Fitch Rates DPL's Secured Debt 'BB/RR2'; Downgrades Unsecured Debt to 'BB-/RR3'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Issuer Default Rating (IDR) of DPL, Inc. (DPL) at 'B+' but has downgraded its unsecured debt rating to 'BB-/RR3' from 'BB/RR2'. Fitch has also assigned the rating of 'BB/RR2' to DPL's newly issued secured debt. The downgrade in the unsecured debt rating follows management's decision to upsize its revolving credit facilities and make them secured by granting liens on certain assets. The Rating Outlook remains Stable for DPL. A full list of rating actions follows at the end of this release. Over $1.3 billion in debt is affected by today's rating action.

Under the new credit agreement, the revolver has been upsized from the current capacity of $100 million to $205 million. The credit agreement provides for increase in the maximum revolver borrowing commitment to $300 million once DPL delivers the Ohio Mortgage, as defined in the credit agreement. Absent additional collateral and lenders' commitment, the revolver borrowings will remain at $205 million. DPL has also refinanced the existing unsecured term loan of $125 million with a new secured term loan facility. The terms of both facilities have been extended by two years to July 2020.

DPL's non-regulated subsidiary, DPL Energy, LLC, is the guarantor under the credit agreement and has provided a limited recourse guarantee secured by 556MWs of its generating assets. Additional security includes a limited pledge of its ownership in DP&L permitted under DPL's existing indentures and limited to 10% of DPL's net consolidated assets as defined in the agreement. DPL may request an additional term loan to refinance its outstanding debt maturities, but the total term loan and revolver borrowing cannot exceed the maximum borrowing limit of $425 million. Fitch has assumed that DPL will deliver Ohio Mortgage to the lenders to utilize the maximum credit available under the agreement. DPL's inability to access additional borrowing capacity will be negative for its credit profile, in Fitch's opinion.

Fitch expects DPL to use its expanded revolver to operate and manage its competitive power generation business. Under the corporate separation order received from the Public Service Commission of Ohio (PUCO), the generation assets of Dayton Power & Light (DP&L, IDR: 'BB+'/Stable Outlook), the wholly owned utility subsidiary of DPL will be separated from the regulated wires business and assumed by a non-regulated subsidiary of DPL. Fitch has assumed that DP&L's first mortgage bond trustee will release the security interest in the generating assets without requiring DP&L to prepay the secured debt.

Fitch views the upsizing of revolving credit facility (RCF) to $300 million as positive for DPL's credit profile since liquidity needs will increase for a stand-alone non-regulated generation business. However, the enhanced liquidity is not resulting in an upgrade of DPL's IDR at this time. DPL's capital structure remains highly leveraged and credit metrics are weak. Once the corporate separation is complete (by the end of 2017), DPL will own through its wholly-owned subsidiaries a non-regulated generation business consisting mainly of coal-fired generating assets and a low-risk wires utility that has yet to right size its capital structure from the current 75% debt to capital ratio.

KEY RATING DRIVERS

Modest pace of Deleveraging: DPL remains highly leveraged with LTM ending March 31, 2015 consolidated adjusted debt to EBITDAR ratio of around 5.1x. Fitch expects DPL to pay down its 2016 debt maturities mainly from cash on hand and operating cash flows. Nevertheless, Fitch expects consolidated debt to EBITDAR ratio will remain above 5.0x and the consolidated funds from operations (FFO) fixed charge coverage ratio will remain between 2.6x-3.2x through 2018.

Regulatory Support: Fitch has assumed continuous regulatory support for DP&L post corporate separation that would allow the utility to right size its capital structure over time from the currently elevated debt levels. The regulatory support could take the form of an additional service stability rider or other cash flow-improving regulatory measures. Absence of a meaningful regulatory support, post corporate separation, could pressure credit metrics of DP&L, and in turn, of DPL.

Rating Linkages: Despite strong strategic and operational linkages between DPL and DP&L, Fitch has currently maintained a three-notch separation between the IDRs of DPL and DP&L. This is driven by a regulatory enforced capital structure for DP&L by the PUCO, which requires the debt ratio to gradually improve to 50% from the current elevated levels of 75%. In addition, PUCO approved corporate separation plan (CSP) prohibits DP&L to guarantee or extend credit to a non-regulated affiliate or DPL to facilitate its divesture of generating assets. PUCO also prohibits DP&L to distribute dividends to DPL if its retained earnings balance is not positive.

