Fitch Rates DTE Electric Co.'s $500MM General & Refunding Mtge Bonds 'A'; Outlook Stable

Fitch Ratings has assigned an 'A' rating to DTE Electric Company's (DECo) $500 million issuance of 30-year general and refunding mortgage bonds. The mortgage bonds will rank pari passu with DECo's existing secured mortgage debt. Proceeds from the issuance will be used to repay short-term borrowings and for general corporate purposes. The Rating Outlook for DECo is Stable.

Stable Outlook: DECo's Outlook reflects Fitch's expectations of stable earnings and cash flows throughout the forecast period due to DECo's regulated utility operations and a constructive regulatory environment in Michigan.

DECO's ratings also consider a sufficient liquidity position, an improving economy, manageable debt maturities, and the ability to manage and fund a rising capex budget. Credit concerns include the future effects of more stringent environmental regulations on DECo's predominantly coal-fired power generation portfolio.

KEY RATING DRIVERS

First GRC Filing in Over 4 Years: In December 2014, DECo filed its 2015 general rate case (GRC) with the Michigan Public Service Commission (MPSC) requesting a $370 million rate increase predicated on a 10.75% return on earnings (ROE) and a 50% equity layer. The filing is based on a forward-looking test year and primarily reflects $2.8 billion in new net plant additions. The new plant additions include the planned purchase of the 732MW natural gas-fired Renaissance Power Plant from LS Power Group for $240 million as well as the planned purchase of a 300MW Michigan-based simple-cycle natural gas-fired power plant. DECo plans to self-implement rates on or after July, 1, 2015, subject to refund, and a decision by the MPSC is expected by December.

Fitch has conservatively modeled a 10% ROE for DECO which approximates recent industry averages. The expiration of securitization charges, renewable surcharge reductions and a continued low-commodity environment provides DECo sufficient headroom to seek base rate increases without significant pressure on retail rates. In DECo's GRC filing, net rates for residential customers are expected to increase modestly by 3% while rates for commercial and large industrial customers are expected to decrease by 7% and 18%, respectively. For the LTM period ending Sept. 30, 2014, DECo's earned ROE was approximately 10.7%, slightly above its current authorized ROE of 10.5%.

Potential Elimination of Retail Open-Access in MI: Recently, talks about customer choice have centered on eliminating retail open-access and moving Michigan's electricity market to full regulation after a previous bill introduced in the U.S. House to raise the customer choice cap beyond 10% did not get any traction. If retail open-access was eliminated it could result in customers coming back to DECo amid tightening capacity markets in MISO, necessitating the need for new generation investments such as the planned purchase of the 732MW gas-fired Renaissance Power Plant. Fitch views the elimination of customer choice as positive for DECo.

New MI Energy Legislation Expected in 2015: In December 2014, Michigan Governor Rick Snyder broadly outlined the state's future energy policy goals by 2025 and indicated he would like to have new energy legislation in place this year when current Renewable Portfolio Standards (RPS) and Energy Efficiency (EE) targets end. The governor emphasized the increased use of cleaner natural gas and wind resources while reducing the state's reliance on less efficient coal generation and indicated he would seek to increase RPS and EE targets through 2025.

DECo recovers its renewable investments under an annual renewable surcharge subject to MPSC approval. DECo expects natural gas-fired generation along with renewables to approximate up to 50% of total generating capacity by 2030, a material improvement from 10% in 2013 and in line with the governor's energy policy goals. Fitch views DECo's investments in renewable energy as favorable and, via the renewable energy surcharge, they provide earnings growth in between GRC proceedings.

Constructive Regulatory Environment: Fitch views the regulatory environment in Michigan as constructive. The current regulatory framework allows for full pass-through of fuel and purchased power costs, reasonable ROE, forward-looking test years and a timely resolution of rate proceedings. In addition, DECo has the ability to file rate cases with self-implementation if the ROE dips below the authorized level (currently at 10.5%).

High Capex: Capital investments are expected to total approximately $4.7 billion through 2017, levels approximately 10% higher than the preceding three-year period. Capital spending will include new generation, distribution and environmental compliance investments. Due to the large capex program, Fitch expects DECo to remain free cash flow (FCF) negative and will need equity support from the parent through 2017 to help maintain their balanced capital structure. Going forward, Fitch expects DECo to fund any deficits by a roughly 50% mix of debt and equity to maintain the present balanced capital structure. Fitch anticipates equity issuances at DTE totaling $200 million this year and annual equity issuances totaling $300 million per year through 2017 through its Dividend Reinvestment Programs (DRIP) and employee pension programs.

Modest Weakness in Credit Metrics: Fitch forecasts DECO's credit metrics to remain commensurate with Fitch's 'BBB+' IDR guidelines for utility companies but anticipates the large capital spending program to pressure leverage metrics modestly. For 2014, DECo's EBITDAR coverage was 7x, and leverage, as measured by debt-to-EBITDAR, was 3.1x. Going forward, Fitch expects EBITDAR coverage ratios to remain above 6x and anticipates debt-to-EBITDAR to increase modestly to 3.4x through 2017 due to anticipated leverage associated with increased capital investments.

Sufficient Liquidity and Manageable Maturities: DECo has approximately $264 million of total liquidity available under its respective credit agreement as of Dec. 31 2014, including $14 million of unrestricted cash and cash equivalents. DECo's $300 million unsecured revolving credit facility matures in April 2018. The facility has a maximum debt-to-capitalization covenant of 65% and, as of Dec. 31, 2014, DECo was in compliance with a debt-to-capitalization ratio of 51% under its credit agreement. Debt maturities over the next four years are manageable and are as follows (excluding securitization maturities): $10 million in 2015, $151 million in 2016, no maturities in 2017, and $300 million in 2018. Maturing debt will be funded through a combination of internal cashflows and external debt refinancings.

KEY ASSUMPTIONS

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

--Fitch modeled an authorized ROE of 10% through 2017.

--Annual retail sales growth of 0.5% per annum through 2017.

--Capex of $4.7 billion through 2017 to be funded primarily from internally generated funds.

--Annual equity infusions of roughly $200 million per annum.

RATING SENSITIVITIES

DTE Electric Co.

Future developments that either individually or combined could lead to positive rating actions include:

--The elimination of DECO's retail open-access program;

--Sustained debt-to-EBITDAR at 3.5x or below.

Future developments that either individually or combined could lead to negative rating actions include:

--An unexpected outcome in DECO's pending GRC that limits the utility's ability to recover cost of capital investments in a timely manner;

--An adverse change in Michigan's regulatory climate;

--Sustained debt-to-EBITDAR metrics in the 3.75x-4.00x range.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Rating U.S. Utilities, Power and Gas Companies' (March 11, 2014);

--'Corporate Rating Methodology' (May 28, 2014);

--'Recovery Ratings and Notching Criteria for Utilities'(Nov.18, 2014).

Applicable Criteria and Related Research:

Recovery Ratings and Notching Criteria for Utilities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813608

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980739

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