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
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.
Fitch's key assumptions within the rating case for IPL:
--A flat electricity volume growth at IPL over the forecast period
--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.
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.
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
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