Fitch Rates IPL's First Mortgage Bonds 'BBB+'; Outlook Stable
Fitch Ratings has assigned a 'BBB+' rating to Indianapolis Power & Light Company's (IPL, Issuer Default Rating 'BBB-') $170 million in 4.65% first mortgage bonds due June 1, 2043. These notes rank pari passu with other first mortgage bonds of IPL. Proceeds from the debt issuance will be used to redeem 2013 debt maturities and partially fund 2013 construction expenditure. The Rating Outlook for IPL is Stable.
The Stable Outlook reflects diversity and quality of cash flow from its regulated utility business. The company also benefits from a sufficient liquidity position, manageable debt maturities, and its ability to support and manage a rising capital expenditure.
Key Rating Drivers:
Large Capex at IPL:
A significant portion of IPL's electricity generation capacity is coal based (about 80%) and is subject to stringent environmental regulations. IPL must retrofit its coal fired power plants either with the new emission control equipment or close these facilities. Fitch's forecast includes about $520 million in capital expenditure for the five largest and most economical coal plants that need to be retrofitted with new equipment to comply with the more stringent environment regulations. These plants represent aggregate nameplate capacity of greater than 2,400 MW, or 65% of IPL's total coal-generation fleet.
Fitch's current forecast also incorporates additional capital expenditure of about $630m for the replacement generating capacity that might be needed in the 2016-17 timeframe as IPL will have to retire its inefficient generating capacity. Even though, these costs are likely to be recoverable from ratepayers via a rate case proceeding, Fitch expects credit metrics during the construction period will be adversely affected.
General Rate Increase Required:
IPL has not requested a formal base rate increase since 1996; however, erosion in the margins due to increase in costs to operate the aging power plants, higher operating costs related to installed environmental equipment, and declining wholesale margins will likely result in a general base rate filing with the Indiana Regulatory Utility Commission (IURC). Fitch's forecast anticipates significant erosion in IPL's ROE by 2014-2015, and Fitch's forecast is adjusted for the new base rate application, albeit at a lower recovery rate for the rate base assets.
Moderate Covenants Protect IPL's Bondholders:
IPL's credit benefits from moderately protective covenants in its financing documents. IPL's credit facility, expiring in 2015, permits dividend distributions only if debt to capital ratio is not greater than 65%. 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.
Steady Credit Metrics:
Fitch forecasts IPL's FFO to debt ratio to weaken to 14% by 2016 before recovering in 2017. Similarly, debt to EBITDA is projected to peak at approximately 4.0x, before declining to between 3.0-3.5x in 2017. IPL's credit metrics by 2017 are consistent with Fitch benchmarks for its 'BBB-' IDR. IPL's current ratings reflect constraint of 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.
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. The customer base is stable.
Liquidity is adequate, but IPL will be dependent on external financing to meet its capex program. IPL maintains a $250 million credit facility that extends until December 2015. IPALCO has no liquidity facilities and depends on upstream distributions from IPL to service its obligations and expenses. $110m of debt maturities in 2013 at IPL will be refinanced.
A positive rating action is unlikely for several years during a period of rising capex led by increasingly stringent environmental regulations and external financing needs at IPL. Fitch also anticipates higher regulatory risk for IPL given the need for a base rate case proceeding in the 2014 to 2015 time period.
An inability to earn an adequate and timely return on IPL's substantial capex program would pressure credit metrics and likely lead to a rating downgrade. Capital expenditures in excess of Fitch's current forecasts could stress the already leveraged capital structure and place an incremental burden of IPL's cash flows.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology, Aug. 8, 2012;
--Utilities Sector Notching and Recovery Ratings, Aug. 12, 2012;
--Parent and Subsidiary Rating Linkage, Aug. 12, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Utilities
Parent and Subsidiary Rating Linkage
Fitch Ratings, Inc.
One State St. Plaza
New York, NY 10004
Brian Bertsch, +1-212-908-0549 (New York)