Fitch Rates AEP Transmission's Senior Notes 'A-'

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'A-' rating to AEP Transmission Company LLC's (AEP Transco) $300 million series D senior notes due 2026 and $400 million series E senior notes due 2046. The notes are unsecured and unsubordinated obligations of AEP Transco.

The net proceeds from the senior notes series D and series E will be lent to AEP Transco's operating subsidiaries to invest in transmission facilities and to refinance their respective short-term borrowings.

Fitch assigned a 'BBB+' Issuer Default Rating (IDR) and an 'A-' senior unsecured debt rating to AEP Transco on Nov. 4, 2016. The ratings and Stable Outlook reflect the company's low business risk profile as a Federal Energy Regulatory Commission (FERC)-regulated electric transmission utility company with modest regulatory lag and earnings volatility. The ratings also reflect the financial support provided by its ultimate parent American Electric Power Co Inc. (AEP; IDR 'BBB').

KEY RATING DRIVERS

Constructive Regulatory Environment

AEP Transco's wholly-owned subsidiaries operate under a FERC approved open access transmission tariff (OATT) that provides timely recovery of capital and operating costs as well as a stable earnings and cash flow profile. The tariff is adjusted annually to reflect actual operating costs, forward looking capital additions and a true-up that reduces regulatory lag. Other favourable elements of the OATT are an above average authorized return on equity (ROE) of 11.20% to 11.49%, inclusive of a 50 basis point adder for belonging to a regional transmission organization (RTO), and a capital structure with 50% equity. AEP Transco's business model entails no material volume, commodity or weather sensitivity.

The recent challenge filings to AEP Transco's FERC-authorized ROE in the PJM Interconnection, LLC (PJM) region poses a modest credit concern, in Fitch's opinion, despite the possibility of a material reduction from the currently authorized 10.99% base ROE. Fitch anticipates credit protection will remain commensurate with the 'BBB+' IDR given the significant financial flexibility at the current ratings and recent outcomes to other challenges. Furthermore, management plans to submit a formula rate adjustment filing requesting use of forward-looking operating expenses and property taxes, which would offset some of the impact of the ROE reduction on earnings during periods of rapid rate base growth.

Asset and Project Diversity

The rapid expansion of AEP Transco's asset portfolio is not a credit concern, in Fitch's view, given the projects' modest technological and execution risks as well as the ability to draw on AEP's managerial experience and financial resources as needed. Furthermore, AEP Transco's rate structure allows for contemporaneous returns on investments, which lessens the pressure from the elevated investments on the balance sheet. AEP Transco plans to invest $1.2 billion to $1.5 billion annually in 2016-2019 to build out its transmission asset network, which should result in a near doubling of the asset base by 2019 compared with $4.5 billion at Sept. 30, 2016.

AEP Transco's portfolio of assets spans six states across the PJM and Southwest Power Pool (SPP) regions, with most assets connecting into the service territories of AEP's vertically integrated regulated utilities. New projects come from three sources - PJM, SPP, and AEP management for local projects - providing diversity in growth opportunities.

Improving Protection Measures

The ratings incorporate a gradual strengthening of credit protection measures in 2016-2018. Fitch assumes that AEP will provide incremental equity infusions as needed to maintain a long-term debt/equity ratio approximately 50%/50%, in line with the regulatory authorization, and expects adjusted debt/EBITDAR to improve to 4.5x-5.0x by 2018.

Relationship with AEP

AEP Transco has operational, financial and functional ties to AEP resulting in a moderate level of ratings linkage. The treasury function is centrally managed with all regulated subsidiaries depending on AEP for short-term liquidity and participating in AEP's regulated money pool. The money pool allows the utilities to manage working capital needs and provides short-term financing. Legal ties are weak as the parent does not guarantee the debt obligations of its regulated subsidiaries. There are no cross default provisions amongst AEP and its subsidiaries.

