Fitch Ratings considers the District of Columbia Public Service Commission's (PSC) denial of the proposed merger between Exelon Corp. (EXC, 'BBB+' IDR, Rating Watch Negative) and Pepco Holdings, Inc. (PHI) to be unfavorable for EXC due to the expense and financing costs incurred to date. However, the denial of the merger will not be the sole driver of resolving the company's Rating Watch Negative status.
Fitch revised EXC's Rating Outlook to Negative prior to the PHI merger announcement due to the ongoing weakness of its competitive generation subsidiary Exelon Generation, Co., LLC (IDR 'BBB', Outlook Stable). Once the proposed merger was announced, EXC was placed on Rating Watch Negative due to the additional leverage from the acquisition financing and the consolidation of the more levered PHI. Since that time power and natural gas prices have not improved, but the recently completed PJM capacity auction for the 2018/2019 delivery year will provide a significant boost in revenue three years from now. The incremental transition auctions scheduled over the next several weeks are also expected to provide a revenue boost as early as 2016.
Once the status of the PHI merger is determined, Fitch will resolve the Rating Watch Negative based on an assessment of EXC's stand-alone consolidated credit and risk profile. Also to be considered is the impact of the acquisition funding that has already been issued, including $4.2 billion of senior unsecured debt and $1.15 billion of hybrid securities that Fitch treats as debt. Approximately $2.75 billion of the acquisition debt is callable at 101% of par in the event the merger is terminated. However, that leaves $1.45 billion of debt maturing in 2017 and 2020 plus the $1.15 billion of hybrid securities that will remain on EXC's balance sheet with no additional earnings source.
In addition, EXC has incurred approximately $205 million of merger related expenses through June 30, 2015 and may be required to pay PHI a termination fee of $180 million, equal to the amount of preferred stock EXC already purchased from PHI to bolster its liquidity during the merger review period.
EXC is likely to request reconsideration of the PSC decision that may include additional customer benefits.
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
Shalini Mahajan, CFA
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