Fitch Ratings has affirmed the Issuer Default Rating (IDR) of Tucson Electric Power Company (TEP) at 'BB+' and revised the Rating Outlook to Positive from Stable. Approximately $1 billion of debt securities are affected by the rating actions. The full list of ratings is included below.
Key rating drivers include TEP's:
--Stable earnings and cash flows;
--Continued management focus on debt reduction and regulatory process;
--High but improving debt leverage;
--Exposure to changes in environmental rules and regulations;
--Interest rate risk exposure on variable-rate debt securities.
The ratings affirmation and Positive Outlook reflect TEP's stable earnings and cash flows, competitive electric rates, an improving debt leverage profile including lower levels of variable-rate debt, and successful renegotiation of its bank agreement in November 2010. Specifically, TEP's new four-year secured credit facility replaced the maximum debt-to-EBITDA leverage covenant in its previous bank agreement with a 70% maximum debt-to-total capitalization covenant. Debt to capital is expected to be a more stable measure than debt-to-EBITDA.
Commodity price risk is mitigated by TEP's purchase power and fuel adjustment clause (PPFAC) that provides for 100% recovery of fuel and purchase power cost variation from amounts reflected in rates.
Rating concerns include high debt leverage, limited room under debt-to-capitalization leverage restrictions in TEP's bank agreements and frozen non-fuel base rates through 2012. TEP is precluded from filing a new rate case before June 30, 2012. Management of costs will be key to maintaining credit metrics. For the last 12-month (LTM) period ending June 30, 2011 TEP's EBITDA and funds from operations coverage ratios were consistent with the rating category at 4.2 times (x) and 3.7x, respectively.
Going forward, Fitch expects TEP's energy sales growth to approximate 1% from its historical 2% to 3% annual rate during 2011-2014, reflecting a slowly recovering economy in Arizona and energy efficiency initiatives.
The ratings and Positive Outlook assume a reasonable outcome in TEP's next rate case. In the intermediate term, TEP is forecasted by Fitch to be modestly free cash flow negative due to increased capital spending needs associated with emissions compliance and transmission investments. Going forward, leverage ratios are also expected to show improvement over the same time period as TEP amortizes its capital lease obligations. Debt-to-total capitalization is expected to decline to 63% in 2014 from 67% at year-end 2010.
Debt maturities at TEP are manageable through 2014, with $331 million of $441 million of TEP's long-term capital lease obligations amortizing through 2015. There are no other scheduled long-term debt maturities.
TEP had total available liquidity of $183 million including $34 million of cash and cash equivalents and $149 million of borrowing capacity available under its secured revolving credit facility as of June 30, 2011.
TEP had $365 million in tax-exempt variable-rate debt outstanding as of June 30, 2011, which corresponds to a 26.7% ratio of variable-rate debt to total long-term debt, including capital lease obligations. As such, TEP faces interest rate risk on the outstanding variable-rate debt, whose rates are reset weekly by its remarketing agents. In an effort to mitigate interest rate risk TEP hedged $50 million of variable-rate debt through a fixed-for-floating interest rate swap.
Fitch also takes into account the credit implications of TEP's status as a subsidiary utility operating company within the UniSource Energy (UNS) corporate complex. Fitch notes that the amount of dividends TEP is permitted to upstream to UNS is limited to 100% of net income per annum under the Federal Power Act. UNS also owns the much smaller, UniSource Energy Services, Inc. (UES), an intermediate holding company which owns two Arizona-based operating utility subsidiaries,
TEP serves more than 400,000 electric customers in Tucson, Arizona.
The full list of ratings affirmed is as follows:
--Long-term IDR at 'BB+';
--First mortgage bonds at 'BBB';
--Secured bank facility at 'BBB';
--Unsecured industrial revenue bonds at 'BBB-';
--Unsecured pollution control revenue bonds at 'BBB-';
--Short-term IDR at 'B'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--' Recovery Ratings and Notching Criteria for Utilities' (Aug. 12, 2011).
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Contacts:
Fitch Ratings
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Daniel Neama, +1-212-908-0561
Associate
Director
Fitch, Inc.
One State Street Plaza
New York, NY
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or
Secondary Analyst:
Philip W. Smyth, CFA,
+1-212-908-0531
Senior Director
or
Committee Chairperson
Glen
Grabelsky, +1-212-908-0577
Managing Director
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Brian Bertsch, +1-212-908-0549
Email: brian.bertsch@fitchratings.com