NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Rating (IDR) of IPALCO Enterprises (IPALCO) to 'BB+' from 'BBB-' and downgraded the instrument rating of IPALCO's senior secured notes by one notch to 'BB+' from 'BBB-'. In addition, Fitch has affirmed the IDR of Indianapolis Power & Light (IPL), IPALCO's wholly owned subsidiary, at 'BBB-' as well as affirmed IPL's security ratings. Approximately $1.8 billion of outstanding debt is affected by these rating actions. The Rating Outlook is Stable.
IPALCO is a holding company with no tangible assets except IPL stock and is a subsidiary of highly leveraged parent, AES Corporation (AES, rated with an IDR of 'BB-', Outlook Stable, by Fitch). IPALCO's ratings reflect its highly leveraged capital structure and the sole support it receives from the upstream distributions from IPL. The ratings of IPALCO and IPL are linked, as both depend upon the cash flows of IPL. The IDRs of both entities consider the combined leverage, which consists of approximately $1 billion of debt at IPL and $800 million of debt at IPALCO. The ratings of IPALCO and IPL are not tightly linked to the IDR of the ultimate parent, AES.
The one-notch downgrade to IPALCO's IDR reflects Fitch's expectation of weakening credit metrics at the consolidated entity primarily due to significant levels of capital spending for environmental compliance at IPL. In order to comply with the Environmental Protection Agency's (EPA) Mercury and Air Toxics Standards (MATS), IPL has publicly stated that it may need to spend between $500 million-$900 million over 2012-16. In its rating case, Fitch has assumed that the environmental expenditures will be toward the midpoint of this range. Fitch has further assumed that IPL finances this expenditure at 55% debt/45% equity, consistent with its current and historical levels of capital structure, leading to an increase in debt at the consolidated entity and pressure on the credit metrics. In Fitch's projection, the equity contribution to finance the incremental capex is generated by a reduction in upstream distribution to IPALCO as well as equity infusion from AES, the ultimate parent. Fitch notes the enhanced financial flexibility at AES to provide equity support to IPALCO.
IPL owns approximately 3,600 megawatts (MW) of generation assets, of which 79% is coal-fired. The five largest and most economical units are Harding 7 and Petersburg 1, 2, 3, and 4, which represent aggregate nameplate capacity of greater than 2,300 MW, or more than 80% of IPL's total coal-generation fleet. To comply with MATS, IPL is considering incremental investments for those units, such as installing fabric filters (baghouses) and/or active carbon injection to control mercury, upgrading existing electrostatic precipitators on Petersburg 3 and 4 units, and replacing wet ash ponds with dry ash disposal. The remaining six units are relatively small (less than 120 MW each), and have been identified by Fitch as candidates for retirement. Fitch's current forecasts do not incorporate any capital expenditures for replacement capacity that might be needed in the 2016 timeframe.
All environment compliance expenditures are likely to be recoverable in customers' rates. Indiana Senate Bill 29 established the Environment Compliance Cost Recovery Adjustment (ECCRA) mechanism, which allows for full recovery of environmental projects and expenditures relating to controlling air emissions. Indiana Senate Bill 251, which became law in May 2011, applies to the costs incurred to comply with other federal mandates, including EPA regulations of emissions other than air emissions, such as costs relating to EPA regulations of cooling water intakes or ash disposal. Filings for ECCRA are made every six months. As a result, Fitch expects timely recovery on the environment expenditures without a requirement of a base rate application. Hence, Fitch forecasts the decline in credit metrics at IPALCO to be temporary over 2012-2015 and expects credit metrics to recover by 2016.
Fitch also expects pressure on credit metrics from lower wholesale power pricing environment at IPL, continued tepid growth in retail sales, a rise in operating costs including pension expenses and the need for higher pension contributions over the next few years. IPL has not had a formal base rate case since 1996, but has managed to earn attractive return on equity (ROE) with ongoing adjustments for fuel and environmental expenses. Given the adequacy of IPL's earned ROE, Fitch does not foresee an IPL rate case filing in the next two years. Fitch's forecast anticipates erosion in IPL's ROE by 2014-2015 that would warrant a base rate application.
Fitch expects the consolidated funds flow from operations (FFO) to total debt to decline to 8%-10% levels by 2014 before recovering to 14%-15% by 2016. Fitch expects the total debt to EBITDA ratio to peak at approximately 5.0 times (x) before declining to 4.0x-4.5x by 2016. The forecasted range of credit metrics in 2016 is consistent with Fitch's guideline ratios for a 'BB+' issuer.