Due to these linkages, Fitch typically limits the notching difference between AEP and its subsidiaries to one-to-two notches. AEP's regulated subsidiaries are rated lower and/or higher than AEP reflecting the strength of their respective balance sheets, the quality of their service areas and the constructiveness of their regulatory environments. Furthermore, Fitch typically restricts the rating differential between participants in a money pool to no more than two notches.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--All projects are subject to FERC's formula rate plan.--Authorized ROE of 10.5%, inclusive of RTO adders.--Capital expenditures of $1.2 billion to $1.5 billion annually.--No dividend.--Cash shortfall funded with a mix of debt and equity contribution to maintain a 50%/50% long-term debt-to-equity ratio.

RATING SENSITIVITIES

Positive Rating Action: Positive rating action is not likely at this time as AEP Transco's ratings are constrained by the IDR of its ultimate parent AEP and by its participation in the regulated money pool with lower-rated affiliates. The credit ratings and Stable Outlook incorporate the expected improvement in credit protection measures, including adjusted debt to EBITDAR of 4.5x to 5.0x by 2018.

Negative Rating Action: Similarly, negative rating action is not likely in the near-term given the earnings visibility under FERC regulation and financial flexibility at the current rating level. Future developments that may, individually or collectively, lead to a negative rating action include adjusted debt/EBITDAR remaining above 5.0x beyond 2018 and significant adverse changes to the regulatory framework. Although not contemplated at this time, a downgrade of AEP could also result in a negative rating action.

LIQUIDITY

AEP Transco and its operating subsidiaries have satisfactory liquidity. The operating subsidiaries participate in AEP's utility money pool with individual borrowing limits set by regulatory orders. AEP had approximately $3.0 billion of total liquidity available at Sept. 30, 2016, including $2.8 billion available under two revolving credit facilities maturing in June 2018 ($500 million facility) and June 2021 ($3 billion facility).

AEP Transco periodically issues long-term notes and lends the proceeds to its operating subsidiaries, through inter-company loans, to refinance their respective short-term borrowings. Inter-company loans are sized for each operating subsidiary to respect their 50% equity FERC-authorized capital structure. AEP Transco had $1.55 billion of long-term debt with well staggered maturities outstanding on Sept. 30, 2016.

AEP Transco must maintain a ratio of debt to total capitalization that does not exceed 67.5%, per the covenants to its financing agreements.

Variation from Criteria

Fitch looks to its Recovery Ratings and Notching Criteria for Utilities dated March 4, 2016 for guidance on the application of its sector recovery uplift. The standard higher notching for debt instruments issued by utilities reflects the above-average recovery prospects in case of default and is based on the fact that valuations of regulated utility companies, or of their underlying assets, vary less over the course of the business cycle than is typical of other corporate business. Criteria stipulate that the sector recovery uplift is not applicable to debt instruments issued by utility holding companies with material unregulated activities or a significant amount of holding-level debt.

A one-notch uplift from the IDR was applied to the ratings of the senior unsecured debt instruments issued by AEP Transco, a holding company with significant holding-level debt. This variation from criteria reflects Fitch's assessment of above-average expected recovery in the event of default and is supported by the absence of independent long-term debt at the subsidiary level as well as a restriction on priority debt (defined as debt secured by a lien or debt of any subsidiary, but excluding debt of a subsidiary owed to AEP Transco) to 10% of the consolidated tangible net assets. Adherence to the FERC authorized capital structure and modest regulatory constraints to upstream dividends from the regulated utilities provide further support for the uplift.

Disclosure: There were no financial statement adjustments made that were material to the rating rationale outlined above.

Date of Relevant Rating Committee: Nov. 4, 2016

Additional information is available on www.fitchratings.com.

Applicable CriteriaCriteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)https://www.fitchratings.com/site/re/885629Recovery Ratings and Notching Criteria for Utilities (pub. 04 Mar 2016)https://www.fitchratings.com/site/re/878227

Additional DisclosuresSolicitation Statushttps://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014889Endorsement Policyhttps://www.fitchratings.com/regulatory

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