Fitch Affirms CMS and Consumers' Ratings; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed CMS Energy Corp's (CMS) Issuer Default Rating (IDR) at 'BBB-' and that of its wholly owned subsidiary, Consumers Energy Co. (Consumers)', at 'BBB'. The Rating Outlooks are Stable. A complete list of rating actions is included at the end of this communication.

CMS' IDR reflects its high leverage, ownership of Consumers ( an integrated utility operating in Michigan), ownership interest in independent power generation assets mainly located in Michigan, as well as ownership in the banking subsidiary, EnerBank USA (EnerBank, privately rated by Fitch). Consumers' low-risk utility operations contribute over 95% of CMS' consolidated earnings. Fitch has assumed no equity investment by CMS to finance the growth at EnerBank. Fitch deconsolidates the debt reported at EnerBank, but includes a contingent liquidity support obligation for any capital shortfall at EnerBank that may need to be funded by CMS.

Consumer's IDR reflects a one-notch uplift from the IDR of CMS driven by the current requirement to maintain a regulatory capital structure of 42% equity. The stand-alone financial profile of Consumers is much stronger and is aided by a supportive regulatory structure in Michigan. Fitch expects a modest decline in Consumers' credit metrics over 2015-2019 given the $7.5 billion capex program over this period under Fitch's conservative rating model, yet these remain solidly within the 'BBB' rating category.

KEY RATING DRIVERS FOR CMS

High Leverage: Current leverage at CMS is high, compared to its peers, and Fitch expects no significant reduction in parent-level leverage over the rating horizon. Year-end 2014 consolidated debt was $8.5 billion; about $3.2 billion or about 40% of the consolidated leverage was parent-only debt. This includes demand deposits at EnerBank. In its financial projections, Fitch deconsolidates Enerbank but applies contingent liquidity support that may be required by the bank regulators for EnerBank's financial viability. Given the large capex at Consumers and Fitch's expectations of periodic equity support by CMS to support Consumers' capital structure, there may not be any material deleveraging opportunities at CMS in the coming years.

Fitch adjusted consolidated debt is expected to rise mainly at Consumers to fund the elevated capex levels. Fitch has assumed a reasonable access to debt capital markets by CMS and Consumers for additional borrowings to supplement internally generated funds for financing the growth capex.

Ownership of Consumers: Consumers' low-risk regulated electric and natural gas utility operations contribute over 95% of CMS' consolidated EBITDA. Fitch expects Consumers' rate-base to grow to about $16.5 billion at the end of 2019 from approximately $12 billion at the close of 2014. Fitch's assumptions include constructive regulatory approval of the General Rate Case (GRC) filings by the utility over the forecast period.

EnerBank Ownership Elevates Risk Profile: CMS has a statutory obligation to financially support EnerBank. The bank regulators may require CMS to infuse additional capital into EnerBank, if EnerBank is under severe financial stress. Currently, EnerBank carries about $1 billion in net outstanding deposits. A material deterioration in the financial viability of EnerBank may negatively affect CMS' IDR. Fitch has adjusted the parent-level leverage for a contingent liquidity support obligation that Fitch believes appropriately reflects the risk of ownership of EnerBank.

Moderate Credit Metrics: Fitch projected CMS' consolidated leverage, as measured by adjusted consolidated debt/EBITDAR, will be between 4.3x and 4.5x over 2015-2019. EBITDAR-based leverage ratio at year-end 2014 was 4.3x. These metrics remain within Fitch guidelines for a 'BBB-' rated utility holding company. Fitch expects funds from operations (FFO)-based fixed-charge ratio to decline to 4.1x by 2019. FYE 2014, FFO-based fixed-charge coverage was 4.3x. The modest weakening of credit metrics over the forecast period reflects a large investment cycle at Consumers, increase in contingent liquidity support for EnerBank, and a rising interest rate environment.

KEY RATING DRIVERS FOR CONSUMERS

Rating Linkages: Fitch believes there are strong rating linkages between CMS and Consumers. CMS relies on Consumers for its liquidity needs and CMS must provide funding to Consumers for it to maintain the regulatory capital structure, especially during a large capex cycle. High leverage at CMS will require continued upstream distributions from Consumers. Legal ownership structure, interdependency of CMS and Consumers for capital and liquidity, and lack of explicit ring-fencing between Consumers and CMS are key elements for linking their IDRs. However, Fitch notches Consumers' IDR by one from the IDR of CMS. The notching reflects credit protection that is afforded by the requirement of maintaining the authorized regulatory capital structure at the utility subsidiary.

Solid Financial Profile: Consumers stand-alone financial metrics, in terms of EBITDAR-based leverage and FFO-based fixed-charge coverage, are solid. Fitch expects the key credit metrics to decline under Fitch's conservative rating model, but remain within Fitch's guidelines for a 'BBB' rated utility subsidiary. Adjusted debt-to-EBITDAR will decline to about 3.6x by the end of 2019 from 2.9x at the end of 2014. Fitch forecasts FFO- based fixed-charge coverage to be around 4.2x by the end of 2019. At the year-end 2014, FFO-based fixed-charge ratio was 5.7x. Fitch has modelled funding of negative free cash flows in accordance with the authorized equity ratio of 42% and a rising interest rate environment over the forecast period.

