Fitch: Some Changes for Closed-End Funds Post Kinder MLP Move

NEW YORK--()--Kinder Morgan's planned acquisition of its two master limited partnership (MLP) units will prompt changes for closed-end fund investors, but the transaction probably does not signal a new trend among MLPs, Fitch Ratings says.

Kinder Morgan announced on Nov. 20 that unitholders had approved its proposed acquisition of its two outstanding master limited partnership (MLP) subsidiaries, Kinder Morgan Energy Partners, LP (KMP; 'BBB'; Rating Watch Negative) and El Paso Pipeline Partners, LP, (EPB). Following the announcement, Fitch took various ratings actions among the Kinder Morgan family of companies to consolidate the issuer default and senior unsecured ratings at 'BBB-' with a Stable Outlook.

The portfolios of 10 Fitch-rated MLP closed-end funds (CEFs) with more than $51.6 billion in aggregate MLP common stock managed by Kayne Anderson, Tortoise and Clearbridge made little change in their allocation to Kinder Morgan related entities. Before the announcement, fund level exposures ranged from 2.8% to 13.3% with an average of 8.5% as of July 31, 2014. After the announcement, the exposure range was 2.4% to 14.1%, with an average of 8.2%.

The change in status of Kinder Morgan from an MLP to a c-corp impacts the degree to which existing closed-end funds may invest in it, depending on each fund's investment policies and organization structure. Nine funds are organized as a corporation, and their investment policies called for at least an 80% holding in MLP securities, leaving just a 20% bucket to fit c-corps like Kinder Morgan. One of the ten funds is organized as a regulated investment company and already limits itself to 25% maximum in MLP securities, thus allowing up to 75% in c-corps.

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Despite the investment policy pressure at the fund level, Fitch notes that allocation changes have been more driven by manager discretion in balancing expected return potential against using all of their fund's non-MLP bucket. One fund manager increased Kinder Morgan exposure by an average of 2.8% across all funds, while the other two managers reduced it by 0.6% and 2.7%.

Fitch looks to CEF investments as collateral to support the asset coverage available to rated notes and preferred stock issued by the funds. Because of the conversion to a c-corp, Fitch has stepped up its haircut on the Kinder Morgan common stock to 52% from 43% at the 'AA' level, with an additional overlay of sector concentration. The step-up is not specific to the Kinder Morgan entity, but represents a higher overall stress Fitch applies to general common stock securities as compared to the MLP asset class. Fitch expects no rating impact on the rated fund notes and preferred stock.

The roll-up of entities into one single creditor class simplifies KMI's corporate structure and provides meaningful benefits to KMI's credit profile. In particular, it does away with the structural subordination that limited KMI's ratings to a notching below its operating subsidiaries and relieves the burden that KMP and EPB's Incentive Distribution Rights imposed on KMI's ability to grow. With cross guarantees extending from and to every significant EBITDA-generating rated issuing entity within the Kinder Morgan family, Fitch's ratings will reflect a consolidated ratings approach that equalizes the outstanding ratings at the ratings level of KMI. While this represents an improvement to KMI's credit profile, the higher rated operating subsidiaries, KMP and select Fitch rated pipeline subsidiaries saw downgrades to the 'BBB-' level. The combined entities will target between 5.0x-5.5x leverage, which is relatively high for the sector. However, KMI's asset size, scale and cash flow profile is relatively unique and much more reflective of an investment grade profile, offsetting concerns around the high leverage targets.

Fitch believes that this corporate conversion will be relatively unique to the Kinder Morgan entities. Fitch does not believe it is likely to start a trend of MLPs moving away from the partnership structure in the near term, though it does provide an option for large-scale, mature growth MLPs facing the incremental burden of high IDR payments to GPs. Given the positive equity response, it will likely be looked at across the space. The acquisition of KMP and EPB also has broader implications for MLP closed-end funds, which are the largest institutional equity investors in the MLP space.

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For Further information on MLP Structure please see: 'MLP End Game: Common Goals - Divergent Strategies' (November 2014); 'Rating Pipelines, Midstream and MLPs - Sector Credit Factors' (January 2014); 'Credit Considerations for the GP/LP Relationship (November 2013).

For further information regarding Fitch's Rating Actions on Kinder Morgan and its affiliates please see: 'Fitch Upgrades Kinder Morgan to 'BBB- & Downgrades Affiliates to 'BBB-; Outlook Stable' (November 20, 2014)

FAM related research:

Fitch Rates New Kayne Anderson Fund Notes 'AAA'& Pfd 'AA'; Affirms Existing Ratings

Fitch Rates Tortoise Energy Infrastructure Pfd at 'AA'; Affirms Existing Ratings

Fitch Rates Clearbridge Energy MLP Fund Inc. Senior Notes 'AAA'; Affirms Existing Ratings

Closed-End Fund Issuance of Debt and Preferred Stock

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

Applicable Criteria and Related Research:

Closed-End Fund Issuance of Debt and Preferred Stock

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=795288

MLP End Game (Common Goals -- Divergent Strategies)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=802308

Rating Pipelines, Midstream and MLPs -- Sector Credit Factors

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722082

Credit Considerations for the GP/LP Relationship

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721999

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Contacts

Fitch Ratings
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Director
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+1 212-908-9191
Fitch Ratings, Inc.
33 Whitehall
New York, NY 10004
or
Ben Han
Analyst
Fund and Asset Management
+1 212-908-9177
or
Peter Molica
Senior Director
Corporate Finance
+1 212-908-0288
or
Kellie Geressy-Nilsen
Senior Director
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+1 212-908-9123
Fitch Ratings, Inc.
33 Whitehall Street
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or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Yuriy Layvand, CFA
Director
Fund and Asset Management
+1 212-908-9191
Fitch Ratings, Inc.
33 Whitehall
New York, NY 10004
or
Ben Han
Analyst
Fund and Asset Management
+1 212-908-9177
or
Peter Molica
Senior Director
Corporate Finance
+1 212-908-0288
or
Kellie Geressy-Nilsen
Senior Director
FitchWire
+1 212-908-9123
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com