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 September 9, 2015 - 4:35 PM EDT
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Fitch Rates Indianapolis Power & Light Co's FMBs 'BBB+'; Outlook Stable

Fitch Ratings has assigned a 'BBB+' rating to Indianapolis Power & Light Company's (IPL, Issuer Default Rating [IDR] 'BBB-'; Outlook Stable) new $260 million, 4.70% first mortgage bonds (FMBs), due on Sept. 1, 2045. These bonds rank pari passu with IPL's other FMBs, including any future FMB issuances. The company intends to use the net proceeds to finance a portion of its elevated construction program. The Rating Outlook is Stable.

Legal ownership structure and lack of explicit ring fencing between IPL and its parent, IPALCO Enterprises, Inc. (IPALCO, 'BB+', Outlook Stable), are key elements for linking IPL's IDR to the IDR of IPALCO. 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

Elevated Capex Spending: Current capex cycle (through 2017) is expected to remain high, in Fitch's opinion. IPL's current capex plan includes retrofitting most of its economical coal-fired power plants 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 implement a general rate increase in 2018. Fitch anticipates erosion in IPL's cash flow measures without the general rate increase. Equity infusion by the IPALCO's shareholders, The AES Corporation (AES, 'BB-', Outlook Negative) and La Caisse de depot et placement du Quebec (not rated by Fitch), will alleviate the rating concerns arising from high capex spending, in Fitch's opinion.

GRC Supports Credit Profile: In December 2014, IPL filed a general rate case (GRC) application with the Indiana Utility Regulatory Commission (IURC). IPL is requesting about $68 million in new revenues. The intervenors in the GRC proceedings have recommended about $6 million increase in the retail rates. Fitch views Indiana's regulatory environment as supportive of IPL's business profile and expects a positive regulatory outcome of the pending GRC with the new retail rates becoming effective in the first quarter of 2016. Another regulator-approved increase in the retail rates will be required to support IPL's capex spending beyond 2015.

Consolidated Credit Profile: Fitch's ratings are based on the consolidated credit profile. IPALCO relies on IPL for its debt service and other funding needs. IPL's reliance on IPALCO for equity support as well as the subordination of IPALCO's debt to IPL's debt are key elements of the consolidated credit profile. The stability of upstream cash flow from IPL and a currently constructive regulatory environment in Indiana partially alleviate the credit concerns arising from IPALCO's exceptionally leveraged capital structure.

Credit Metrics Volatility Expected: The assigned ratings takes into account the expected decline in the credit metrics through 2017 and the recovery thereof to reasonable levels by 2018. Fitch expects IPL's credit metrics to remain constrained until the regulators approve an increase of the company's retail tariffs to recover its investment in new generating capacity and the related operating costs. Fitch's rating model assumes implementation of new retail rates in the first quarter of 2018 (1Q18). Fitch forecasts IPL's funds from operations (FFO) based leverage (adjusted debt-to-FFO) at the end of 2018 will be around 4x and FFO based interest coverage (FFO-to-interest) is expected to be around 4.3x at the end of the same period. These metrics are in line with Fitch's expectations for the assigned IDR.

Environmental Policy Challenges: Management expects about 44% of IPL's long-term power generation capacity to remain coal-based. Even with the installation of new emission controls, the long-term public policy challenges to coal-fired generation remain a threat to the long-term viability of these assets. In assigning the IDR, Fitch relies on the environmental compliance cost rider and Indiana Senate Bills 29 and 251 for timely recovery of these investments.

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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for IPL:

--A flat electricity volume growth at IPL over the forecast period (2015-2018).

--Fitch has assumed that IPL will give up majority of its margins from wholesale electricity once its next GRC application is approved. Currently, there are no limits on IPL to share its off-system sales.

--For wholesale electricity revenues and margins, Fitch used WoodMac's projected power prices for the forecast period.

--Fitch's rating case assumptions include regulatory approval of IPL's GRC applications with the new rates becoming effective from Jan. 1, 2016 and Jan. 1, 2018.

--Fitch has assumed a balanced funding of IPL's capex.

RATING SENSITIVITIES

Positive Rating Action: A positive rating action is unlikely over the rating horizon (2015 - 2018) given the elevated 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.

Negative Rating Action: 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 GRC 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 IPL 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 IPL.

Date of relevant rating committee: Dec. 14, 2014.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990569

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst:
Roshan Bains, +1-212-908-0211
Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst:
Shalini Mahajan, CFA, +1-212-908-0351
Managing Director
or
Committee Chairperson:
Philip Smyth, CFA, +1-212-908-0531
Senior Director
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com


Source: Business Wire (September 9, 2015 - 4:35 PM EDT)

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