EIX
Fitch Ratings has assigned an 'A-' rating to Southern California Edison Co.'s (SCE) first and refunding mortgage bonds.
The bonds are SCE's secured obligations, ranking equally with the utility's other senior secured indebtedness. Proceeds will be used to fund the payment of wildfire claims and related expenses above the amount of expected insurance proceeds, repay commercial paper borrowings and for general corporate purposes.
SCE's current Long-Term Issuer Default Rating (IDR) is 'BBB'. The Rating Outlook is Stable. SCE is a wholly-owned subsidiary of Edison International (EIX; BBB/Stable).
Key Rating Drivers
Wildfire Risk Management: The large reduction in structures destroyed by SCE-linked wildfires in 2019-2023 compared with 2017-2018 is a key factor supporting SCE's IDR and Stable Outlook. SCE appears to have made progress strengthening the grid's fire resilience in light of materially reduced wildfire activity over the past five years, despite challenging conditions. While Fitch believes efforts to minimize wildfire destruction may be taking root, sustained recurrence of similarly destructive firestorm activity as 2017-2018 cannot be ruled out and would result in adverse credit rating actions.
Post-2018, SCE-linked wildfires have been far smaller and third-party liability exposures much more manageable from a credit perspective compared with liabilities from the 2017 Thomas and Koenigstein fires and the 2018 Montecito mudslides (collectively TKM), as well as the 2018 Woolsey Fire. SCE estimates gross losses from the 2017-2018 wildfire and mudslide events of $9.9 billion and has resolved most of the claims from those fires as of June 30, 2024. However, losses associated with post-2018 wildfire liabilities are not expected to be material after insurance and regulatory recoveries.
Wildfire Cost Recovery Filings: In August 2023, SCE filed an application with the California Public Utilities Commission (CPUC) requesting rate recovery of $2.7 billion of prudently incurred losses related to the TKM. SCE was also seeking recovery of about $65 million in restoration costs. Last week SCE filed a motion in the TKM cost recovery proceeding seeking approval of a settlement agreement between SCE and the California Public Advocates Office. If approved by the CPUC, SCE will be authorized to recover 60%, or approximately $1.6 billion, of losses and about $55 million in restoration costs.
Ultimate approval of the settlement and recovery of these liabilities through a securitization, which is not included in Fitch's projections, would be credit supportive. SCE also intends to file for rate recovery of costs associated with the 2018 Woolsey Fire in this quarter. The application will include around $5.0 billion of uninsured claims.
California Regulatory Compact: Fitch believes regulatory practices in California are generally balanced and credit supportive. However, SCE and other California investor-owned utilities are subject to an active legislature and prone to a relatively high degree of political risk, dating back to the energy crisis of 2001-2002. In Fitch's view, legislative actions and rate regulation in recent years have generally been credit supportive. The durability of a balanced regulatory compact in California is a key rating factor, especially in light of SCE's large projected capex.
Regulatory support for timely recovery of SCE investment to further wildfire resilience and safety and California's ambitious clean energy policy goals and other costs will be a critical determinant of future credit quality, along with recovery of 2017-2018 wildfire liabilities. The increase in authorized return on equity by the CPUC under the Cost of Capital Formula Adjustment Mechanism, to 10.75% from 10.05%, was a constructive credit development.
Rate Case Filing: SCE filed its 2025 General Rate Case in May 2023 with the CPUC for the four-year period 2025-2028, requesting authorization of a test year 2025 revenue requirement of approximately $10.3 billion. This represents a $1.9 billion, or 23% increase over the approximately $8.4 billion 2024 revenue requirement adopted in Track 4, or about 9.5% increase in total system average rate vs. 2024.
SCE has reached partial settlements with the intervenors for about 19% of the O&M and 8% of capital requested. The company also updated revenue requirement increases to $670 million, $750 million, and $730 million in 2026, 2027 and 2028, respectively. The filing supports the capex program and projected 6%-8% rate base growth in 2023-2028 timeframe. The proposed decision is expected by October 2024. Fitch estimates a constructive outcome from the rate case filing, in line with the recent rate decisions in the state.
