News Column

Fitch Expects to Rate IPL'S FMBs 'BBB+'; Outlook Stable

June 10, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings expects to assign a 'BBB+' rating to Indianapolis Power & Light Company's (IPL, Fitch Issuer Default Rating 'BBB-'; Stable Outlook) upcoming issuance of $130 million in first mortgage bonds (FMBs), due in 2044. These notes rank pari passu with IPL's other FMBs, including any future FMB issuances. The company intends to use the net proceeds from this offering to finance a portion of its elevated construction program.

Legal ownership structure and lack of explicit ring fencing between IPL and its parent, IPALCO Enterprises, Inc. (IPALCO), are key elements for linking IPL's IDR to the IDR of IPALCO (BB+, Stable). Fitch has notched IPL's IDR one notch higher than IPALCO's IDR given its low-risk business profile and moderate capital structure. Preapproval of the total debt at IPL by the Indiana Utility Regulatory Commission (IURC) also supports a notch difference in the IDRs of IPALCO and IPL.

KEY RATING DRIVERS

High Capex: Current capex cycle (through 2017) is expected to be high, in Fitch's opinion. IPL's current capex plans include retrofitting most of its economical coal-fired electricity generation units with the new emission control equipment and to build a new natural gas fired power plant as a replacement for its retiring generating capacity. Fitch expects concurrent recovery of environmental capex under the 'environmental compliance cost recovery adjustment' (ECCRA) clause of the Indiana utility regulations. As of now, IPL has retired about 170MW of its existing generation capacity and plans to retire additional 470MW of its generating capacity by 2016. A new 600MW combined cycle gas turbine plant (CCGT) and conversion of 200MW of IPL's coal-fired units to natural gas will replace the retired capacity for which the IURC has already issued the certificate of public convenience and necessity. Lack of regulatory mechanisms to recover certain operating costs and costs to replace inefficient generating capacity will require IPL to request a general rate increase to improve its cash flow profile. Fitch anticipates erosion in IPL's cash flow measures without the general rate increase. Equity infusion by the ultimate parent, The AES Corporation (AES), will alleviate the rating concerns arising from high capex cycle, in Fitch's opinion.

Near-term General Rate Case Likely: The last IURC approved general rate increase was implemented in 1996. Fitch's rating case model assumptions include regulatory approval of IPL's general rate case applications by the IURC. In the past, the company was able to offset rising costs with strong wholesale electricity margins and concurrent recovery of environmental costs, including capex. However, continuously depressed wholesale electricity margin environment and increase in certain costs will require IPL to request a general rate increase to support the consolidated credit profile.



Consolidated Leverage Based Credit-Profile: IPALCO's IDR reflects a highly leveraged capital structure with consolidated debt reaching 96% of the total capital at the end of 2013 under the pooling of interest accounting convention. Fitch views consolidated leverage as a key rating driver, along with IPALCO's reliance on IPL to support debt-service and the subordination of IPALCO's debt to that of IPL's debt. Stability of upstream cash flow from IPL and currently a constructive regulatory environment in Indiana partially alleviate the credit concerns arising from exceptionally leveraged capital structure.

Credit Metrics Volatility Expected: The assigned ratings takes into account the expected decline in the credit metrics through 2015 and recovery thereof to reasonable levels by 2018. IPL's adjusted debt to funds from operations (FFO) and FFO-to-interest ratios at the end of 2013 were 3.7x and 4.8x respectively. These ratios are within Fitch's guidelines for IPL's current IDR ('BBB-'), but are expected to decline over the current capex cycle ending in 2017. Fitch projects IPL's credit metrics to remain constrained until the regulators approve increase in IPL's retail tariffs, especially to recover its investment in the new generating capacity. Fitch expects IPL's FFO based leverage (adjusted-debt-to-FFO) to be around 4x at the end of 2018 and FFO based interest coverage (FFO-to-interest) is expected to be around 4.3x at the end of the same period, in line with Fitch's expectations for the assigned IDR.

Environmental Policy Challenges for Coal-fired Generation: IPL's long-term power generation capacity will be coal based. Even with the installation of new emission controls, the long-term policy challenges to coal-fired generation remains a threat to the long-term viability of these assets. Fitch relies on ECCRA and the Indiana Senate bills 29 and 251 for the timely recovery of these investments in assigning the IDR. The Senate bills allow the recovery of federally mandated environmental compliance costs and the installation of clean coal technologies reducing airborne emissions associated with the use of coal.

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 in a timely manner. The customer base is stable.

LIQUIDITY

Liquidity is adequate, but IPL will depend on external debt to finance its capex program. IPL maintains a $250 million credit facility that extends until May 2019.

RATING SENSITIVITIES

A positive rating action is unlikely over the rating horizon (2014 - 2018) given the rising capex at IPL that will be partially debt financed. External financing of increasingly stringent environmental regulation based investment at IPL will constrain the credit protection measures over the rating horizon. Fitch's rating concerns also include increased regulatory risk to IPL's cash flow given that the management plans to file two general rate increase applications over the rating horizon.

Fitch will downgrade the IDR of both companies, if IPL's credit metrics on a sustainable basis, fail to be within the Fitch's guidelines for a 'BBB' rated entity. A restrictive regulatory outcome in the upcoming rate proceedings, if adverse for the credit protection measures on a sustainable basis, will also result in a negative rating action.

Fitch will also consider a negative rating action on IPALCO due to certain adverse regulatory developments, such as: changes that reduce the likelihood of timely recovery of the operating costs (fuel, purchased power, or environmental costs) or imputes less than a full income tax rate in the rates for IPL adversely affecting the credit protection measures at IPALCO. In addition, an absolute increase in debt at IPALCO will also result in a negative rating action at IPALCO.


Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=833938

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Roshan Bains

Director

+1-212-908-0211

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Shalini Mahajan

Senior Director

+1-212-908-0351

or

Committee Chairperson

Glen Grabelsky

Managing Director

+1-212-908-0577

or

Media Relations

Brian Bertsch, New York, +1-212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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