NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of IPALCO Enterprises (IPALCO) at 'BB+' and of Indianapolis Power & Light (IPL)'s, IPALCO's wholly owned subsidiary, at 'BBB-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this communication.
IPALCO's ratings reflect quality of cash flow from its regulated operating company-IPL, and a highly leveraged capital structure. IPALCO's cash flows are currently limited to dividends received from IPL and are subordinated to IPL's debt service and capital requirements. Legal ownership structure and lack of explicit ring fencing between IPL and IPALCO are key elements for linking IPL's IDR to the IDR of IPALCO. Fitch has notched IPL's IDR one notch higher than IPALCO's IDR given its low-risk business profile and moderate capital structure. Preapproval of the total debt at IPL by the Indiana Utility Regulatory Commission (IURC) also supports a notch difference in the IDRs of IPALCO and IPL.
KEY RATING DRIVERS
High Capex: Current capex cycle (through 2017) is expected to be high, in Fitch's opinion. IPL's current capex plans include retrofitting most of its economical coal-fired electricity generation units with the new emission control equipment and to build a new natural gas fired power plant as a replacement for its retiring generating capacity. Fitch expects concurrent recovery of environmental capex under the 'environmental compliance cost recovery adjustment' (ECCRA) clause of the Indiana utility regulations. As of now, IPL has retired about 170MW of its existing generation capacity and plans to retire additional 470MW of its generating capacity by 2016. A new 600MW combined cycle gas turbine plant (CCGT) will replace the retired capacity. Fitch's capex forecast also includes conversion of IPL's existing 200MW of coal-fired units to natural gas.
Lack of regulatory mechanisms to recover certain operating costs and costs to replace inefficient generating capacity will require IPL to request a general rate increase to improve its cash flow profile. Fitch anticipates erosion in IPL's cash flow measures without the general rate increase. Equity infusion by AES, to maintain the regulatory capital structure at IPL, and the regulatory preapproval of the investment by the IURC will alleviate the rating concerns arising from high capex cycle, in Fitch's opinion.
Near-term General Rate Case Likely: The last IURC approved general rate increase was implemented in 1996. Fitch's rating case model assumptions include regulatory approval of IPL's general rate case applications by the IURC. In the past, the company was able to offset rising costs with strong wholesale electricity margins and concurrent recovery of environmental costs, including capex. However, continuously depressed wholesale electricity margin environment and increase in certain costs will require IPL to request a general rate increase to support the consolidated credit profile.
Constrained Cash Flows: IPALCO is a holding company with no tangible assets, except its investment in IPL. IPALCO relies on dividends from IPL and it is the sole source of funding for IPALCO. Fitch expects approximately $500 million of additional equity infusion in IPL through 2018 to maintain the regulatory capital structure while executing its elevated capex plan. The source of new equity proceeds will be IPL's ultimate parent, AES. A mixture of operating cash flows, equity, and debt will be used to fund elevated capex and the distributions from IPL.
Consolidated Leverage Based Credit-Profile: IPALCO's IDR reflects a highly leveraged capital structure with consolidated debt reaching 96% of the total capital at the end of 2013 under the pooling of interest accounting convention. Fitch views consolidated leverage as a key rating driver, along with IPALCO's reliance on IPL to support debt-service and the subordination of IPALCO's debt to that of IPL's debt. Stability of upstream cash flow from IPL and currently a constructive regulatory environment in Indiana partially alleviate the credit concerns arising from exceptionally leveraged capital structure.
Credit Metrics Volatility Expected: The affirmation of the ratings takes into account the expected decline in the credit metrics through 2015 and recover to reasonable levels by 2018, for both the issuers. IPL's adjusted debt to fund from operations (FFO) and FFO-to-interest ratios at the end of 2013 were 3.7x and 4.8x respectively. These ratios are within Fitch's guidelines for IPL's current IDR ('BBB-'), but are expected to decline over the current capex cycle ending in 2017. Fitch projects IPL's credit metrics to remain constrained until the regulators approve increase in IPL's retail tariffs, especially to recover its investment in the new generating capacity. Fitch expects IPL's FFO based leverage (adjusted-debt-to-FFO) to be around 4x at the end of 2018 and FFO based interest coverage (FFO-to-interest) is expected to be around 4.3x at the end of the same period, in line with Fitch's expectations for the assigned IDR.
