approximately $7 Billion of Securities Affected
New York, November 07, 2003 -- Moody's downgraded the ratings of Pepco Holdings, Inc.
and its subsidiaries Potomac Electric Power Company, Potomac Capital
Investment Corp., Delmarva Power and Light Company,
Atlantic City Electric Company, and Conectiv. The rating
outlook is stable for Conectiv, Atlantic City Electric, and
Delmarva Power. The rating outlook is negative for Pepco Holdings,
Potomac Electric Power, and Potomac Capital Investment Corp.
The rating action concludes a review initiated on July 17, 2003.
Ratings downgraded include the following:
Pepco Holdings, Inc.'s senior unsecured debt to Baa2
Potomac Electric Power Company's senior secured debt to A3 from
A1; senior unsecured debt to Baa1 from A2; preferred securities
to Baa3 from Baa1; and its short-term rating for commercial
paper to Prime-2 from Prime-1.
Potomac Electric Power Company Trust I's preferred securities to
Baa3 from Baa1.
Potomac Capital Investment Corp.'s senior unsecured debt
to Baa2 from Baa1.
Atlantic City Electric Company's senior secured debt to A3 from
A2; senior unsecured debt to Baa1 from A3; preferred stock to
Baa3 from Baa2; and short-term rating for commercial paper
to Prime-2 from Prime-1.
Atlantic Capital II's preferred securities to Baa2 from Baa1.
Delmarva Power and Light Company's senior secured debt to A3 from
A2; secured pollution control bonds to A3/VMIG 2 from A2/VMIG 1;
senior unsecured debt to Baa1 from A3; preferred stock to Baa3 from
Baa2; and its short-term rating for commercial paper to Prime-2
Delmarva Power Financing I's preferred securities to Baa2 from Baa1.
Conectiv's senior unsecured debt to Baa2 from Baa1.
Rating confirmed include the following:
Pepco Holdings, Inc.'s Prime-2 rating for commercial
Moody's has lowered Pepco Holdings' debt ratings due to weaker
than anticipated financial performance, expected additional pressure
on the company's credit metrics as a result of various rate freezes
at the company's subsidiaries, and the relatively slow pace
of the company's delevering strategy. The negative rating
outlook for Pepco Holdings reflects the uncertainty surrounding Mirant's
attempt to reject its back-to-back purchased power agreements
(PPAs) with Potomac Electric, under Mirant's bankruptcy proceeding.
If Mirant is successful, there would be a substantial negative impact
on the consolidated entity's profitability and cash flow.
We note that consolidated debt continues to be reduced, albeit at
a slower than expected pace, with cash proceeds from the sale of
real estate and securities portfolio at Potomac Capital Investment and
cash proceeds from Atlantic City Electric's planned securitization
financings. However, the debt reduction benefit is partially
offset by the fact that these activities also entail the loss of assets
and cash flow that formerly supported the company's debt.
The downgrade of Potomac Electric reflects cash flow coverages that are
more consistent with the lower rating category, the negative effect
of recently renegotiated terms and conditions associated with the transition
power agreements (TPAs) with Mirant. Under the settlement agreement
with Mirant for the TPAs, Potomac Electric will be paying an average
of $40 per megawatt-hour from an average of $34 per
mwh, while it collects $41 per mwh (unchanged) from its customers
under its Standard Offer Service tariff. Under the renegotiated
terms and conditions of the settlement, the company estimated that
it would lose approximately $60 million in pre-tax margin
over the remaining contract period of the TPAs. The contract period
expires on June 30, 2004 in Maryland and February 7, 2005
in the District of Columbia. As an additional item to the settlement,
the parties agreed that Potomac Electric will have an allowed, pre-petition
unsecured bankruptcy claim of $105 million. Potomac Electric's
ability to recover damages from the Mirant bankruptcy estate would depend
on the ultimate recovery rate for unsecured creditors. Any amount
recovered would be shared with customers under the previously established
Generation Procurement Credit formula contained in the restructuring rate
agreements in Maryland and the District of Columbia. The TPA settlement
agreement requires the approval of the bankruptcy court, which the
company expects will occur before year end.
The negative outlook for Potomac Electric reflects the risk of substantial
loss of margin if Mirant is successful in its attempt to reject its PPAs
with Potomac Electric. Based upon the regulatory review of the
Mirant contracts at the time these were entered into, and regulatory
precedents in its service territory, the company may be able obtain
regulatory support for recovery through its distribution rates if the
contracts are rejected. However, this process could be quite
lengthy, and there is no assurance that the company could recover
the full amount of any economic loss. Under the back-to-back
PPAs, Potomac Electric buys power from third parties at above-market
prices and sells it to Mirant for the same price. Under Potomac
Electric's restructuring rate agreements with the Maryland Public
Service Commission and the District of Columbia Public Service Commission,
there is a provision that would allow Potomac Electric to recover the
stranded costs associated with the PPAs from its customers if the generation
asset sale did not include the transfer of the PPAs to the buyer.
