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Rating Action:

Moody's revises outlook for Public Service of Oklahoma to negative

23 Apr 2020

Approximately $1.4 billion of debt affected

New York, April 23, 2020 -- Moody's Investors Service ("Moody's") revised the outlook for Public Service Company of Oklahoma (PSO, A3) to negative from stable and affirmed its existing ratings. PSO is a vertically integrated electric utility subsidiary of American Electric Power Company, Inc. ("AEP", Baa1 negative).

RATINGS RATIONALE

"While PSO's earnings profile improved following its 2019 rate case decision, its cash flows are being negatively impacted by the return of excess deferred taxes and the inability to accelerate recovery of the Oklaunion coal-fired plant that is scheduled to close in October 2020" said Laura Schumacher, Vice President - Senior Credit Officer. In addition, Moody's expects the company's continuing capital program will maintain negative pressure on credit metrics such that the ratio of cash flow from operations excluding working capital changes (CFO pre-WC) to debt will remain below the 19% threshold we have established for PSO's A3 rating.

For full year 2019, PSO's ratio of CFO pre-WC to debt was around 18.3%, and its return on equity (ROE) was reported at 10.7%. While these metrics are meaningfully stronger than the CFO pre-WC to debt ratios below 17% and reported ROEs below 7% demonstrated in 2017 and 2018, when the company was experiencing significant regulatory lag, Moody's does not believe this improvement will be sustained.

Although PSO's 2019 rate decision meaningfully improved the utility's earning ability, its cash flow continues to be negatively impacted by the effects of federal tax reform, including the loss of bonus depreciation and a fairly rapid (five year) return of excess depreciation. Cash flow forecasts have also been negatively impacted by the Oklahoma Corporation Commission's (OCC) denial of PSO's request to accelerate recovery of the Oklaunion plant to 2028 versus its original planned 2046 closure date. In addition, while the OCC approved rider recovery of PSO's transmission related costs, there is still some lag in recovery as increased expenditures are deferred into the subsequent year.

Adding to PSO's financial stress is the fact that the economy in its service territory is heavily dependent on the volatile energy sector, which is under pressure due to lower oil and gas prices as well as a drop in global demand following the outbreak of the coronavirus. Against this backdrop, the company continues to invest in its systems to assure reliable performance and environmental compliance.

From an environmental perspective, in addition to controlling the emissions of its fossil fleet, PSO is planning to reduce its carbon transition risk by participating in AEP's proposed North Central Wind development. The plan includes PSO's acquisition of 45% of three wind projects in Oklahoma, totaling up to 1,485 megawatts (MW), for a total investment of approximately $2 billion ($900 million for PSO). Another AEP subsidiary, Southwestern Electric Power Company (SWEPCo, Baa2 stable) with operations in Texas, Louisiana and Arkansas, will acquire the remaining 55%. To date, regulatory approval for a total of 1,176 MW have been received from three out of the four state commissions and the Federal Energy Regulatory Commission (FERC). Hearings covering the remaining 309 MW allocated to Texas occurred in February, with a decision required by July of 2020. The project is scalable and can move forward even in the event Texas declines their allocation.

While the final size and financing arrangements for North Central Wind have not yet been determined, Moody's expects the acquisition will be funded with a combination of debt and equity in a relatively balanced manner. However, the given the long-lived nature of the assets, and the likely need to defer production tax credits, there could be additional downward pressure on credit metrics.

Environmental, social and governance considerations incorporated into our credit analysis for PSO are primarily related to carbon regulations and social risks related to demographic and societal trends, as well as customer and regulatory relations. PSO has moderate carbon transition risk within the regulated utility sector as the majority of its energy is generated by fossil fuels, with most of it coming from natural gas. The North Central Wind project will increase PSO's controlled wind generating capacity from 18% to over 25% of total capacity, coal generation represents under 10%. From a governance perspective, financial strategy and risk management are key considerations.

Rating outlook

PSO's negative outlook reflects Moody's expectation that the PSO's cash flow will continue to be under pressure while it maintains its substantial capital program causing the utility's ratio of CFO pre-WC to debt to remain under 19%.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Factors that could lead to an upgrade

The rating is not likely to move upward over the next 12-18 months. Longer term, if there were to be an increase in cash flow, perhaps due to regulatory activity or load growth, or a reduction in leverage such that we could expect key financial credit metrics to strengthen; for example, a ratio of CFO pre-WC to debt sustained above 25%, there could be upward pressure on the rating.

Factors that could lead to a downgrade

If the regulatory environment took a more adversarial tone, or if there were to be a significant increase in capital or operating expenditures that were not able to be recovered on a timely basis, the rating could move down. If key financial credit metrics continue to be low for the credit profile, including CFO pre-WC to debt remaining below 19%, there could be downward pressure on the rating.

Affirmations:

..Issuer: Public Service Company of Oklahoma

....Issuer Rating, Affirmed A3

....Senior Unsecured Regular Bond/Debenture, Affirmed A3

Outlook Actions:

..Issuer: Public Service Company of Oklahoma

....Outlook, Changed To Negative From Stable

PSO is a vertically integrated electric utility company headquartered in Tulsa, Oklahoma and a wholly owned subsidiary of AEP. PSO has a rate base of about $3 billion (6.5% of AEP's total rate base), and 2019 revenues of about $1.5 billion (9.5% of AEP's revenue).

The principal methodology used in these ratings was Regulated Electric and Gas Utilities published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1072530. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Laura Schumacher
VP - Senior Credit Officer
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Michael G. Haggarty
Associate Managing Director
Infrastructure Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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