Fitch Ratings has assigned a First-Time Long-Term Issuer Default Rating (IDR) of 'BBB' to Keystone Appalachian Transmission Company (KATCo).
The Rating Outlook is Stable.
The rating and Stable Outlook reflect KATCo's low risk business profile, supportive economic regulation and relatively predictable earnings and cash flows. The ratings also consider the company's parent-subsidiary rating linkage (PSL) with its ultimate corporate parent, FirstEnergy Corp (FE; BBB-/Stable). KATCo's standalone credit profile is stronger than FE's, with leverage projected to average less than 3.0x during 2024-2026 compared with FE's 4.9x over the same time horizon. Under Fitch's PSL criteria, the difference between the IDR of FE and KATCo is limited to one notch.
Key Rating Drivers
Credit Supportive Rate Regulation: KATCo operates under a Federal Energy Regulatory Commission (FERC) rate regime that, in Fitch's view, provides the company with a reasonable opportunity to earn its 10.45% authorized return on equity (ROE) and deliver relatively predictable earnings and cash flows. KATCo operates under a forward-looking FERC-approved tariff with annual true ups to effectively recover operating expenses and reflect prospective capital additions. KATCo controls approximately 4,300 circuit miles of transmission lines operating exclusively in the PJM Interconnection (PJM).
In October 2020, KATCo filed its proposed new tariff with FERC to establish a forward-looking formula rate, reaching an uncontested settlement agreement that the utility filed with FERC in January 2023. In May 2023, FERC approved the uncontested settlement without condition or modification. Fitch views FERC rate regulation as generally balanced from a credit perspective.
New FERC Tariff Granted: Fitch believes FERC approval of a forward-looking formula rate for KATCo is a constructive development. The FERC-approved settlement authorizes a 10.45% ROE, including a 50bps adder for participation in a regional transmission organization (RTO) and a hypothetical capital structure.
The FERC-authorized settlement precludes parties from filing to change base ROE or ROE-based transmission incentives or capitalization during the moratorium period of four years following the filing of the settlement or three years after the asset transfer date, whichever is longer. However, under the provisions of the settlement, a final rulemaking regarding the ROE adder for RTO participation would apply to KATCo regardless of the moratorium on changes to ROE. While a reduction in KATCo's authorized ROE due to FERC's review of its ROE methodology cannot be ruled out, Fitch views the risk as manageable within the utility's current rating category.
FERC Update: Currently, there are two vacancies on FERC with the recent departure of James Danly with adjournment of the 2023 congressional session. In addition, FERC review of its ROE methodology, which has been underway for several years, continues. Fitch believes uncertainty regarding FERC's composition and potential changes in the commission's ROE methodology is manageable within KATCo's current rating category.
Low Business Risk Profile: KATCo's ratings and Stable Outlook consider the electricity transmission company's low, standalone business risk profile and relatively predictable earnings and cash flows. The utility bears no commodity price, volumetric or customer concentration risk. In Fitch's opinion, competitive authorized ROE and formula-based rates with annual true-ups support predictable cash flows.
Low Leverage: KATCo's FFO leverage is expected to remain strong from 2024 through 2026. Fitch projects KATCo FFO leverage of 2.2x in 2024, 2.6x in 2025 and 2.8x in 2026, metrics that are strong for KATCo's 'BBB'/Stable IDR. KATCo's ratings are constrained under Fitch's Parent and Subsidiary Linkage Rating Criteria.
Parent Subsidiary Linkage: KATCo's standalone credit profile is stronger than FE's, reflecting balanced rate regulation under FERC, low business risk and strong credit metrics. Legal ring fencing is considered porous between FE and KATCo given the general protections and incentives afforded by economic regulation via prescribed capital structures and authorized ROE requirements under its formula-based tariff.
Access and control are open. While KATCo has direct access to capital markets, FE manages KATCo and its sister utilities' centrally, and strategic linkage is strong. KATCo participates in FE's utility money pool and recently negotiated a $150 million RCF. FE's treasury operations are centralized. Accordingly, the difference between FE's and KATCo's IDRs based on Fitch's PSL criteria is limited to one notch.
Derivation Summary
Based on estimated EBITDA of $43 million in 2024, KATCo is much smaller than AEP Transmission, which had 2022 EBITDA approximating $1.2 billion. It is larger than GridLiance West (A-/Stable), as measured by its $24 million of 2022 EBITDA. KATCo is a wholly-owned subsidiary of FE. While KATCo operates exclusively within PJM Interconnection (PJM), AEP Transmission is more diverse, operating in PJM and the Southwest Power Pool (SPP). GridLiance West, like KATCo, operates solely within a single independent system operator's footprint - the California Independent System Operator's (CAISO).
KATCo's FERC authorized ROE of 10.45% compares with AEP Transmission's 10.35% in PJM and 10.5% in SPP and 10.6% for GridLiance in CAISO. KATCo's projected 2024-2026 credit metrics are stronger than AEP Transmission and GridLiance West. KATCo's 2024-2026 FFO leverage is estimated by Fitch to average 2.5x, considerably better than GridLiance West's 3x average over the same time period and AEP Transmission's expected range of 4.0x-4.3x over the next few years. The difference in KATCo's IDR, like AEP Transmission, is limited by rating linkage with its corporate parent.
Key Assumptions
Fitch's Key Assumptions within our Rating Case for the issuer include
Continued credit supportive FERC rate regulation;
No change in KATCo's authorized ROE of 10.45%;
Capex averages somewhat more than $90 million over the forecast period.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
A rating upgrade at corporate parent FirstEnergy Corp and FFO leverage of 4.5x or better on a sustained basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A rating downgrade at FirstEnergy Corp.;
FFO leverage of worse than 5.5x;
Unexpected deterioration in rate regulation.
Liquidity and Debt Structure
Solid Liquidity: KATCo entered into a $150 million revolving credit facility scheduled to expire October 2027. Fitch anticipates KATCo will participate in FE's regulated utility money pool and have direct access to debt capital markets. Like many utilities, KATCo is expected to be FCF negative over the 2024-2026 forecast. KATCo has no debt outstanding. Fitch expects it to be solidly capitalized with FFO leverage estimated at below 3x 2024-2025.
Issuer Profile
KATCo, a transmission-only operating subsidiary of FE, controls approximately 4,300 circuit miles of transmission lines in central, south central and western Pennsylvania. In addition, KATCo plans to build new transmission in the Allegheny Power Zone of the PJM Interconnection and operates exclusively in the PJM Interconnection (PJM).
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
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
FIRSTENERGY CORP. 