Capex Spending: Capex at SCE is driven by wildfire mitigation and spending to support state greenhouse gas reduction targets. Management expects these expenditures to approximate $32 billion-$38 billion during 2024 through 2028. The large majority of SCE's 2024-2028 capex budget targets investment in its distribution grid and the remainder transmission and generation investment. Ultimate capex through 2028 could be higher as the company is planning to file for approval of additional spending, including AMI 2.0 program in 2025. Higher than expected load growth could also drive additional spend longer term. Fitch expects any additional capex will be funded in a credit supportive manner.
SCE has been investing in hardening its system to mitigate wildfire risk. Through June 30, 2024, it hardened 84% of distribution lines in high fire risk areas and expects to harden just under 90% by the end of 2025. These efforts are augmented by the installation of state-of-the-art equipment to enhance situational awareness in high fire risk areas, including meteorological equipment and surveillance cameras. Operational changes include risk-informed inspections, increased line clearing and hazardous tree management, as well as efforts to reduce and improve public safety power shutoff performance.
Wildfire Insurance Fund: AB 1054, Senate Bill (SB) 901 and a few other laws were enacted in California to protect the public against deadly wildfires and support creditworthiness of state utilities. AB 1054 created a $21 billion wildfire insurance fund for the three large electric investor-owned utilities in California, including SCE, to defray prudently incurred wildfire-related liabilities under inverse condemnation in excess of $1 billion. The legislation also caps liabilities, limiting exposure to 20% of transmission and distribution equity rate base.
The AB 1054 insurance fund is designed to address this mismatch in cash recovery and liability payments, providing a robust source of funds to buffer SCE and the other large investor-owned utilities from liquidity and funding challenges associated with large firestorm-related liabilities. Fitch believes premature exhaustion of the AB 1054 fund due to elevated wildfire activity and related claims would be an adverse development from a credit perspective. California applies inverse condemnation to IOUs when their equipment is deemed to have ignited a wildfire, holding the IOUs strictly liable, even if they complied with all rules and regulations.
Improving Credit Metrics: With the large majority of the 2017-2018 wildfire liabilities resolved, Fitch expects SCE's 2024-2026 credit metrics to improve significantly, averaging better than 4.0x, versus 6.1x 2023. Fitch's projections assume no 2017-2018 wildfire liability cost recovery. Wildfire risk remains a key headwind from a credit perspective, notwithstanding SCE's considerable efforts to enhance system resilience and safety.
Parent-Subsidiary Rating Linkage: Fitch has determined a parent-subsidiary relationship exists between SCE and its corporate parent, EIX. Based on the companies' Standalone Credit Profiles (SCPs), their IDRs are the same. SCE accounts for virtually all of EIX's consolidated earnings and cash flow. Fitch would apply a stronger subsidiary, weaker parent approach to rate SCE and EIX under its 'Parent and Subsidiary Rating Linkage Criteria' should their SCPs diverge, reflecting EIX's dependence on cash flow from SCE to meet its obligations. In that scenario, both legal ringfencing and access and control would be deemed by Fitch to be porous, resulting in a maximum two-notch differential in SCE's and EIX's IDRs.
Derivation Summary
SCE and utility peer, Pacific Gas and Electric Company (PG&E, BB+/Positive), are among the largest utilities in the U.S. SCE, with 5.3 million electric customers, is smaller than PG&E, which has 5.5 million electric and 4.5 million natural gas customers, but is considerably larger than peers, Jersey Central Power & Light Company (JCP&L, BBB+/Positive), with 1.2 million electric customers, and The Dayton Power & Light Company (DP&L, BBB-/Stable), with 0.5 million electric customers.
All four utilities have been challenged in recent years by regulatory and other headwinds. SCE and PG&E are integrated electric utilities with somewhat higher operating risk profiles, in Fitch's opinion, compared with DP&L and JCP&L's lower-risk transmission and distribution utility operations.
