Fitch Rates Southern Company's Senior Notes 'A'; Outlook Negative

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned its 'A' rating to the Southern Company's issuance of $600 million series 2015A 2.750% senior notes due June 15, 2020. These notes are senior, unsecured obligations of Southern Company. The Rating Outlook is Negative.

The net proceeds from the issuance will be used to repay a portion of Southern Company's outstanding short-term indebtedness, which totalled approximately $765 million as of June 8, 2015, and for other general corporate purposes.

Last week, Fitch revised the Rating Outlook for Southern Company to Negative from Stable primarily due to the simultaneous undertaking of two large and complex generation projects by its utility subsidiaries, i.e the Kemper Integrated Gasification Combined Cycle (IGCC) project and Vogtle nuclear units 3 and 4, both of which have seen material construction delays and rising regulatory concerns, which have weakened the profile of Southern Company at its current rating level. Southern Company's current and forecasted credit metrics, while consistent with historical measures, do not adequately offset the enhanced business risk that is expected to linger until the two projects enter successful operations.

Southern Company has issued $1.5 billion in equity over 2013-2014 to fund a substantial portion of Kemper cost overruns. However, Fitch believes that management's appetite for additional equity issuance to support future cost overruns at Kemper or finance growth aspirations at its non-regulated subsidiary, Southern Power Company, is limited at this point, which could result in higher than expected parent company debt issuance, thereby putting pressure on consolidated credit metrics.

Fitch will resolve the Negative Outlook over the next 12-24 months based on the successful completion and operations of Kemper, resolution of regulatory uncertainty in Mississippi and issuance of approximately $1 billion in securitization proceeds at Mississippi Power Company. At the same time, Fitch will continue to monitor the construction progress of the new Vogtle nuclear units based on the current costs and schedule and continuation of regulatory support for Georgia Power Company as demonstrated through future Vogtle Construction Monitoring (VCM) proceedings and the next general rate case filing in mid-2016.

KEY RATING DRIVERS

High Project Execution Risk: Fitch's rating concerns for Southern Company include significant construction and regulatory risks associated with the two large baseload projects under construction, namely the 2,200 MW Vogtle nuclear units 3 and 4 in which Georgia Power owns a 45.7% stake and the 580 MW Kemper IGCC plant being built by Mississippi Power. The Vogtle units are experiencing a significant delay in the construction schedule and the Georgia Public Service Commission (PSC) has not been inclined to recertify the original costs or schedule until the first unit reaches substantial completion. The EPC contract is largely fixed and Georgia Power believes that the contractors are responsible for the incremental construction costs arising from the delay. However, the utility is exposed to owner's oversight and financing costs that will need to be recovered from ratepayers. Fitch expects that any adjustments to the overall project costs will be deemed recoverable by the Georgia PSC.

The Kemper project has faced significant overruns relative to its original project costs estimate. The project is now expected to cost $6.2 billion, of which $1.3 billion is subject to exemptions and exceptions from the regulatory cost cap. Of the remaining $4.9 billion, Mississippi Power does not intend to seek rate recovery for $2.1 billion of costs incurred above the $2.88 billion cost cap and has taken an equivalent charge to income through its 1Q'15 financial results. With the project close to 88% complete, future cost increases may not be material. But the project is entering a crucial phase of gasifier start up and integration with the combined cycle units. Issues with start-up activities could delay the operational date (currently estimated as first half of 2016) that exposes Mississippi to additional costs (approximately $15 million-$40 million per month) and greater regulatory risk.

Conservative Business Model: Southern Company's ratings recognize the relatively stable and predictable cash generation of its utility subsidiaries that have generally experienced a constructive regulatory framework in their service territories. Southern Power follows a conservative business model by selling power output through long-term sale contracts with creditworthy counterparties and taking on has minimal commodity exposure. At present, regulatory risk is subdued for Southern Company's utility subsidiaries, except Mississippi Power, given the 2013 rate resolutions at Georgia Power, Alabama Power and Gulf Power. The key regulatory issues to monitor are the outcome of Mississippi Power's recent rate filings and future prudency reviews on Kemper costs, the next base rate case proceeding at Georgia Power (to be filed mid-2016 for rates to be effective January 2017) and the semi-annual VCM filings for the new Vogtle nuclear units.

Positive Sales Trend: Southern Company's utilities have witnessed an improving trend in customer sales and electricity sales as their service territories continue to benefit from economic rebound, job growth and population in-migration. On a combined basis, customer count grew by 0.8% in 2014 and retail sales grew by 3.3%. Industrial sales exceeded expectations with a 3.3% GWH sales growth in 2014 reflecting a rebound across most of the major industrial segments. Industrial sales have shown positive year-over-year growth for eight consecutive quarters now. Residential sales are also trending above expectations, while commercial sales continue to be soft. Fitch's financial forecasts embed a 0.5%-1% sales growth across most of Southern Company's utility subsidiaries.

High Environment Capex: Fitch expects Southern Company's consolidated environmental compliance expenditures to wind down after 2015, a majority of which is being spent to meet the Mercury and Air Toxics Standards (MATS) rule. The company is planning to spend approximately $2.1 billion over 2015-2017 on environmental capex. All of Southern Company's regulated subsidiaries, with the exception of Georgia Power, have environmental trackers. Georgia Power has typically recovered environmental compliance-related costs through base rate case decisions.

Stable Credit Metrics: Fitch expects Southern Company's funds from operations (FFO) adjusted leverage to be approximately 4.1x by 2017 and FFO coverage ratios to remain above 4.8x. Adjusted debt to EBITDAR is expected to approach 3.6x by 2017. The financial forecasts do not assume any additional cost escalation at Kemper and incorporate only the announced projects at Southern Power. Higher than expected capex needs at the subsidiaries, if not partly financed by parent equity, could result in higher than forecasted holding company debt, thereby, putting pressure on consolidated credit metrics.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case are as follows:

--At Alabama Power, modest increases in RSE rates over 2015-2017, 1.5% increase under CNP C (environmental) rates in 2015 and 2.5% in 2016 and 0.5% increase in electricity sales in 2015 and 2016;

--At Georgia Power, 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, 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, ROE of 9.7% for 2015-2017, 100% ownership of Kemper IGCC with 85% of the project recovered through regulated rates, No change to current rate plan for Kemper cost recovery, 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, growth projects as announced and balanced funding of growth capex.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a Stable Rating Outlook include:

--COD of Kemper without any material escalation in currently projected capital costs followed by successful operational performance;

--Constructive outcome in Mississippi Power's pending rate filing that mirrors the current rate plan;

--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;

--Sustained FFO adjusted leverage at or below 3.5x over the forecast period.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--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 4.25x or higher on a sustained basis.

LIQUIDITY

At March 31, 2015, Southern and its subsidiaries had approximately $1.1 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 March 31, 2015 was approximately $1.8 billion. Approximately $1.4 billion of commercial paper borrowings were outstanding as of March 31, 2015.

FULL LIST OF RATING ACTIONS

Fitch currently rates the following with a Negative Outlook:

Southern Company

--Long-term Issuer Default Rating (IDR) at 'A';

--Short-term IDR at 'F1';

--Commercial paper at 'F1';

--Senior unsecured notes at 'A'.

Date of Relevant Rating Committee: June 5, 2015.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

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

Recovery Ratings and Notching Criteria for Utilities (pub. 05 Mar 2015)

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

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986172

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY, 10004
or
Secondary Analyst
Julie Jiang
Director
+1-212-908-0708
or
Committee Chairperson
Robert Hornick
Senior Director
+1-212-908-0523
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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