Fitch has notched IPL's IDR one level above that of IPALCO. There is no longer any explicit regulatory ring-fencing between IPL and IPALCO. However, IPL's credit benefits from moderately protective covenants in IPL's financings. IPL's mortgage bonds limit the amount of dividends to IPALCO to the amount of retained earnings, and its credit facility has a covenant that permits payment of distributions to IPALCO only if the debt to capital is no greater than 65%.
The terms of IPALCO's $800 million notes provide a modest degree of separation between IPALCO and AES. IPALCO's total debt is limited to $1 billion (versus $800 million currently outstanding). The ratio of IPALCO's EBITDA to interest must exceed 2.5x, and debt cannot exceed 67% of total capitalization on an adjusted basis to make a distribution or intercompany loan to its parent, according to IPALCO's articles of incorporation. Changing the articles of incorporation would require shareholder approval by AES, IPALCO board approval, and filing the revision with the secretary of state. IPALCO and IPL maintain separate identity from AES, and do not mingle their cash with that of AES. Fitch does not maintain a close linkage between the ratings of AES and those of IPALCO and IPL, but any material weakening of the credit of AES could adversely affect Fitch's ratings of IPALCO and IPL.
Fitch notes that IPL's individual leverage based on cash flow measures is low relative to Fitch guidelines for the 'BBB-' IDR, and credit ratios are robust and can withstand significant deterioration within the existing rating category. Fitch anticipates IPL's FFO to debt ratio to weaken to 16%-17% by 2014 before recovering to more than 20% by 2016. Similarly, the debt to EBITDA is projected to peak at approximately 3.0x, before declining to 2.5x. IPL's forecasted credit metrics in 2016 are consistent with Fitch benchmarks for companies with IDRs in the range of 'A' to 'BBB+'. IPL's current ratings are constrained by the additional leverage at IPALCO and the need for a high proportion of IPL's earnings to be upstreamed to IPALCO as dividends to support IPALCO debt.
IPL benefits from the stable regulatory and business 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. As mentioned, IPL is also able to recover investments to bring its coal-fired power plants into environmental compliance using a rate-tracker mechanism. The customer base is stable and well diversified and volumetric risk is mitigated by a block retail rate structure.
What Could Trigger a Rating Action
Ratings Upgrade Unlikely: Positive rating actions are unlikely for several years during a period of rising capex and external financing needs.
Increased Leverage: If IPALCO does not have access to equity sources and relies on debt to fund future environmental capex, the ratings for IPALCO and IPL could decline.
Cash Flow Could Decline: Rising expenses not subject to tracker adjustments or sales declines would reduce cash flow at IPL. This would place greater pressure on the upstream dividends and credit ratios of IPALCO due to the additional leverage. A delay in rate case filing or lack of adequate rate relief could also materially weaken the credit metrics as compared to Fitch's current forecasts.
Adverse Regulatory Developments: Any change that reduces the likelihood of timely recovery of the costs of fuel, purchased power, or environmental compliance, or imputes less than a full income tax rate to IPL would adversely affect ratings of IPALCO and IPL.
Higher than Anticipated Capex: Capital expenditures in excess of Fitch's current forecasts could accentuate the stress that the combined entity will undergo over the next three years. Fitch has not factored in any additional capex at IPL related to potential new generation or repowering of existing coal-fired capacity. Fitch has assumed that the capacity lost due to any potential retirements of smaller coal units can be replaced initially with power purchase agreements.
Fitch downgrades the following with a Stable Outlook:
IPALCO Enterprises, Inc.
--Long-term IDR to 'BB+' from 'BBB-';
--Senior secured debt to 'BB+' from 'BBB-'.
Fitch affirms the following with a Stable Outlook:
Indianapolis Power & Light Co.
--Long-term IDR at 'BBB-';
--Senior secured debt at 'BBB+';
--Secured pollution control revenue bonds at 'BBB+';
--Unsecured pollution control revenue bonds at 'BBB';
--Preferred stock at 'BB+'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--Corporate Rating Methodology, Aug. 12, 2011;
--Utilities Sector Notching and Recovery Ratings, Aug. 12, 2011;
--Parent and Subsidiary Rating Linkage, Aug. 12, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
Recovery Ratings and Notching Criteria for Utilities
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648449
Parent and Subsidiary Rating Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647210
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