DP&L's creditworthiness has been adversely impacted by regulatory developments. However, the most recent rate case decision and energy security plan approval should drive credit quality improvement in the next couple of years. JCP&L's regulatory lag has weakened credit metrics in recent years, but a more balanced outcome in its last base rate case has offered support. The ratings of DP&L and JCP&L also reflect high leverage at their respective corporate parent companies. Extreme weather and climate related events are a risk for JCP&L and DP&L, but Fitch believes catastrophic wildfire risk is more pronounced for SCE and PG&E from a credit perspective.
Fitch expects SCE's FFO leverage to average above 4.0x during 2024-2027, against above 5.0x for PG&E. JCP&L's FFO leverage is expected to average 3.3x and DP&L's FFO leverage to average 5.0x over the next few years. Fitch believes uncertainty regarding the magnitude, frequency and destructive force of California's wildfires and associated third-party liabilities heighten regulatory and operating risks for SCE and PG&E in comparison to peers. Legislative initiatives addressing wildfire-related regulatory and liquidity issues are key factors stabilizing the ratings of SCE and PG&E.
Key Assumptions
No rate recovery of 2017-2018 wildfire liabilities;
SCE pays approximately $9.9 billion of total wildfire-related third-party liabilities;
Average annual capex in-line with company's guidance;
Credit supportive federal and state economic regulation;
Timely recovery of memo account balances;
Balanced funding of SCE's capex program.
RATING SENSITIVITIES
Factors That Could, Individually Or Collectively, Lead To Positive Rating Action/Upgrade
Consistent, incremental progress reducing firestorm risk in the intermediate-to-long term;
Regulatory approval to recover 2017-2018 wildfire costs in rates;
More manageable utility-triggered wildfire activity consistent with post-2017/2018 levels in the intermediate term;
Successful implementation of AB 1054 with regard to resiliency initiatives, durability of the wildfire insurance fund and CPUC interpretation of standards and procedures;
Better than expected regulatory outcomes with respect to timeliness and substance;
FFO leverage of 4.5x or better on a sustained basis.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Continuing catastrophic wildfire activity that depletes the wildfire fund faster than expected, exposing the company to incremental wildfire liabilities;
Execution risk associated with AB 1054, including safety certification issuance, implementation of the wildfire insurance fund or unexpectedly large prudence disallowance by the CPUC;
Ineffective operating response to wildfires;
Poor public safety power shutoff execution, communication and management;
Adverse political, legislative or regulatory developments;
FFO-adjusted leverage exceeding 5.3x for a sustained period.
Liquidity and Debt Structure
Fitch believes SCE has ample consolidated liquidity. It has negotiated a committed $3.4 billion revolving credit facility that is scheduled to terminate in May 2027. As of June 30, 2024 SCE had $1.8 billion available to be borrowed under the facility and $68 million of cash on hand. Fitch assumes SCE will be FCF negative, like most utilities, due to its large capex program to mitigate catastrophic wildfire activity and meet California's greenhouse gas reduction goals.
Fitch expects cash shortfalls to be funded with a balanced mix of debt and equity. SCE has direct access to debt capital markets and also relies on EIX for equity infusions to balance its funding needs. Fitch believes debt maturities at SCE are manageable.
Issuer Profile
Southern California Edison is one of the largest investor-owned electric utilities in the U.S. The utility provides electricity services to 15 million people through five million customer accounts across a 50,000 square-mile service territory in Central, Southern and Coastal California.
Summary of Financial Adjustments
Fitch adjusts SCE's financial ratios, removing securitization-related revenue, amortization, interest expense and debt from SCE's financials. This reflects protections and commitments granted under state law that create a transferable, non-bypassable special tariff to a ringfenced special purpose entity with no recourse to the utility.