IPALCO's 2013 consolidated, adjusted-debt-to-FFO ratio increased to about 5.9x and FFO-to-interest ratio for the same period declined to 2.8x. Credit metrics for 2013 reflect debt and internal cash flow funding of a large capex at IPL. In 2013, capex increased by 86% over 2012 as the company embarked on over a $2 billion capital program to install environmental equipment on its most economical coal units and to replace its inefficient and non-compliant generating units. Debt funding of the capex and the lower operating margins adversely affected credit protection measures in 2013.
Under Fitch's conservative rating case, consolidated, adjusted debt-to-FFO ratio at IPALCO will increase to over 6x by 2016 before declining to 5.5x in 2018. The forecasted range of consolidated credit metrics through 2018 is lower than Fitch's guideline ratios for a 'BB+' rated issuer, but the weakness in credit protection measures is temporary. Concerns over the constrained credit protection measures due to elevated capex levels over the rating horizon (2014-2018) are alleviated by the regulatory preapproval required for these investments and the concurrent recovery of environmental capex under the Indiana regulations. Under Fitch's rating case, the credit protection measures will begin to improve once the construction cycle is complete and the IURC approved increase in IPL's retail rates is implemented to recover new investments along with a reasonable return on its ratebase.
Environmental Policy Challenges for Coal-fired Generation: IPL's long-term power generation capacity will be coal based. Even with the installation of new emission controls, the long-term policy challenges to coal-fired generation remains a threat to the long-term viability of these assets. Fitch relies on ECCRA and the Indiana Senate bills 29 and 251 for the timely recovery of these investments in assigning the IDR. The Senate bills allow the recovery of federally mandated environmental compliance costs and the installation of clean coal technologies reducing airborne emissions associated with the use of coal.
IDR Not Linked to AES: The terms of IPALCO's $800 million notes provide a modest degree of separation between IPALCO and its parent, AES. IPALCO's total debt is limited to $1 billion ($800 million currently outstanding). The ratio of IPALCO's EBITDA to interest must exceed 2.5x, and debt cannot exceed 67% of total capitalization on an adjusted basis to make a distribution or intercompany loan to its parent, according to IPALCO's articles of incorporation. Changing the articles of incorporation would require AES approval, IPALCO board approval, and filing the revision with the secretary of state. IPALCO and IPL maintain separate identity from AES and do not mingle their cash with that of AES. These factors separate the ratings of IPALCO or IPL from the IDR of AES.
Stable Regulatory Environment: IPL benefits from the stable regulatory environment in Indiana. IPL has minimal commodity price exposure due to a regulatory pass-through mechanism that allows the utility to recover fuel and purchased power costs on a timely basis. Legislative measures exist for IPL to recover environmental compliance related investments in a timely manner. The customer base is stable.
Liquidity is adequate, but IPL will depend on external debt to finance its capex program. IPL maintains a $250 million credit facility that extends until December 2015. IPALCO has no liquidity facilities and depends on upstream distributions from IPL to service its obligations and expenses. There are no significant debt maturities until 2016 and Fitch expects IPALCO to timely refinance its debt maturities
A positive rating action is unlikely over the rating horizon (2014 - 2018) given the rising capex at IPL that will be partially debt financed. External financing of increasingly stringent environmental regulation based investment at IPL will constrain the credit protection measures over the rating horizon. Fitch's rating concerns also include increased regulatory risk to IPL's cash flow given that the management plans to file two general rate increase applications over the rating horizon.
Fitch will downgrade the IDR of both companies, if, IPL's credit metrics on a sustainable basis, fail to be within the Fitch's guidelines for a 'BBB' rated entity. A restrictive regulatory outcome in the upcoming rate proceedings, if adverse for the credit protection measures on a sustainable basis, will also result in a negative rating action.
Fitch will also consider a negative rating action on IPALCO due to certain adverse regulatory developments: changes that reduce the likelihood of timely recovery of the operating costs (fuel, purchased power, or environmental costs) or imputes less than a full income tax rate in the rates for IPL adversely affecting the credit protection measures at IPALCO. In addition, an absolute increase in debt at IPALCO will also result in a negative rating action at IPALCO.
Fitch has affirmed the following with a Stable Outlook:
IPALCO Enterprises, Inc.
--Long-term IDR at 'BB+';
--Senior secured debt at 'BB+'.
Indianapolis Power & Light Co.
--Long-term IDR at 'BBB-';
--Senior secured debt at 'BBB+';
--Secured pollution control revenue bonds at 'BBB+';
--Preferred stock at 'BB+'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 05, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective 12 August 2011 to 8 August 2012