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08 Dec 2016
New York, December 08, 2016 -- On Dec 6, 2016, FirstEnergy Corp (FirstEnergy, Baa3
stable) disclosed a number of new developments related to its merchant
business. This includes changes to revolving credit facilities
and term loans at FirstEnergy, its regulated subsidiaries,
FirstEnergy Solutions Corp (FES, Caa1 negative) and Allegheny Energy
Supply Co (AES, B1 negative), a reconstitution of FES'
board of directors and progress towards the sale of assets at AES.
From a credit perspective, these changes come with both positive
and negative implications to FirstEnergy and FES, but are largely
consistent with management's intent to exit the merchant business
within the next 18 months, and overall are credit neutral for FE.
FirstEnergy's new exposure to FES has negative credit implications
but is manageable:
The most important change was the termination of FES and AES' existing
$1.5 billion unsecured revolving credit facility and its
replacement with a $700 million secured revolving credit facility.
The new secured facility has a term of two years, through Dec 31,
2018, and names FirstEnergy as the lender. AES will no longer
be a borrower under the new facility. For FirstEnergy, this
creates a new exposure to FES that did not exist before. However,
the impact on FirstEnergy's credit is mitigated by the following
1. We do not see this as management's appetite for new merchant
exposure at FirstEnergy but rather as a necessary step for its eventual
exit from the business. The changes to the revolving facilities
have enabled the elimination of a couple of potentially problematic covenants
that could have otherwise affected parent FirstEnergy.
2. FirstEnergy has assumed a secured exposure to FES. There
is currently about $612 million in secured debt at FES compared
to a total of $3 billion of funded balance sheet debt. Assuming
a FES bankruptcy, secured debt will enjoy better recovery prospects
than unsecured debt. In August 2016, we published an illustrative
estimate of FES' asset values, about $2.3 billion,
which provides a material cushion and asset coverage.
3. We already incorporate a view that FirstEnergy could face additional
liabilities related to a potential FES bankruptcy filing or restructuring.
For example, we think FE can accommodate up to $1 billion
of incremental, contingent liabilities from a FES bankruptcy or
restructuring, in addition to currently outstanding guarantees for
pensions, at its current Baa3 rating level. Any exposure
under this new revolver that is not recoverable in the event of an FES
bankruptcy will be considered as part of this $1 billion limit
4. These changes also make very likely that unsecured bondholders will sue FirstEnergy for converting what was an unsecured revolving credit facility into a secured one, although for a lower amount. In general, we believe bondholder lawsuits are likely in the event of an FES bankruptcy (we discuss other such exposures later in this report) but this is yet another avenue for lawsuits and increases the contingent exposure associated with such lawsuits.
FirstEnergy's new covenant package supports merchant separation:
FirstEnergy's new revolving credit facilities come with covenant
changes that eliminate certain risks for FirstEnergy in the event of a
restructuring/bankruptcy at FES and will ease the exit from the merchant
business. Under the prior facilities, an adverse legal judgment
in excess of $100 million, if not paid or stayed in 30 days,
was an event of default not just under the FES revolver but also under
the FirstEnergy revolver. This covenant will no longer apply to
judgments against FES and AES although it remains applicable to the utility
subsidiaries. The prior revolvers also required FirstEnergy to
maintain a debt to total capitalization ratio of no more than 65%.
While this covenant still applies, the denominator of the ratio
calculation will now benefit from exclusions not only for previously incurred
non-cash charges and write-downs but also up to $5.5
billion of future asset impairments at FES, AES and their subsidiaries.
Sale Proceeds from AES are a credit positive:
FirstEnergy announced that on December 1, 2016, AES entered
into a non-binding letter of intent for the sale of its gas and
hydro facilities for $885 million (slightly below our estimate
from August 2016 of $1 billion), including $305 million
of debt assumed by the buyer. This implies net proceeds to FirstEnergy
of about $580 million. Should this or a similar transaction
be consummated, any net proceeds to FirstEnergy would be an incremental
positive relative to our scenario assuming such proceeds are used for
debt reduction. At the time of our rating affirmation for FirstEnergy,
we had assumed zero value to FirstEnergy from the merchant business.