Date of Relevant Committee
27 April 2023
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Southern California Edison Company has an ESG Relevance Score of '4' for Exposure to Environmental Impacts due to the threat of catastrophic wildfire activity partially offset by the constructive impact of AB 1054, including creation of the wildfire fund and limits on prudence disallowance, and ongoing efforts by EIX, SCE and the State of California to improve system resilience against firestorm activity. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Southern California Edison Company has an ESG Relevance Score of '4' for Exposure to Social Impacts due to wildfire activity and its adverse impact on the utility's relationship with customers which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
RATING ACTIONS
Entity / Debt
Rating
48
Fitch Assigns 'BB+' Rating to NiSource's Junior Subordinated Notes
Tue 03 Sep, 2024 - 9:53 am ET
Fitch Ratings - New York - 03 Sep 2024: Fitch Ratings has assigned a 'BB+' rating to NiSource Inc.'s (NI; BBB/Stable) planned fixed-to-fixed rate reset junior subordinated notes. Proceeds from the offering will be used for general corporate purposes, including to finance capital expenditures, for working capital and to repay existing indebtedness. The securities are eligible for 50% equity credit based on Fitch's hybrid methodology. Features supporting the equity categorization of these debentures include their junior subordinate priority, the option to defer interest payments on a cumulative basis for up to 10 years on each occasion and no step-up.
NI's credit profile is supported by its 100% regulated gas and electric utility operations in six states. The recent closing of the partial sale of 19.9% of NIPSCO will provide additional funding for NI's aggressive growth capex program while improving its financial flexibility.
Key Rating Drivers
Low Business Risk: NI's ratings and Outlook are supported by stable cash flows and earnings from 100% regulated gas and electric utilities in six states. The gas rate base is approximately 69% of the total rate base. Gas distribution utilities benefit from supportive recovery mechanisms and less exposure to environmental mandates.
Four states have legislations that prohibit municipalities from banning natural gas use. At a county level, Maryland is the only state within NI's service territory that restricts the use of fossil fuel, including natural gas, in buildings. However, Maryland makes up a very small portion of NI's customers and cash flow. Fitch considers Ohio, Pennsylvania and Indiana - NI's top three service territories - to be among the most supportive jurisdictions in the U.S.
Supportive Gas Regulation: Gas utilities have revenue decoupling in Ohio, Maryland and Virginia, weather normalization in Pennsylvania, Maryland, Virginia and Kentucky, and straight fixed variable rates in Ohio. All of NI's gas utilities use infrastructure trackers except in Pennsylvania. Gas rates in Indiana are nearly 50% fixed for residential and commercial customers. Approximately 50% of the total revenue is non-volumetric.
Gas utilities in Indiana, Kentucky and Ohio have authorized ROEs of 9.75%, 9.35% and 9.60%, respectively. Other gas utilities have ROEs for infrastructure programs ranging from 9.275% to 9.700%. Maryland did not have a specified ROE in its latest 2023 rate case.
Supportive Electric Regulation: NIPSCO electric's authorized ROE is 9.80%, compared with the industry average of mid-9%. In Indiana, the Transmission, Distribution and Storage System Improvement Charge statute provides for cost recovery between rate cases for safety, reliability and modernization, and allows for preapproval of a seven-year plan of eligible investments. Up to 80% of eligible costs can be recovered using semiannual trackers. Transmission projects are regulated by the Federal Energy Regulatory Commission (FERC), which enjoy forward-looking rates and construction work in progress recovery with over 10% ROE.
Last Rate Case Constructive: Fitch views NIPSCO's last electric rate case settlement and final order favorably. On March 10, 2023, NIPSCO filed a settlement allowing a $262 million base rate increase based on a 9.8% ROE and 51.63% equity layer. The ROE is higher than the industry average of mid-9%. Under the settlement, NIPSCO would withdraw a variable cost tracker (VCT) for its coal-fired generation plants and replace it with a new environmental cost tracker (ECT). The ECT would allow fewer categories of costs than the VCT, totaling about $29.9 million annually. The commission fully adopted and approved the settlement in August 2023.