AES' Ownership Credit Neutral: DPL's IDR is not directly linked to the ratings of AES Corporation (AES, 'BB-', Outlook Negative), its ultimate parent due to weak legal linkages. AES has not extended any guarantees to DPL's debt holders nor indicated commitment of any future liquidity support to DPL including equity infusions. Fitch has assumed future funding of DPL's capital needs to depend upon its internally generated funds from operations and access to debt markets.

Sufficient Liquidity: Fitch believes that upsizing of the RCF alleviates the pressure on DPL's liquidity given $130 million due in 2016 and additional liquidity needs arising post corporate separation (Jan. 1, 2017) to manage the hedging strategy for the non-regulated generation assets. The new RCF will mature in July 2020.

Recovery Analysis:

The debt ratings of DPL are notched above or below the IDR as a result of the relative recovery prospects in a hypothetical default scenario under Fitch's 'Recovery Ratings and Notching Criteria for Non-Financial Corporates Issuers' criteria report.

Fitch values the non-regulated power generation assets using a net present value (NPV) analysis, which is derived using the plant valuation provided by Wood Mackenzie, Fitch's third-party power market consultant, as well as Fitch's own gas price deck and other assumptions. Fitch has used $270/KW to value the non-regulated generating assets, including those to be transferred out of DP&L. In addition, Fitch valued DPL's equity interest in DP&L at $450 million, which reflects an assumption that DP&L will achieve a balanced capital structure by 2020.

The rating of 'BB/RR2' for DPL's new secured debt is based on Fitch's recovery waterfall and incorporates the limit on total security available to the secured debtholders under the credit agreement. The Rating for DPL's unsecured debt is 'BB-/RR3', and for its subordinated debt is 'B/RR5'. The 'RR2' rating reflects superior recovery prospects given default with securities historically recovering 71%-90% of current principal and related interest and reflects a two-notch positive differential from DPL's 'B+' IDR. The 'RR3' rating reflects a one-notch positive differential from the 'B+' IDR and indicates good recovery of principal and related interest of between 51%-70%. The 'RR5' reflects a below-average recovery prospect given default with securities historically recovering between 11%-30% of the outstanding principal and interest.

Revised Financial Covenants: Under DPL's new credit agreement, DPL is required to maintain two financial covenants. The leverage based on total debt-to-EBITDA ratio cannot exceed 7.25x for the fiscal quarter ending Dec. 31, 2018, 6.25x for the fiscal year ending 2019, and 5.25x beginning January 2020. The interest coverage based on consolidated EBITDA-to-consolidated interest cannot fall below 2.1x through the fiscal quarter ending Dec. 31, 2018 and 2.25x thereafter.

KEY ASSUMPTIONS

--Fitch expects DP&L to generate between $160 million and $170 million of EBITDA over the forecast period from its wires-only business.

--Annual electricity sales volumes are assumed to increase between 0.5%-1% at operating companies over next three years.

--Fitch has assumed net equity infusion by DPL in DP&L and regulatory support to enable deleveraging at the utility in order to achieve the targeted regulatory capital structure of 50% by 2020.

--DPL hub power prices of $34-$37/MWh and actual capacity prices in PJM Interconnect LLC operated wholesale market to forecast EBITDA for DPL's competitive generation business.

--Interest rate assumption for DPL is 6%.

RATING SENSITIVITIES

Positive: An upgrade for DPL is not likely in the next 12-18 months given the highly leveraged consolidated capital structure, large short-dated debt maturities, and increased merchant risk with the anticipated transfer of generating assets from its utility to a non-regulated subsidiary.

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

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

--Consolidated adjusted debt-to-EBITDAR for DPL increases above 6.5x on a sustainable basis;

--Inability of DPL to refinance a portion of the 2016 debt maturities.

FULL LIST OF RATING ACTIONS

DPL

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

--Short-term IDR affirmed at 'B';

--Senior unsecured debt downgraded to 'BB-/RR3' from 'BB/RR2';

--Assigned Secured debt rating of 'BB/RR2'.

DPL Capital Trust II

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

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

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=989179

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989179

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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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
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@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
Michael Weaver
Managing Director
+1 312-368-3156
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com