Associate Director
+1 212-908-0561
or
Committee Chairperson
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
[email protected]
Elizabeth Fogerty, +1 212-908-0526
[email protected]

Source: Fitch Ratings

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