NIPSCO filed its gas rate case in October 2023, requesting a two-step base rate increase totaling $161.9 million. On March 20, 2024, the company filed a settlement for a two-step base rate increase totaling $120.9 million. The first increase would take effect shortly after an order is issued, likely in September 2024. The second increase would take effect shortly after the commission approves the company's compliance filing, around March 1, 2025. On July 31, 2024 the commission approved the settlement agreement.
Elevated Capex: NI's capex remains elevated. Over the 2024-2028 period, Fitch expects NI's base capex plan to be about $16.4 billion, supporting annual rate base growth of about 8%-10%. Most projects are small, providing flexibility in execution. NI's robust capex program is mainly supported by infrastructure modernization legislations and riders in all its service territories. Renewable projects are preapproved, reducing regulatory uncertainties.
Cleaner Generation: NI plans to retire all coal generation by 2028. As of Dec. 31, 2023, 42% (1,177MW) of NIPSCO's nameplate generation capacity was from coal generation. It remains on track to retire R.M Schahfer's remaining two coal units by the end of 2025. Michigan City will retire by 2028 subject to approval by the Midcontinent Independent System Operator. NI proposed that the retiring units be replaced by demand side management resources, solar, energy storage and upgrades to the Sugar Creek Generating Station. Fitch views the proposed coal phaseout by 2028 will improve business risk and credit positive over the longer term.
Credit Metrics: Over the last three years, NI's credit metrics were affected by the Merrimack Valley gas explosions, the pandemic, an asset sale in Massachusetts, one-time expenses associated with NiSource Next initiative and unfavorable weather. The FFO leverage ratio averaged around 6.0x in the past four years. Over the 2024-2026 period, Fitch forecast FFO leverage of about 5.6x-5.9x.
Parent Sub Linkage: NiSource and NIPSCO's Standalone Credit Profiles are the same. NIPSCO has a very small amount of debt as it relies on NiSource solely for liquidity and capital access. NiSource has not issued any new debt at the operating company levels and doesn't plan to do so going forward. The legacy public debt will be repaid as they mature. NIPSCO's Standalone Credit Profile is not analytically meaningful.
Derivation Summary
NI's fully regulated business model provides predictable earnings and cash flow compared with Southern Company Gas (BBB+/Stable), which invests in unregulated operations. NI's business model, geographic diversification and supportive regulations mitigate its relatively weak credit metrics. Similar to IPALCO Enterprises, Inc. (BBB-/Stable), which also operates in Indiana, NI's subsidiary NIPSCO has coal generation.
However, NI's operation is diversified and gas focused compared with IPALCO's single-state electric generation. Both NI and IPALCO are executing a large capex program. Fitch expects NI's FFO leverage to be around 5.5x-5.9x in 2024-2026 while that of IPALCO is around 5.1x-6.3x in 2024-2026. NI's larger scale and asset mix result in the one-notch IDR difference from IPALCO, although their FFO leverage ratios are similar.
Key Assumptions
Capex of about $16.4 billion in total between 2024 and 2028;
Normal weather;
Modest customer growth;
No adverse regulatory outcomes;
All debt maturities are refinanced.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
NI and NIPSCO could be upgraded if consolidated FFO leverage is consistently below 5.0x.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Consolidated FFO leverage sustains above 6.0x with low probability of recovery;
Material adverse changes in NI's regulatory construct that result in unexpected lag or disallowance in recovering capex.
Liquidity and Debt Structure
Adequate Liquidity: NI continues to have sufficient liquidity. As of Jun. 30, 2024, it had about $101 million of unrestricted cash and $1,206 million availability under its $1.85 billion unsecured revolving credit facility, after factoring in $644 million of commercial paper outstanding.
NI is required to maintain total debt to total capitalization that does not in exceed 0.70 to 1 under the credit facility. There are no debt maturities in 2024 and about $1.26 billion due in 2025.
Issuer Profile
NiSource Inc. is a fully regulated utility holding company whose regulated subsidiaries provide natural gas and electricity to 3.8 million customers across six states.
Date of Relevant Committee
15 July 2024
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS
Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
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