Regulatory Support Critical: The 2008 Energy Law in Michigan provided the legislative framework for a balanced regulatory environment. The rate design components to mitigate regulatory lag include forward test year. An automatic power supply cost recovery mechanism and a gas cost recovery mechanism facilitate timely recovery of commodity costs. In Michigan, utility GRCs are determined within 12-months of the GRC application filing date and authorized interim rates can be implemented within six months of the filing date - the permanent rate increase is subject to true-up or refund. Fitch does not expect any change in the current regulatory construct in Michigan.

Continued GRC Filings Expected: In December 2014, the company filed a GRC application with the Michigan Public Service Commission (MPSC) to increase its electric rates by $163 million before the end of 2015. In addition, the management plans to file additional GRC applications with the MPSC over the next few years to recover $4.5 billion of additional rate-base growth through 2019. Fitch expects constructive outcomes (at or close to the currently authorized 10.3% return on equity) and timely approval of the GRC applications given a supportive regulatory framework in MI as highlighted above. The expiration of securitization debt provides Consumers with headroom to recover a part of rate-base investment without subjecting the retail customers to large rate increases. Fitch expects total retail rate increases for electricity and natural gas distribution over the forecast period will not exceed 3%-4% annually.

Potential Elimination of Retail Open Access in MI: Recent discussions about customer choice have centered on eliminating retail open access and moving MI's electricity market to full regulation after a previous bill introduced in the MI state assembly 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 Consumers amid tightening capacity markets in MISO, necessitating the need for new generation investments such as the planned purchase of the 520MW gas-fired Jackson Power Plant. Fitch views the elimination of customer choice as positive for Consumers.

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 and Energy Efficiency 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. Consumers recovers its renewable investments under an annual renewable surcharge subject to MPSC approval. Fitch views Consumers' future investments in renewable energy as favorable and, via the renewable energy surcharge, provides earnings growth in between GRC proceedings.

Large capex plan: Consumers is expected to spend $7.5 billion in regulated capex over 2015-2019. The capex plan includes about $3 billion for the existing system replacement and upgrades, about $900 million for environmental regulation compliance, about $600 million for system reliability projects, and about $1 billion on gas infrastructure and new generation capacity. Fitch expects the utility to finance the capex in line with its authorized capital structure and anticipates some equity support from the parent.

RATING SENSITIVITIES

CMS

Positive:

Future developments that may, individually or collectively, lead to a positive rating action include:

--Consolidated debt-to-EBITDAR in the 3.75x-4.00x range on a sustainable basis;

--The sale of EnerBank.

Future developments that may, individually or collectively, lead to a negative rating action include:

--Failure to achieve, on a sustained basis, Fitch adjusted consolidated debt-to-EBITDAR of 4.5x;

--Material deterioration in the MI regulatory climate and/ or adverse regulatory outcome in the GRC that has been filed with the MPSC or will be filed by Consumers over the next few years;

--Any deterioration in the credit measures that result from higher use of leverage or outsized shareholder-friendly activity.

Consumers

Positive: Consumers' IDR is currently constrained by CMS' credit profile. A positive rating action at CMS will result in a rating upgrade for Consumers provided it can achieve adjusted debt to EBITDAR of 3.5x on a consistent basis.

Future developments that may, individually or collectively, lead to a negative rating action include:

--Failure to achieve, on a sustainable basis, adjusted debt-to-EBITDAR of 3.8x;

--A two-notch downgrade of CMS' IDR.

KEY ASSUMPTIONS

--Consumers' rate-base to grow to approximately $16.5 billion by the end of 2019 from $12 billion at the end of 2014;

--Periodic GRC applications with the MPSC to recover Consumers' investment in rate-base and associated costs. Fitch has assumed an average ROE rate of 10.3% and current equity-to-regulatory capital of 42% for Consumer's GRC filings through 2019;

--Expected equity support by CMS in Consumers in the range of $150 million-$175 million annually;

--Annual electricity sales volume growth of about 0.5% between 2016 and 2019 and flat natural gas sales volume;

--Management's O&M costs reduction target of $100 million by 2018, achieved with the expected change in the fuel mix, reduced employee count, restructured benefit plans, and installation of smart meters, are included in Fitch's forecast.

LIQUIDITY

Consolidated liquidity at the end of Dec. 31, 2014 was sufficient, with $207 million in unrestricted cash and $1.2 billion available through revolving credit facilities maturing in December 2018; $615 million of the undrawn credit facilities was earmarked for Consumers. Fitch has assumed refinancing of debt maturities over the rating horizon.

Fitch has affirmed the following ratings of CMS Energy Corp.:

--Long-term IDR at 'BBB-';

--Senior unsecured debt at 'BBB-';

--Senior secured debt (bank credit facility) at 'BBB-';

--Short-term IDR at 'F3'.

Fitch has affirmed the following ratings at Consumers Energy Co.:

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB+';

--Senior secured debt at 'A-';

--Preferred Stock at 'BBB-';

--Short-term IDR at 'F3'.

The Rating Outlooks are Stable.

Additional information is available on www.fitchratings.com

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980270

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Contacts

Fitch Ratings
Primary Analyst
Roshan Bains
Director
+1 212-908-0211
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Daniel Neama
Associate Director
+1 212-908-0561
or
Committee Chairperson
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Roshan Bains
Director
+1 212-908-0211
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Daniel Neama
Associate Director
+1 212-908-0561
or
Committee Chairperson
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com