Fitch Rates IPALCO's Secured Debt 'BB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'BB+' rating to IPALCO Enterprises, Inc.'s (IPALCO; Issuer Default Rating 'BB+'; Outlook Stable) issuance of senior secured debt. These notes rank pari passu with IPALCO's other senior secured debt, including any future senior debt issuances. The company intends to use the net proceeds from this offering to refinance its 2016 senior debt maturities.

IPALCO's ratings reflect quality of cash flow from its regulated operating company-Indianapolis Power & Light 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.

KEY RATING DRIVERS

Elevated Capex at IPL: Current capex cycle (through 2017) at IPL 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, refueling of certain coal fired units to gas, and building 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 combined cycle gas turbine plant (CCGT) and conversion of 200MW of IPL's coal-fired units to natural gas will replace the retired capacity for which the IURC has already issued the certificate of public convenience and necessity (CPCN). Fitch anticipates erosion in IPL's cash flow measures until its recently filed general rate case (GRC) application is approved by the Indiana Regulators. Equity infusion by IPALCO's shareholders will alleviate the rating concerns arising from the elevated capex cycle, in Fitch's opinion.

Consolidated Credit-Profile: IPALCO's IDR reflects a highly leveraged capital structure with consolidated debt reaching 92% of the total capital at the end of 2014 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 assigned rating takes into account the expected decline in the credit metrics through 2017 and recovery thereof to reasonable levels by 2018. IPALCO's consolidated adjusted debt to EBITDAR and funds from operations (FFO) fixed charge ratios at the end of latest 12 months (LTM) March 2015 were 5.1x and 3.6x respectively. These ratios are expected to decline over IPL's current capex cycle ending in 2017. Fitch projects IPALCO's consolidated credit metrics to remain constrained until the Indiana regulators approve increase in IPL's retail tariffs, especially to recover its investment in the new generating capacity. Fitch expects IPALCO's consolidated adjusted debt to EBITDAR ratio to be below 5.0x at the end of 2018 and FFO based interest coverage (FFO-to-interest) is expected to be slightly over 3.0x at the end of the same period, in line with Fitch's expectations for the assigned IDR.

Environmental Policy Challenges for Coal-fired Generation: The management expects that about 44% of IPL's long-term power generation capacity will be coal based. The remainder will include renewable resources and natural gas fired plants. 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.

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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for IPALCO:

--A flat electricity volume growth at IPL over the forecast period (2015-2018).

--Fitch has assumed that IPL will give up majority of its margins from wholesale electricity once its next GRC application is approved. Currently, there are no limits on IPL to share its off-system sales.

--For wholesale electricity revenues and margins, Fitch used WoodMac's projected power prices for the forecast period.

--Fitch's rating case assumptions include regulatory approval of IPL's GRC application and new rates will become effective beginning Jan. 1, 2016.

--Fitch used management's forecast for equity infusions in IPALCO to partially fund IPL's capex program over the forecast period.

--Fitch used management's capex forecast.

RATING SENSITIVITIES

Positive Rating Action: A positive rating action is unlikely over the rating horizon (2015-2018) given the elevated 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.

Negative Rating Action: Fitch will downgrade the IDR of both companies, if IPL's credit metrics on a sustainable basis, fail to be within the Fitch guidelines for a 'BBB' rated entity. A restrictive regulatory outcome in the upcoming GRC 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, such as: 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 material increase in debt at IPALCO will also result in a negative rating action at IPALCO.

Date of Relevant Rating Committee: Dec. 12, 2014.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

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

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986586

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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
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Phil Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@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
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Phil Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com