NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDR) of DPL Inc. (DPL) at 'B+' and Dayton Power Light & Company (DP&L) at 'BB+'. The Rating Outlook for both entities has been revised to Negative from Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
--Ohio Supreme Court order jeopardises pending ESP;
--Alternative rate relief needed to maintain ratings;
--Near-term financial flexibility impaired.
The ratings affirmation and revision of the Rating Outlook follows the Ohio Supreme Court's rejection of DP&L's "service stability rider" (SSR) charge which could have material negative credit impact on DP&L and DPL. In addition to cash flow reduction in the near term, the court ruling could jeopardise the extension of a similar rate structure beyond 2016 as requested in DP&L's pending Electric Security Plan (ESP) filed with the Public Utility Commission of Ohio (PUCO) in February 2016. Fitch views the receipt of these payments as key to reducing leverage at DP&L and DPL.
The resolution of the Negative Outlook will depend upon the amount, sustainability and timeliness of alternative regulatory rate relief from PUCO, as well as the companies' ability to refinance or repay the 2016 maturities in a timely manner with reasonable terms.
The Ohio Supreme Court ruling terminates collection of the remaining SSR in 2016 of approximately $55 million per Fitch's estimate; $250 million of SSR payments that have been collected are not subject to refund. The ruling is an adverse development that casts doubt upon the proposed extension in the pending ESP of a similar rate structure to the SSR. This rate structure is an alternative to a "reliable electricity rider" (RER) which is similar to the Purchased Power Agreements (PPA) proposed by other Ohio utilities. Fitch notes that the PPAs have been largely abandoned by other Ohio utilities due to jurisdictional issues.
Fitch continues to believe that the PUCO will ultimately authorize an alternative rider for DP&L to mitigate the Ohio Supreme Court ruling. However, the path and timing to that end are primary credit concerns.
The court ruling has negative implications for DPL and DP&L's liquidity due to loss of cash flow from SSR and associated uncertainties surrounding the 2016 maturities. However, the companies should have sufficient liquidity to cover net cash needs in the next 12 months. Fitch projects DPL and DP&L to be modestly free cash flow positive in 2016 and expects negative free cash flow in 2017 without additional rate relief.
As of March 31, 2016, DP&L has $445 million first mortgage bonds due on Sept. 15, 2016 and DPL has $57 million senior unsecured notes due in October 2016. DP&L's $100 million 2006 pollution control bonds due in 2036 can be called at par on Sept. 1, 2016. Although Fitch believes that most of these maturities will be refinanced or repaid as planned, the possibility of achieving desirable financing terms and flexibility of the timing of execution are likely reduced.
Fitch intends to maintain a three-notch differential between the IDRs of DPL and DP&L. This is due to Fitch's belief that the existing regulatory measures, such as the capital structure requirement and restriction on dividend in case of negative retained earnings, provide some protection of DP&L's credit quality, but don't effectively insulate it from DPL in certain distress scenarios.
The debt instrument rating at DPL is notched above or below the IDR as a result of the relative recovery prospects in a hypothetical default scenario. Fitch affirms the instrument rating for DPL based on a recovery analysis. Fitch values the power generation assets using a net present value (NPV) analysis and the equity value in DP&L is added to derive DPL's enterprise value for the recovery analysis. Fitch assigned a 'BB/RR2' rating to DPL's senior secured revolving credit facility and term loan. The 'RR2' rating reflects a two-notch differential from the 'B+' IDR and indicates that Fitch estimates superior recovery of principal and related interest of between 71% - 90%. Fitch also assigned a 'BB-/RR3' rating to DPL's senior unsecured notes, reflecting a one-notch differential from the 'B+' IDR, implying good recovery of principal and related interest of between 51% - 70%.
--Several rate relief scenarios and correspondent deleveraging levels and timing were assumed;
--No equity support from AES;
--DP&L's debt-to-cap ratio assumed to reach 50% in 2018.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
DPL and DP&L's rating Outlook can be stabilized if prospective rate relief is forthcoming, such that DPL's consolidated adjusted debt-to-operating EBITDAR can sustain comfortably below 6x and/or FFO-lease adjusted leverage below 6.5x. Divesture of DPL's merchant generation after the separation, in part or whole, could result in positive rating actions.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
Rating downgrades at DPL could be triggered by the absence of timely regulatory support in Ohio and/or continued challenging market conditions for its merchant generation business. Deterioration of DPL's consolidated adjusted debt-to-operating EBITDAR ratio on a sustained basis to above 7x or FFO-lease adjusted leverage sustained above 7.5x without a visible path for recovery could result in rating downgrades.
If DP&L fails to refinance its first mortgage bonds in 2016 with reasonable terms, ratings may be downgraded. Other factors that could cause negative rating actions include, but are not limited to, lower-than-expected cash flow at DP&L or the inability to execute deleveraging at DP&L, such that the future transmission and distribution utility's stand-alone debt-to-operating EBITDAR and FFO-lease adjusted leverage sustain above investment grade guideline ratios of 5x and 6x, respectively.
Fitch has affirmed the following ratings:
--Long-Term IDR at 'B+';
--Short-Term IDR at 'B';
--Secured debt at 'BB/RR2';
--Senior unsecured debt at 'BB-/RR3'.
Dayton Power & Light Company
--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'.
The Ratings Outlook has been revised to Negative from Stable.
Date of Relevant Rating Committee: July 12, 2016
Additional information is available at 'www.fitchratings.com'.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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