On October 15th, the Northern Texas Federal District Court asserted
that Mirant's motion for rejection of the PPAs should be removed
from the bankruptcy court, and should instead be adjucated at the
Federal District Court level. As ordered by the Federal District
Court, Potomac Electric filed briefs on the matter on October 30,
2003 and Mirant filed reply briefs on November 6. The Federal Energy
Regulatory Commission also filed its brief. A court hearing is
unlikely to occur until 2004, and final resolution of the matter
could be a prolonged process.
The downgrade of Potomac Capital Investment's (PCI) debt rating
reflects the downgrade of Pepco Holdings. PCI's debt obligations
are unconditionally guaranteed by Pepco Holdings. The negative
outlook mirrors the negative outlook at Pepco Holdings.
The downgrade of Delmarva Power's ratings reflects expected cash
flow erosion due to its current rate cap, which extends through
2006, as well as an expected modest increase in leverage.
The stable outlook reflects the company's lower business risk as
a regulated transmission and distribution utility and the hedging of price
and volume risk associated with its provider of last resort obligations.
Delmarva Power's Standard Offer Service obligations are being supplied
by Conectiv Energy through 2006.
Moody's notes that Pepco Holdings' family of companies is
interrelated and operates as an integrated system. This interrelationship
includes operating transactions and contracts between some affiliates,
tax sharing agreements that entail substantial benefit to some entities,
and movement of funds under a money pool arrangement. In addition,
Pepco Holdings, Potomac Electric, Atlantic City Electric and
Delmarva Power all share the same bank credit facilities.
The downgrade of Atlantic City Electric (ACE) reflects the interrelationship
with its T&D affiliates, and the expectation that the parent
will continue to extract a relatively high dividend to meet its own needs.
However, the stable rating outlook for ACE reflects the company's
ability to maintain relatively predictable and steady financial performance
as a regulated utility over the next several years. We note that
ACE has recently received several favorable regulatory decisions,
which will enable the company to strengthen its financial performance
in the intermediate term. Approvals from the New Jersey Board of
Public Utilities include the securitization of $440 million of
stranded costs at the end of 2002 and the recent authorization for ACE
to recover $125 million in deferred fuel and purchased power costs
associated with non-utility generation contracts, as well
as permission for ACE to issue $155 million in securitization debt
for its stranded investment in December 2003, and ACE anticipates
that it will receive regulatory approval to issue an additional $110
million in 2004. Proceeds from the securitization financings will
be used to pay down debt. ACE's "all requirements"
or provider of last resort obligations are under one-year to three-year
contracts recently completed under the New Jersey Basic Generation Service
The downgrade of Conectiv's rating reflects the downgrades of its
principal subsidiaries, Atlantic City Electric and Delmarva Power.
The stable rating outlook for Conectiv recognizes the relatively stable
financial performance expected on a consolidated basis, with significant
cash flow and earnings from the regulated delivery business of Atlantic
City Electric and Delmarva Power. Expansionary capital spending
by Conectiv Energy, Conectiv's non-regulated generation
subsidiary, has resulted in substantially negative free cash flow
in 2001, 2002, and 2003. However, capital expenditures
will be significantly reduced to approximately $20 million per
year from 2004 through 2006, which should result in a better balance
between retained cash flow and capital spending.
Pepco Holdings, Inc., a diversified holding company,
is headquartered in Washington, D. C. Pepco Holdings,
Inc. is the parent holding company of Potomac Electric Power Company
(a regulated transmission and distribution utility), Potomac Capital
Investment Corporation (a non-regulated finance company whose debt
is unconditionally guaranteed by Pepco Holdings), and Conectiv (intermediate
holding company of Atlantic City Electric Company and Delmarva Power and
Light Company). Atlantic City Electric is a regulated transmission
and distribution utility and Delmarva Power and Light is a regulated transmission
and distribution utility.
Corporate Finance Group
Moody's Investors Service
MOODY'S DOWNGRADES RATINGS OF PEPCO HOLDINGS, INC. (TO Baa2 SR.UNSEC.); POTOMAC ELECRIC (TO A3 SR.SEC.); DELMARVA P&L (TO A3 SR.SEC.); POTOMAC CAPITAL INVESTMENT (TO Baa2 SR. UNSEC.); CONECTIV (TO Baa2 SR. UNSEC.) AND ATLANTIC CITY ELEC. (TO A3 SR.SEC.)
Mo Ying W. Seto
Senior Vice President
Corporate Finance Group
Moody's Investors Service