-- Increased competition because of lower wholesale
electricity prices will continue to materially reduce DPL's
-- We expect the unregulated retail business to grow because
of the eventual transition to generation market rates.
-- The company's financial position is stressed due to the
substantial amount of acquisition debt layered on by parent
-- We are lowering our ratings on DPL Inc. and its wholly
owned subsidiary, Dayton Power & Light (DP&L), including the
corporate credit rating on both entities, to 'BB' from 'BBB-'
and removed them from CreditWatch with negative implications. We
are also lowering our issue ratings on DPL's senior unsecured
debt to 'BB-' from 'BB+' and on DP&L's senior secured debt to
'BBB-' from 'BBB+'.
-- The outlook is stable, reflecting our baseline forecast
for consolidated adjusted FFO to debt of about 8% to 10% for the
next three years. Rating Action On Nov. 8, 2012, Standard &
Poor's Ratings Services lowered its corporate credit ratings on
DPL Inc. and subsidiary Dayton Power & Light Co. (DP&L) two
notches, to 'BB' from 'BBB-', and removed them from CreditWatch
negative. The outlook is stable.
At the same time, we lowered our issue ratings on DPL's
senior unsecured debt to 'BB-' from 'BB+'. We assigned a
recovery rating of '5', indicating our expectation that lenders
would receive modest (10% to 30%) recovery of principal in a
default. We also lowered our issue rating on DP&L's senior
secured debt two notches, to 'BBB-' from 'BBB+'. We revised the
recovery rating on the senior secured debt to '1', reflecting
high (90% to 100%) recovery, from '1+'. All debt issue ratings
have also been removed from CreditWatch negative. Rationale
Standard & Poor's ratings on DPL Inc. reflect the company's
consolidated credit profile, which includes its association with
the weaker credit quality of its parent, The AES Corp.
(BB-/Stable/--). DPL is the holding company for regulated
electric utility DP&L. The ratings also reflect DPL's "strong"
business risk profile and its "aggressive" financial risk
profile, as defined in our criteria. (We rank business risk from
"excellent" to "vulnerable" and financial risk from "minimal" to
"highly leveraged.") We view DPL and DP&L's business risk
profiles as "strong" based on the increased competition among
Midwest energy retail providers and the expected growth of the
unregulated retail business. In addition, we expect competition
to increase because of lower wholesale electricity prices, which
will materially reduce DPL's profit margins.
The company's financial position has very little cushion due
to the increased amount of acquisition debt from parent company
AES. DPL recently announced that it will be taking an impairment
charge of $1.85 billion on the goodwill associated with the AES
purchase. Although we do not expect this impairment to affect
cash flows, it will substantially weaken net income and earnings
in 2012 as well as the total-debt-to-capital ratio. DPL's credit
quality is heavily influenced by the substantial additional
acquisition-related debt and its adverse impact on the company's
key financial measures. Consequently, our baseline forecast
calls for total debt to EBITDA of about 6.5x to 7.0x and
adjusted FFO to total debt to be about 8% to 10%. Our ratings on
DPL and DP&L are higher than our rating on parent AES, as
structural protections (a separateness agreement, an independent
director, and debt limitations and covenants) provide some
insulation to the subsidiaries. Our assessment of both entities'
strong business risk profiles is based on DP&L's eventual
transition to generation market rates.
We expect increasing competition from lower wholesale
electricity prices to materially reduce DPL's profit margins in
the next 12 to 24 months. Our assessment also takes into account
the expected growth of the unregulated retail subsidiary, a lack
of fuel diversity, and a weak economy in Dayton. Those factors
are partly offset, in our view, by the lower-risk regulated
transmission and distribution portion of the business, generally
low-cost generating facilities, and the completion of an
extensive environmental compliance program. With heightened
competition in Ohio, unrated affiliate DPL Energy Resources now
provides electricity to about 77% of DP&L's estimated 57%
switched load at market rates. DP&L recently filed a new
electric security plan (ESP) for Jan. 1, 2013, through May 31,
2016. The company's current ESP expires on Dec. 31, 2012. The
new plan would reflect a proportionate blend of the rate
resulting from a competitive bidding process and DP&L's current
ESP generation prices.
DP&L is proposing to blend in auction results with current
standard-service offer rates, starting with a 10% mix of auction
results and culminating in a 100% move to market rates in June
2016. DP&L has also requested approval for a non-bypassable
service stability rider (SSR) and a customer-switching tracker.
We view the SSR and the tracker as good for credit quality as
they would provide additional cash flow that would otherwise be
lost in the company's transition to full market rates. As a
reference point, AEP Ohio's recent ESP filing with the Public
Utilities Commission of Ohio includes a non-bypassable rider.
AEP also filed to create a separate generation company for its
Ohio generation assets. We assess DPL's financial risk profile
as aggressive, reflecting our base-case scenario of adjusted
funds from operations (FFO) to total debt of about 8% to 10% and
adjusted total debt to EBITDA of about 6.5x for the next 12
months. For the 12 months ended June 30, 2012, adjusted FFO to
debt was 11%, compared with 12% at year-end 2011; adjusted debt
to EBITDA was 5.8x, slightly weaker than 5.2x at year-end 2011.
Liquidity Liquidity is "adequate" under Standard & Poor's
corporate liquidity methodology, which categorizes liquidity in
five standard descriptors.
"Adequate" liquidity supports our 'BB' issuer credit rating
on DPL and its subsidiary DP&L.
