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Global Credit Research - 25 Oct 2010
New York, October 25, 2010 -- Moody's Investors Service today downgraded the Issuer Rating of E.ON
U.S. LLC (E.ON U.S.) to Baa2 from A3
and the Issuer Ratings of its two utility subsidiaries, Kentucky
Utilities Company (KU) and Louisville Gas and Electric Company (LG&E),
to Baa1 from A2. Moody's also downgraded KU and LG&E's
short-term ratings for variable rate demand debt to Prime-2
from Prime-1. These rating actions conclude the review for
possible downgrade that commenced on April 29, 2010. The
rating outlooks for E.ON U.S., KU and LG&E
Separately, Moody's confirmed KU and LG&E's outstanding
tax-exempt debt at A2. The rating confirmation considers
that, in the case of LG&E, the formerly unsecured debt
has been secured with first mortgage bonds provided to the trustee and,
while KU's bonds are currently unsecured, the utility intends
to secure them in a similar manner over the next week. It is Moody's
policy to generally rate first mortgage bonds of investment-grade
rated utilities two alpha-numeric ratings higher than its Issuer
Rating or senior unsecured debt rating.
The downgrade of E.ON U.S., KU and LG&E's
Issuer Ratings follows receipt of several regulatory approvals,
most notably from the Kentucky Public Service Commission (KPSC),
relating to the proposed sale of E.ON U.S. by E.ON
AG (E.ON: A2 senior unsecured) to PPL Corp. (PPL:
Baa3 senior unsecured) for approximately $7.625 billion.
While approval from the FERC remains outstanding, we believe there
is a high probability that it will be received and that the transaction
will close in a matter of weeks. Upon closing of the transaction,
E.ON U.S. will become a subsidiary of PPL and will
be renamed LG&E and KU Energy LLC (LKE), with KU and LG&E
remaining as distinct and separate operating entities. In the unlikely
scenario that the merger is not consummated, the Issuer Ratings
for E.ON U.S., LG&E and KU would likely
revert back to their respective prior assigned levels.
"E.ON's ownership of E.ON U.S.,
KU and LG&E was an important factor supporting their prior respective
Issuer Ratings" said Moody's Vice President Scott Solomon.
"Specifically, E.ON's size, scale and credit
profile provided liquidity and financial flexibility in the form of significant
inter-company funding along with a liberal dividend policy that
strengthened the related company's respective financial position
and provided ratings lift".
Today's downgrades were triggered by the expected near-term
transfer of ownership and the elimination of any ratings lift.
E.ON U.S., KU and LG&E's ratings,
however, are well positioned within their newly assigned rating
categories and reflective of sound financial metrics and a generally supportive
regulatory environment that provides for above-average cost recovery.
Fluctuations in KU and LG&E's cost of fuel and purchased power,
for instance, are recoverable with minimal regulatory lag while
investments and costs borne by the utilities in order to remain compliant
with the Clean Air Act are recoverable through an environmental surcharge
KU and LG&E's ratio of consolidated cash flow before changes
in working capital (CFO pre W/C) to debt and CFO pre-W/C interest
coverage for the twelve months ended June 30, 2010, were each
approximately 20% and 5.6 times, respectively.
Financial metrics for both utilities are expected to trend modestly upward
over the near-term due in large part to rate increases that became
effective in August 2010. That being said, both utilities
are expected to increase their respective dividend payments under PPL
ownership. E.ON U.S. is expected to generate
consolidated CFO pre-W/C to debt metrics in the mid-to-upper
teens and CFO pre-W/C interest coverage above 4 times, placing
it firmly in the mid-Baa rating category.
KU and LG&E, combined, had approximately $2.6
billion of long-term debt outstanding at December 31, 2009.
Of this amount, approximately 70% was intercompany debt provided
by E.ON affiliates (the remaining 30% is tax-exempt
debt that will remain outstanding). While the absolute amount of
debt at KU and LGE is not expected to be impacted by the proposed acquisition,
PPL anticipates ultimately refinancing the intercompany debt with first
mortgage bond debt offerings at KU and LG&E and senior unsecured debt
at LKE (the renamed E.ON U.S.)
Moody's Issuer Ratings are an opinion of the ability of an entity to honor
its senior unsecured financial obligations. Specific debt issues
may be rated differently and are considered unrated unless rated by Moody's.
That being said, it is Moody's expectation that any debt offering
by LKE would likely be rated Baa2.
The KPSC's approval of the acquisition included two commitments
affecting rates. The first places a moratorium on any base rate
increases by KU and LG&E until 1/1/13. The second provision
establishes a mechanism under which earnings at the utilities in excess
of a 10.75% ROE will be shared equally between ratepayers
and shareholders. The agreement has no impact on the utilities'
ability to seek rate adjustments through their existing fuel and environmental
cost adjustment mechanisms.
The stable outlook considers the modest expected improvement in financial
metrics over the near-term and the supportive regulatory environment
in which the utilities operate.
Upward pressure may materialize for KU and LG&E if they achieve financial
metrics such as CFO pre-WC to debt in excess of 25% and
retained cash flow to debt of greater than 17% on a sustainable
basis. LKE's rating may be upgraded if it achieves consolidated
CFO pre-WC to debt in excess of 19% on a sustainable basis.
KU, LG&E and LKE's ratings could be downgraded should
the utilities encounter unexpected problems integrating with PPL or if
unexpected changes are made to the regulatory compact that currently provides
for timely recovery of costs. Financial metrics that may trigger
downward rating pressure include, for KU and LG&E, ratios
of CFO pre-WC to debt of below 16% or, in the case
of LKE, below 13%.
The principal methodology used in rating E. ON U.S.
LLC was Regulated Electric and Gas Utilities rating methodology published
in August 2009. Other methodologies and factors that may have been
considered in the process of rating this issuer can also be found on Moody's
E.ON U.S. LLC is headquartered in Louisville,
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings,
public information, confidential and proprietary Moody's Investors
Service's information, confidential and proprietary Moody's
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of maintaining
a credit rating.
MOODY'S adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
MOODY'S considers to be reliable including, when appropriate,
independent third-party sources. However, MOODY'S
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service provides a date that it believes is the most reliable
and accurate based on the information that is available to it.
Please see the ratings disclosure page on our website www.moodys.com
for further information.
Please see the Credit Policy page on Moodys.com for the methodologies
used in determining ratings, further information on the meaning
of each rating category and the definition of default and recovery.
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's Investors Service
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's Investors Service
Moody's Investors Service
Moody's downgrades the Issuer Ratings for E.ON U.S. and its subsidiaries
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