Fitch Affirms Ratings for Appalachian Power Co.; Outlook Stable

Fitch Ratings has affirmed the ratings of Appalachian Power Co. (APCo) as follows:

--Issuer Default Rating (IDR) at 'BBB-';

--Senior unsecured debt and pollution control revenue and solid waste disposal bonds at 'BBB';

--Preferred Stock at 'BB+'.

Approximately $3.8 billion of debt is affected. The Rating Outlook for the company is Stable.

Key drivers of the rating are the company's affiliation with parent, American Electric Power Co. (AEP; IDR 'BBB' with a Stable Outlook), regulated electric utility operations, and solid liquidity position. While the utility is able to participate in the AEP power pool and AEP money pool, given AEP's highly centralized treasury and electric operations, any deterioration in the credit quality of the parent company could impair the ratings of APCo. Rating concerns primarily relate to below average credit metrics through 2013 due to regulatory lag and a recent $54 million disallowance in Virginia, a relatively restrictive outcome in the company's most recent rate case in Virginia, and uncertainty regarding the pending base rate request in West Virginia.

Recent financial performance was negatively impacted by higher operating and maintenance expenses, and continued elevated balances of under-recovered fuel costs, currently estimated to be approximately $354 million, including carrying costs. As a result, the company's ratio of normalized EBITDA to interest and debt to EBITDA are below average for the 'BBB-' rating category at 3.31 times (x) and 5.45x, respectively, for the twelve-month period ended June 30, 2010. Fitch's affirmation of APCo's ratings and the continuation of the Stable Outlook reflect the expectation that the company's credit metrics will improve over the next three years, with EBITDA to interest forecasted to approximate 4.0x and leverage to decline to 3.8x by 2014, as a result of phased-in recovery of under-recovered fuel costs in West Virginia through 2013. Fitch notes that capital spending at the utility is relatively modest, averaging approximately $420 million per year through 2012. APCo's internally generated cash flows are more than sufficient to finance the company's capex program and the company is projected to be free cash flow positive through the next several years.

In July 2010, the Virginia State Commerce Commission (VSCC) issued an order approving a $62 million base rate increase for APCo, based on a 10.53% return on equity (ROE). The order also allowed the deferral of approximately $25 million of incremental storm expense incurred in 2009. The order denied recovery of the Virginia share of the Mountaineer Carbon Capture and Storage (CCS) Project in base rates, which resulted in a pre-tax write-off of $54 million in the second quarter of 2010. APCo initially filed a generation and distribution base rate request for $154 million, based on a 13.35% ROE in July 2009. The company filed for reconsideration of the order as it relates to the Mountaineer project, however, it was denied on Aug. 5, 2010. Through June 30, 2010, the utility has recorded a noncurrent regulatory asset of $58 million, consisting of $38 million in project costs and $20 million in asset retirement costs. APCo and Alstom Power Inc. jointly constructed a CO2 capture validation facility, which was placed into service in September 2009. APCo also constructed and owns the necessary facilities to store the CO2. The company has requested regulatory recovery of and a return on its estimated increased Virginia and West Virginia jurisdictional share of its project costs and recovery of the related regulatory asset amortization.

In May 2010, APCo filed a $156 million base rate increase request with the West Virginia Public Service Commission (WVPSC), based on an 11.75% ROE to be effective March 2011. Hearings are scheduled for December of this year. In July 2010, the WVPSC approved a settlement agreement for $96 million, including $10 million of construction surcharges, related to APCo's second year expanded net energy charge (ENEC) increase. APCo is currently operating under an order that will provide the recovery of under-recovered fuel expenses through 2013. The overall increase is for $355 million, with the first year increase of $124 million effective October 2009.

APCo's liquidity position remains strong, with $600 million of available capacity under the AEP money pool. Total AEP available liquidity of approximately $2.9 billion as of June 30, 2010, including $838 million of cash on hand. AEP's credit facilities are comprised of a $1.454 billion facility that matures in April 2012, a $1.5 billion facility that matures in June 2013 and a $478 facility that matures in April 2011. The credit agreements contain a covenant that requires AEP to maintain a debt to total capitalization at or below 67.5%. APCo and certain other companies in the AEP system also have a $478 million three-year agreement. Under the facility, letters of credit may be issued. As of June 30, 2010, APCo had $232 million of letters of credit outstanding under this agreement to support variable-rate pollution control bonds. The company's borrowing limit is $300 million.

Debt maturities over the next five years are considered manageable and are as follows: $300 million in 2010, $250 million in 2011, $250 million in 2012, $70 million in 2013 and $0 in 2014. Fitch expects the company to refinance its maturing debt.

Additional information is available at www.fitchratings.com.

Related Research:

--'Corporate Rating Methodology' Aug. 16, 2010;

--'Credit Rating Guidelines for Regulated Utility Companies' July 31, 2007;

--'U.S. Power and Gas Comparative Operating Risk (COR) Evaluation and Financial Guidelines' Aug. 22, 2007;

--'Utilities Sector Notching and Recovery Ratings' March 16, 2010.

Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646

Credit Rating Guidelines for Regulated Utility Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=334652

U.S. Power and Gas Comparative Operating Risk (COR) Evaluation and Financial Guidelines

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=338030

Utilities Sector Notching and Recovery Ratings

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=504546

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