Our assessment is based on the following factors and
-- We expect liquidity sources (including FFO and credit
facility availability) to exceed uses by more than 1.2x over the
next 12 months;
-- Debt maturities over the next year are manageable;
-- Even if EBITDA declines by 15%, we believe net sources
will be well in excess of liquidity requirements; and
-- The company has good relationships with its banks and has
a good standing in the credit markets. DPL's projected sources
of liquidity are mostly operating cash flow and available bank
lines. Its projected uses are mainly for necessary capital
expenditures and debt maturities. The company's ability to
absorb high-impact, low-probability events with limited need for
refinancing, its flexibility to reduce capital spending or sell
assets, its sound bank relationships, its solid standing in
credit markets, and its generally prudent risk management
further support our assessment of its liquidity as adequate.
DP&L's next maturity, in October 2013, is significant, at $470
million. Given the magnitude of the maturity, we expect the
company to address it well in advance of the due date. DP&L
maintains a $200 million revolving credit facility that matures
on April 20, 2013. The company also has another $200 million
revolving credit facility that expires in August 2015. Subject
to certain conditions and approvals, DP&L has the option to
increase both facilities by up to an additional $50 million
each. DPL recently reduced the limit on its $125 million credit
facility to $75 million and negotiated changes to the covenant
requirements with the bank group.
The first financial covenant, originally a
total-debt-to-capitalization ratio, was changed, effective Sept.
30, 2012, to a total-debt-to-EBITDA ratio.
The ratio is not to exceed 7.0x to 10.0x as of Sept. 30,
2012, and the ratio steps up to 8.25x to 10.0x by Sept. 30,
2013. The company is currently in compliance with this covenant.
In addition, EBITDA to interest must be at least 2.5x under the
covenant. The company is currently in compliance with this
covenant as well. Both DP&L bank agreements have one financial
covenant requiring that DP&L's total debt to capital not exceed
65%; the company is comfortably in compliance, as its actual
ratio is about 43%. In our analysis, we assumed liquidity of
about $680 million over the next 12 months, consisting of
projected FFO, excess cash, and availability under the credit
facilities. We estimate liquidity uses of roughly $560 million
during the same period for capital spending, dividends, and debt
maturities. Recovery analysis We assign recovery ratings on all
debt issued by non-investment-grade rated corporate entities,
and these ratings determine potential notching of issue ratings
relative to our corporate credit rating on that company.
Our recovery analysis is based on a simulated default by the
company with its existing capital structure.
Highlights of our recovery analysis are as follows:
-- Our recovery analysis for DPL and DP&L was based on a
simulated default in 2016, at which point all of its power
assets will have transitioned to competitive-merchant status.
-- Following a simulated default, we valued the regulated
assets (the transmission and distribution equipment and
non-bypassable charge) at their approximate net book value of
$955 million as a proxy for the allowed regulated return on
these critical assets, and we valued the power assets at about
$905 million using a dollar-per-kilowatt (kw) approach that
considers the nature of the individual assets and the conditions
assumed in our simulated default scenario.
-- We assumed a higher dollar-per-kilowatt multiple for the
Zimmer ($450/kw), Killen ($425/kw), and Miami ($425/kw) coal
plants because environmental updates will have been completed
prior to our simulated default date and because these facilities
are newer and run with greater efficiency than the other coal
Conversely, we used lower multiples for the Stuart
($375/kw), East Bend ($350/kw), and Conesville ($350/kw) coal
plants because these facilities are somewhat older or less
efficient and because these facilities could require additional
environmental upgrades to meet federal and state laws. We have
assigned no value to the Beckjord and Hutchings coal plants,
which should be decommissioned, or to the low-margin retail
These assumptions produced a gross enterprise value of $1.86
billion. Based on the company's relatively simple capital
structure, we have estimated administrative bankruptcy expenses
at 3%, producing a net enterprise value of about $1.8 billion.
-- DP&L's secured debt is expected to total $923 million at
default (including an estimate of six months' accrued interest)
and would have the highest priority claim to this value. This
suggests the potential for full recovery and total coverage of
195%, but the transfer of regulated assets to a merchant arm
would leave only about 100% of the remaining regulated-asset
Under our first-mortgage-bond criteria, this produces a '1'
recovery rating, reflecting our expectation of 90% to 100%, thus
the secured issue rating of 'BBB-', which is two notches higher
than the corporate credit rating, although certain debt backed
by bond insurance from Berkshire Hathaway is rated higher based
on the insurer's credit rating. After accounting for other
estimated claims at DP&L (two revolving facilities, which we
assume would be fully drawn at default, and structurally senior
preferred stock) of about $424 million, roughly $447.5 million
in remaining value would be available to DPL creditors.
This suggests total coverage of about 24% for DPL's
unsecured debt of roughly $1.8 billion. As such, this debt has a
'5' recovery rating, reflecting modest (10% to 30%) recovery
prospects, and an issue rating of 'BB-'. Outlook The stable
rating outlook on DPL reflects Standard & Poor's baseline
forecast that consolidated adjusted FFO to debt will be about 8%
to 10% over the next 12 to 18 months. Significant risks to the
forecast include increasing competition from lower electricity
prices that could materially lower DPL's profit margins and a
weaker economy than we currently expect.
We could lower the ratings if FFO to debt is consistently
lower than 8% or the business risk profile weakens as a result
of the disproportionate growth of the competitive energy
Conversely, we could raise the ratings if FFO to debt
consistently strengthens to greater than 15% on a sustained
basis, which we would expect to result mostly from higher
electricity prices and an improved economy.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Liquidity Descriptors For Global Corporate Issuers, Sept.
-- Analytical Methodology, April 15, 2008
Downgraded; Off CreditWatch
Dayton Power & Light Co.
Corporate credit rating BB/Stable/-- BBB-/Watch
Senior unsecured BB- BB+/Watch Neg
Recovery rating 5
Dayton Power & Light Co.
Senior secured BBB- BBB+/Watch Neg
Recovery rating 1 1+
DPL Capital Trust II
Preferred stock B+ BB/Watch Neg