Fitch Rates PECO Energy's First and Refunding Mortgage Bonds 'A+'

Fitch Ratings has assigned an 'A+' rating to PECO Energy Company's new issue of $575 million first and refunding mortgage bonds due 2033.

The net proceeds from the transaction will be used to refinance a $50 million term loan maturing in June 2023, currently outstanding CP and for general corporate purposes. PECO's Long-Term Issuer Default Rating (IDR) is 'A-' with a Stable Rating Outlook.

Key Rating Drivers

Low-Risk Business Profile: PECO's ratings reflect the utility's low-risk electric transmission and distribution (T&D) and gas distribution business, favorable Pennsylvania Public Utility Commission (PAPUC) regulation and strong credit profile. Approximately 60% of PECO's rate base is electric distribution and 25% is natural gas distribution that is regulated by the PAPUC. Approximately 15% of PECO's rate base is electric transmission regulated by the Federal Energy Regulatory Commission (FERC). Fitch views PAPUC and FERC as favorable regulatory jurisdictions.

Electric Distribution Rate Case Settlement: The PAPUC approved a settlement in PECO's electric rate case in November 2021. The settlement resulted in a $132 million increase effective Jan. 1, 2022. Like PECO's prior electric rate case, the outcome was reached through a black-box settlement and return parameters were not disclosed. The company originally requested a $246 million base rate increase based upon a 10.95% ROE and equity capitalization of 53.41% and test YE Dec. 31, 2022. Rates in Pennsylvania are set on a forecast test year, which reduces regulatory lag.

Gas Distribution Rate Proceedings: PECO filed a gas distribution rate case with the PAPUC on March 31, 2022. The company is requested an $82.1 million rate increase based upon a 10.95% ROE and 53.41% capitalization. The company's filing was necessitated by continued investment in new and replacement gas rate base, and increasing operations and maintenance expenditures, among other items. In October 2022, the commission approved a black box settlement that resulted in a $55 million increase effective January 2023.

Weakening Credit Metrics: PECO's financial position is consistent with its rating, but continued increased capex (forecast at $6.2 billion in 2023-2026) has decreased headroom at the current rating level. PECO's metrics may be further pressured by the implementation of a new 15% corporate alternative minimum tax (CMT) as a result of August 2022's Inflation Reduction Act (IRA). If the current regulations concerning the calculation of CMT are not modified, Fitch expects Exelon will take necessary measures to keep subsidiaries, including PECO, from exceeding rating thresholds on a sustained basis. Failure by Exelon to take appropriate measures to bring PECO's leverage in line with an 'A-' rating would have negative rating consequences.

Parent-Subsidiary Rating Linkage: There is parent subsidiary linkage between Exelon and its rated subsidiaries, including PECO. Fitch determines Exelon's standalone credit profile (SCP) based upon consolidated metrics. Fitch considers PECO have stronger SCP than Exelon. As such, Fitch has followed the stronger subsidiary path. Emphasis is placed on the subsidiary's status as regulated entities. Legal ring fencing is considered porous given the general protections afforded by economic regulation.

Access and control are evaluated as porous. Exelon centrally manages the treasury function for all of its entities and is the sole source of equity; however, PECO issues its own short-term and long-term debt. Due to the aforementioned linkage considerations, Fitch will limit the difference between Exelon and PECO to two notches.

Derivation Summary

PECO's credit profile as a regulated T&D utility is weaker than other peers with 'A-' Long-Term IDRs, such as Connecticut Light & Power Company (CL&P; A-/Stable) or Exelon subsidiary Baltimore Gas and Electric (BG&E; A-/Stable). PECO's FFO leverage for the TTM ended Dec. 31, 2022 was 4.3x and may exceed its 4.3x downgrade threshold at times over the forecast period. For the same period, CL&P's FFO leverage is 3.9x. Fitch expects CL&P's FFO leverage to average around 3.5 through 2025.

BG&E's FFO leverage for the TTM ended Dec. 31, 2022 was 3.9x, and Fitch expects it to average approximately 3.7x over the forecast period, adjusting for energy-efficiency capex. PECO, BGE and CL&P serve similar numbers of customers -- 1.7 million for PECO, 1.3 million for BGE and 1.3 million for CL&P. Historically, Fitch has considered Pennsylvania regulation to be more supportive than Connecticut or Maryland.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer:

Dividends managed to achieve allowed equity ratio;

Relatively flat sales and customer growth;

Four-year (2023-2026) capex plan of $6.2 billion.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Sustained FFO leverage at or below 3.5x and an upgrade of Exelon.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Sustained FFO leverage at or above 4.3x on a sustained basis;

Unexpected negative regulatory developments.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: PECO's $600 million committed credit facility provides ample liquidity. The credit facility supports a CP program of equal size and provides for direct borrowings. The credit facility extends to February 2027. PECO also participates in the Exelon corporate money pool. Parent Exelon can lend to, but not borrow from, the money pool. PECO had no outstanding money pool borrowings as of March 31, 2023. The company had no draws under its credit facility as of the same date; however, had $145 million outstanding CP. Cash and cash equivalents as of March 31, 2023 were $27 million.

PECO's total adjusted debt (including current maturities) as of March 31, 2023 totaled approximately $4.9 billion, including $184 million of subordinated debentures that qualify for 50% equity credit under Fitch's methodology. Other than the subordinated debentures, all of the long-term debt outstanding is first mortgage bonds secured by PECO's utility property. PECO's next corporate maturity is $350 million in 2025.

Issuer Profile

PECO Energy is a regulated electric T&D and natural gas distribution utility in Pennsylvania.

Summary of Financial Adjustments

As of Dec. 31, 2022, PECO had $184 million of subordinated debentures that qualify for 50% equity credit under Fitch's rating methodology.

Date of Relevant Committee

10 May 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.