Our analysis assumed that FES and AES simply went away, and focused
on the financial profile of FirstEnergy and its regulated subsidiaries,
along with any additional bankruptcy related liabilities that may arise,
for which we arrived at a limit of $1 billion.
Further, FirstEnergy's subsidiary Monongahela Power Co.
(MP, Baa2 stable) announced recently that it was evaluating options
for its 487 MW ownership interest in the 3000 MW Bath county pumped storage
hydro project, driven by recent changes to PJM's capacity
market rules that reduced the capacity value of the Bath county station
by about half owing to its inability to produce power continuously during
all hours of the day. We think this raises the possibility that
AES' 1300 MW Pleasants coal plant may be added to MP's rate
base and the ownership in Bath county station divested. Political
support in West Virginia for the coal industry creates a favorable environment
for this possibility. The state supported the addition to rate
base in 2013 of the Harrison coal plant, a merchant asset owned
by AES. Any proceeds to AES from such a transaction on the Pleasants
asset would be a further positive for FirstEnergy if the proceeds are
ultimately used for debt reduction.
Separation from merchant generation is a bumpy road, but FE is stepping
in the right direction.
While this announcement is a step in the right direction, we acknowledge
that the road to full separation from its merchant business could involve
more twists and turns. In its filing on Dec 6, 2016,
FirstEnergy also indicated that there continue to be significant commercial
relationships among FE, FES and AES. These relationships
involve administrative services and support, cash management and
tax sharing, among others, which would be subject to review
and possible challenge in the event of an FES bankruptcy filing.
FirstEnergy may need to incur additional liabilities on account of such
challenges.More liabilities could arise if, for instance,
FirstEnergy chose to pay off any material judgments against FES related
to the ongoing rail contract arbitration. In our opinion,
the changes to the various revolving credit facilities makes it less likely
that FirstEnergy would directly pay of any arbitration liability.
While it is possible that FES may draw on its revolver with FirstEnergy
in order to do so, the FES board will weigh that action against
the alternative of simply filing FES and making the rail companies pari
passu with existing unsecured bond holders. Even with the board
changes that were announced, FirstEnergy still appoints three of
the five members on FES' board.
Other liabilities related to an FES restructuring/bankruptcy could arise
from nuclear decommissioning. FES' nuclear decommissioning
trusts are adequate funded at the current point in time relative to their
licensed timeframes. But the trusts would be inadequate to fund
an immediate decommissioning of the plants. Should one or more
of its plants be retired due to weak merchant market conditions,
we think it is likely that FES would opt for the SafeStor option,
which provides for an additional 60 years before ultimate decommissioning.
Other retiring nuclear plants such as Vermont Yankee have done so.
However, it is likely that the Nuclear Regulatory Commission (NRC)
will be involved in determining the ultimate outcome should FES go bankrupt
and choose not to continue operating the plants. In the unlikely
but worst case scenario of an immediate decommissioning of the plants,
it is possible that FirstEnergy may have additional funding responsibilities
as the NRC may look towards the prior owners of the plants for funding.
Offsetting all of these potential liabilities would be any net proceeds
from the sale of AES assets as mentioned above. Our $1 billion
limit is the net additional debt that FirstEnergy can bear while still
maintaining an adequate financial profile. Its ability to bear
FES related costs improves if proceeds from AES are used to retire debt
at FirstEnergy, or to pay off FirstEnergy related costs.
This publication does not announce a credit rating action. For
any credit ratings referenced in this publication, please see the
ratings tab on the issuer/entity page on www.moodys.com
for the most updated credit rating action information and rating history.
Swami Venkataraman, CFA
Senior Vice President
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
Associate Managing Director
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
No Related Data.
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