Fitch: PEPCO Holdings Tax Payment Manageable
NEW YORK -- February 25, 2013
PEPCO Holdings Inc.'s (PHI) planned deposit with the Internal Revenue Service
(IRS) will a remove major overhang to PHI's credit profile, though it will
temporarily increase the company's leverage, according to Fitch Ratings.
PHI plans to make a deposit with the IRS of between $220 million and $260
million related to its cross-border lease portfolio. This will raise PHI's
leverage, which is already aggressive for the rating category. The planned
deposit is well below PHI's cross-border related tax exposure of approximately
$744 million. The difference results from the application of accumulated tax
deductions unrelated to the lease portfolio and includes the carry back or
forward of net operating losses, settled tax positions, and amounts on deposit
with the IRS.
Fitch expects PHI will seek to liquidate all or a portion of its lease
portfolio and to use any proceeds to reduce debt. PHI estimates a partial or
complete liquidation could be accomplished within one year. Fitch considers a
reduction in leverage to be important to maintaining PHI's existing ratings
and Stable Rating Outlook. After giving effect to the tax deposit, Fitch
estimates the consolidated ratios of debt/EBITDA and FFO/debt will approximate
5.0x and 14%, respectively, in 2013.
The planned deposit, which is expected by March 31, 2013, will stop the
accrual of additional interest costs on the tax liability while PHI determines
whether it will continue to litigate the IRS's tax position. PHI plans to fund
the payment with short-term borrowings and available cash. Fitch believes
existing credit facilities and funds from exercising a forward equity sale as
previously planned provide sufficient liquidity. The forward equity sale,
which must be exercised by March 5, 2013, is expected to provide approximately
PHI also expects to record a non-cash charge of between $355 million and $380
million (after-tax) reflecting a reduction in its equity investment in the
lease portfolio and additional interest expense. The reduction in retained
earnings is largely offset by exercising the equity forward contract.
The cross-border lease portfolio is structured as a sale and leaseback
transaction commonly referred to as a sale-in, lease-out (SILO) transaction.
The IRS disallowed a substantial portion of the tax benefits related to the
lease portfolio beginning with PHI's 2001 income tax return. After failing to
negotiate a settlement, PHI initiated litigation in the U.S. federal Claims
Court in January 2012 related to its 2001 and 2002 federal tax returns, which
The decision to take the write-down and make the tax deposit follows a Jan. 9,
2013, decision by the U.S. Court of Appeals for the Federal Circuit in a
similar case for Consolidated Edison Company of New York, Inc. that disallowed
tax benefits of a lease-in, lease-out transaction. Consequently, PHI
determined that its tax position related to the cross-border leases no longer
meets the more likely than not standard of recognition for accounting
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. , 2012);
-- 'Parent and Subsidiary Rating Linkage', Aug. 12, 2011
-- 'Recovery Ratings and Notching Criteria for Utilities' (Nov. 12, 2012);
Applicable Criteria and Related Research
Recovery Ratings and Notching Criteria for Utilities
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology
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Fitch Ratings, Inc.
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