TEXT-Fitch cuts DPL, puts DPL and Dayton Power on watch negative

Wed Nov 7, 2012 5:02pm EST

Nov 7 - Fitch Ratings has downgraded the Issuer Default Rating (IDR) of DPL
Inc. (DPL) to 'BB' from 'BB+'. In addition, Fitch has placed DPL and
its wholly owned subsidiary The Dayton Power and Light Company (DP&L) on Rating
Watch Negative. The Rating Watch Negative implies that the ratings may be either
lowered or affirmed and are typically resolved over a relatively short period of
time. Fitch expects to resolve the Rating Watch Negative for DPL and DP&L once
the outcome of DP&L's recently filed Electric Security Plan (ESP) is known.

The downgrade in DPL's ratings and the assignment of Rating Watch Negative is
driven by significantly reduced EBITDA and FFO expectations compared with
Fitch's prior forecasts. A material reduction in power prices that has
exacerbated switching to alternate retail electricity providers among DP&L's
standard service offer (SSO) customers and reduced DP&L's wholesale revenues
accounts for Fitch's revised expectations. The substantial increase in leverage
at DPL following the acquisition by The AES Corporation (AES, rated 'BB-'
Outlook Stable by Fitch) is causing additional stress on DPL's credit metrics,
in an operating environment that continues to worsen.

DPL's ratings reflect its highly leveraged capital structure and the primary
support it receives from the upstream distributions from DP&L. The ratings of
DPL and DP&L are linked and the IDRs of both entities consider the combined
leverage, which consists of approximately $1.7 billion of debt at DPL and $0.9
billion of debt at DP&L. The ratings of DPL and DP&L are not tightly linked to
the IDR of the ultimate parent, AES. However, any material weakening of the
credit of AES could adversely affect Fitch's ratings of DPL and DP&L.

DP&L is facing several regulatory and market challenges in Ohio. Its current ESP
expires in Dec. 31, 2012. DP&L has filed for a new ESP to be effective Jan. 1,
2013 in an environment where low power prices have caused acceleration in
customer switching and heightened retail competition. DP&L has requested a
nonbypassable charge of $120 million over the five-year ESP period, a faster
transition of SSO tariff to market, and a commitment to file a generation
separation plan by YE 2013 such that DP&L expects that the non-regulated
generation business would be legally separated from the regulated transmission
and distribution business by YE 2017.

Switching has accelerated in DP&L's retail territory in 2012. As of June 30,
2012, approximately 56% of DP&L's customers had switched to alternate suppliers.
Through the first six months of 2012, customer switching has impacted DP&L's
gross margin by $110 million and DPL's gross margin by 59 million. The lost
gross margin at DP&L has been partially offset by higher margins at DPL's
non-regulated subsidiary, DPL Energy Resources (DPLER), which has been
successful in winning a majority of the switched load. DPLER is also actively
competing for the retail load in non-DP&L service territory.

DPL's credit metrics have sharply deteriorated in the wake of increased
switching and falling wholesale revenues. For the last twelve months (LTM) ended
June 30, DPL's consolidated funds from operations (FFO)-to-debt ratio was 11%
and debt-to-EBITDA ratio was 6.3x. Fitch expects a further deterioration of
these metrics absent a waning of residential switching, a constructive ESP
outcome and material debt reduction at DPL. All these three factors bear
monitoring and will be used by Fitch to drive future rating actions.

DP&L's LTM metrics remain robust, though these have moderated somewhat from
their very strong historical financial performance as a result of increased
competition in the competitive retail energy market and weaker wholesale
revenues. For the LTM ending June 30, DP&L's FFO-to-debt ratio was 38% and its
debt-to-EBITDA ratio was 2.1x. Fitch forecasts DP&L's robust credit metrics to
deteriorate somewhat based on the terms of the requested ESP and assuming that
residential switching exacerbates for a few months before moderating. However,
Fitch expects DP&L's forecasted credit metrics to remain superior relative to
Fitch guidelines for the 'BBB-' IDR. DP&L's current ratings are constrained by
the additional leverage at DPL and the need for a high proportion of DP&L's
earnings to be upstreamed to DPL as dividends to support parent debt.

Fitch has notched DP&L's IDR two levels above that of DPL. The Merger
Stipulation, as approved by the Public Utility Commission of Ohio (PUCO), places
explicit financial restrictions on DP&L that reduces its credit risk relative to
DPL. DP&L is required to maintain a capital structure that includes an equity
ratio of at least 50% and cannot have a negative retained earnings balance. In
addition, the DP&L Articles of Incorporation, and the Ohio state codes place
further restrictions on: (1) upstream dividend distribution; (2) transactions
with an affiliate such as liquidity support, debt incurrence or collateral
support; and (3) issuance of new debt without explicit approval from the PUCO.

Liquidity is adequate and is supported by DP&L's cash flows and full
availability on the utility's $200 million revolving credit facility maturing in
August 2015 and $200 million revolving credit facility maturing in April 2013.
DPL also has full availability on its own $75 million revolving credit facility
maturing in August 2014. Subsequent to a recent amendment to its credit
agreement, the capacity on the revolver was reduced to $75 million, from $125
million previously. The amendment also eliminated the prior debt to capital
financial covenant replacing it with a debt to EBITDA covenant. The amendment
also imposes significant restriction on DPL's ability to pay dividend to AES. In
the third quarter of 2012, DPL recognized an estimated $1.85 billion non-cash
goodwill impairment charge. DPL had recorded substantial goodwill of $2.6
billion in the fourth quarter of 2011 in connection with its acquisition by AES.

DP&L has a significantly large debt maturity on Oct. 1, 2013, with its $469
million first mortgage bonds coming due. Although these notes account for more
than half of DP&L's existing debt outstanding, Fitch expects the replacement of
this debt to be manageably done prior to maturity.

What Could Trigger a Rating Action

Outcome of the ESP: Fitch expects to resolve the Rating Watch for DPL and DP&L
once the outcome of the recently filed ESP is known. While no procedural
schedule is set as of now, it is Fitch's expectation that the PUCO could issue a
final order before the end of the first quarter of 2013.

Pace of debt reduction: A constructive ESP outcome in itself may not be adequate
to ward off negative rating actions for DPL and DP&L. Fitch expects DPL to
significantly reduce debt from the current levels to prevent further downgrade
to ratings.

Higher switching levels: Higher than anticipated switching levels and the
inability to secure a switching tracker in its ESP order could place additional
stress on DP&L's cash flows, and in turn, exert greater pressure on the upstream
dividends from DP&L to DPL.

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 few years.

Ratings Upgrade Unlikely: Positive rating actions are unlikely for several years
given the highly leveraged balance sheet at DPL and the structural change in the
operating environment facing DP&L. The separation plan, once filed by DP&L and
approved by the PUCO, and the resulting capital structure at the regulated
utility will have an important bearing on the future rating actions for DP&L.

Fitch has downgraded the following ratings and placed them on Rating Watch

--Long-term IDR to 'BB' from 'BB+';
--Senior unsecured debt to 'BB' from 'BB+'.

DPL Capital Trust II
--Junior subordinate debt to 'B+' from 'BB-'.

Fitch has placed the following ratings on Rating Watch Negative:

--Short-term IDR 'B'.

--Long-term IDR 'BBB-';
--Senior secured debt 'BBB+';
--Preferred stock 'BB+';
--Short-term IDR 'F3''.

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. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug 8, 2012);
--'Recovery Ratings and Notching Criteria for Utilities' (Aug. 12, 2012);
--'Rating North American Utilities, Power, Gas, and Water Companies' (May 16,

Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies
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