Fitch Affirms DPL and DP&L's Ratings; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Issuer Default Rating (IDR) of DPL, Inc. (DPL) at 'B+' and Dayton Power & Light Company's (DP&L) IDR at 'BB+'. A full list of rating actions follows at the end of this release. The Rating Outlook is Stable. Over $2.3 billion in debt is affected by today's rating action.

DPL's IDR reflects a highly leveraged capital structure and still elevated regulatory risk associated with corporate separation whereby DP&L's generating assets will be transferred to a separate non-regulated entity at the end of 2016 under a regulatory order of the Public Utility Commission of Ohio (PUCO).

DP&L's ratings reflect a strong business risk profile as a transmission and distribution utility post corporate separation. However, its expected pro-forma leverage will be high, and constructive regulatory support will be needed to deleverage it to a more reasonable capital structure. DP&L's ratings are also constrained by a weak parent and the absence of explicit ring fencing.

KEY RATING DRIVERS:

Regulatory Support Critical: With DP&L yet to receive the generation separation order from PUCO, there remains considerable uncertainty around the capital structure that will be permitted at the utility. DP&L currently has about $900 million of debt outstanding and its regulatory rate base is estimated to be approximately $1 billion after the generation assets are moved to a non-regulated affiliate.

Fitch believes considerable regulatory support will be needed to right size the utility's capital structure over time, which could take the form of additional service stability rider (SSR) or other cash flow improving regulatory measures. PUCO approved current SSR ($110 million a year) is set to expire in 2016. While the regulatory support can take different forms, Fitch rating case assumes continuation of the SSR beyond 2016, albeit at a reduced level, to effect deleveraging at the utility to reasonable levels.

Modest pace of Deleveraging: DPL remains highly leveraged with LTM ending June 2014 consolidated adjusted debt to EBITDAR ratio around 6.5x. Fitch sees modest pay down of parent debt over 2014-18 supported by cash distributions from DP&L and cash generated by its non-regulated businesses. Fitch has also assumed that DPL is able to achieve targeted deleveraging by prepayment of a portion of its 2016 debt maturities and the consent of DP&L's first mortgage bond trustees to release the security interest in the generating assets. Fitch expects consolidated adjusted debt to EBITDAR ratio to be between 5.5x - 6.0x and the consolidated interest coverage ratio (EBITDAR/Interest) to be between 2.6x - 3.0x by 2018. Fitch has assumed that DPL will successfully manage its 2016 maturities. It is key to note that post corporate separation (Jan. 1, 2017), the hedging strategy for the non-regulated generation assets will dictate the liquidity needs of the business and could pressure DPL's credit profile.

Rating Linkages: Fitch has currently three-notch separation between the IDRs of DPL and DP&L. Despite its low-risk regulated business profile post generation separation and Fitch's expectation of regulatory support to rebalance the capital structure, Fitch has constrained DP&L's ratings based on its ownership by a weak parent and lack of explicit ring fencing provisions. Any further downgrade in DPL's ratings could result in commensurate downward rating actions for DP&L.

AES' Ownership Credit Neutral: DPL's IDR is not linked to the ratings of AES Corporation (AES, 'BB-', Outlook Stable), its ultimate parent. Fitch assigned ratings do not factor equity infusions from AES for DPL's capital needs nor any future liquidity support. Future funding of DPL's capital needs will depend on its consolidated funds from operations and its access to the debt markets.

Sufficient Short-term Liquidity: At the end of June 2014, DPL and DP&L had about $40 million in cash and $400 million available in revolving credit facilities. The current liquidity is sufficient to cover short-term capital needs of the group, at least through 2015.

Recovery Analysis:

The unsecured debt rating at DPL is notched above or below the IDR, as a result of the relative recovery prospects in a hypothetical default scenario.

Fitch values the power generation assets using a net present value (NPV) analysis and the equity value in DP&L is added to the parent recovery prospects. The generation asset NPVs vary significantly based on future gas price assumptions and other variables, such as the discount rate and heat rate forecasts in DP&L's service territory. For the NPV of generation assets used in Fitch's recovery analysis, Fitch uses the plant valuation provided by its third-party power market consultant, Wood Mackenzie as well as Fitch's own gas price deck and other assumptions. Fitch also evaluates information from the recently concluded power plant sale transactions in its recovery analysis. Fitch has used a multiple of equity only cash flow to derive value of DP&L's 'wire only' business and added to the NPV of its generating assets.

Fitch has assigned a 'BB/RR2' rating to DPL's senior unsecured notes. The 'RR2' rating reflects a two-notch positive differential from the 'B+' IDR and indicates that Fitch estimates superior recovery of principal and related interest of between 71%-90%.

RATING SENSITIVITIES

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

--An upgrade is not likely in the next 12-18 months given a highly leveraged consolidated capital structure, large short-dated consolidated debt maturities, and increased merchant risk with the anticipated transfer of mainly coal-fired generating assets by DP&L to a non-regulated entity.

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

--Absence of regulatory rate relief to facilitate debt reduction at DP&L;

--Lower than expected cash flow at DP&L such that its standalone credit profile falls below that of a 'BBB' rated company;

--Consolidated adjusted debt to EBITDAR ratio remains above 6.5x on a sustainable basis;

--Inability of DPL to fund the short-dated debt maturities.

Fitch has affirmed the following rating with a Stable Outlook:

DPL

--Long-term IDR at 'B+';

--Short-term IDR at 'B';

--Senior unsecured debt at 'BB/RR2'.

DP&L

--Long-term IDR at 'BB+';

--Senior secured debt at 'BBB';

--Preferred stock at 'BB';

--Short-term IDR at 'B'.

DPL Capital Trust II

--Junior subordinate debt at 'B/RR5'.

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

Applicable Criteria and Related Research:

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

--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers', Nov. 19, 2013.

Applicable Criteria and Related Research:

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

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

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721836

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=870054

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Contacts

Fitch Ratings
Primary Analyst
Roshan Bains
Director
+1-212-908-0211
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Shalini Mahajan
Senior Director
+1-212-908-0351
or
Committee Chairperson
Glen Grabelsky
Managing Director
+1-212-908-0577
or
Media Relations:
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Roshan Bains
Director
+1-212-908-0211
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Shalini Mahajan
Senior Director
+1-212-908-0351
or
Committee Chairperson
Glen Grabelsky
Managing Director
+1-212-908-0577
or
Media Relations:
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com