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Rating Action:

Moody's Downgrades Indianapolis Citizens Energy Group Water, Gas and Thermal and CWA Wastewater Revenue Bonds; Outlook Stable

03 Oct 2013

Approximately $2.636 Billion Debt Securities Affected

New York, October 03, 2013 -- Moody's Investors Service today downgraded the ratings for $927,090,000 Indianapolis (Citizens Energy Group) Water System first lien (Water System) revenue bonds to A2 from A1, the ratings for $42,905,000 Water System second lien bonds to A3 from A2 as well as the ratings for $884,665,000 Citizens Wastewater Authority (CWA) first lien revenue bonds to A2 from A1 and the ratings for $314,005,000 CWA second lien bonds to A3 from A2.

Concurrent with this rating action, Moody's also lowered the ratings for $125,420,000 Indianapolis Thermal Energy System Revenue (Thermal) bonds to A3 from A2, the ratings for $51,420,000 Indianapolis first lien Gas Utility System (Gas Utility) bonds to A2 from Aa3 and the ratings for $291,310,000 Indianapolis Gas Distribution Utility System (Gas Distribution) bonds to A3 from A2.

This rating action concludes a review for possible downgrade on each of the Indianapolis Citizens Energy Group (CEG) entities that was initiated in July 2013. Moody's also affirmed the MIG 1 rating on the Series 2013 B Thermal Energy System bond anticipation notes.

The rating outlook for Indianapolis Water System, CWA, Gas and Thermal Systems is stable.

The City of Indianapolis Board of Directors for Utilities, doing business as Citizens Energy Group, owns the gas, thermal and water systems and operates the wastewater system through the CWA, a separate legal entity, but still governed by the same Indianapolis Board of Directors for Utilities.

Rating Rationale

The downgrades recognize the business model under which CEG enterprises operate. The organizational structure, management and governance of CEG embody constraints and elements that are different from those of the great majority of U.S. Public Finance enterprises. The rating assigned reflects the potential for performance challenges that are not expected for mainline municipal enterprises. For example, CEG's investment in ProLiance Holdings LLC, a wholesale natural gas marketing operation with annual revenues in excess of $1 billion, exemplifies their non-traditional more corporate like approach as the wholesale natural gas marketing operation can expose the consolidated entity to earnings volatility. During 2012, ProLiance suffered a $51 million loss and the potential for earning volatility continues as CEG held on to a portion of the business following a sale earlier this year. While we acknowledge that each of the revenue bond indentures at Indianapolis CEG Water System, CWA, Gas and Thermal contain bondholder protections similar to that of a typical municipal utility enterprise, including a legal structure that appears to adequately fence off the utility enterprises from financial exposure from the broader unregulated business activities of CEG's Citizens Resources, there are weaknesses in the structure, including the ability to move cash across the system, particularly from the Gas and Thermal utilities, that in our opinion detract from credit quality. In addition to CEG's more corporate-like business risk taking strategy, additional factors that lowered the ratings to the mid-to-low A rating category, include the regulated rate-setting process, which is a credit weakness for a municipal system and CEG's significant consolidated leverage. The ratings also reflect the potential exposure to non-traditional municipal finance risks since CEG governs all the utilities as well as Citizens Resource's unregulated businesses. Collectively, these present additional credit risks which we have factored into today's rating action.

Water

The downgrade of the Water System first lien revenue bonds to A2 from A1 and its second lien bonds to A3 from A2 considered the CEG's significant debt leverage; satisfactory financial metrics and the regulated cost recovery process particularly since the water rate covenant is relatively weak compared to other peers. Indianapolis recognized its inability to manage its water system due to the inability to get sufficient rate increases while the system had to comply with more rigorous federal environmental regulations. After the acquisition, CEG, who had recorded a satisfactory record of managing the city's gas system, has thus far demonstrated the capability to improve water services. However, the amount of the pending rate request is material. While regulatory support appears to be in place, the rate covenant is not required to be considered by the regulatory board. There is a "municipal ratemaking statute" which stipulates what the utility can recover, but the lack of an annual requirement indicates less restrictive nature of the requirement. In light of the significant capital investment required over the next decade sustained regulatory support is required.

In 2012, debt service coverage ratio was 1.38 times which is below average for an essential purpose municipal utility. For the first nine months of FY 2013, water sales were down 10.6% owing partly to coming off 2012 results which featured above average sales. As mentioned, a 14.7% increase in water rates has been proposed to the IURC reflecting the incremental investment, higher debt service and the lower water sales level. The state Office of Utility Consumer Counselor (OUCC) has submitted a proposal that is pending that would limit the rate increase to 3%.

Rating Outlook

Moody's believes the outlook is stable given CEG's satisfactory record of managing the water services and forecasted finances which include rate increases.

What Could Change Rating Down:

The rating could be lowered should CEG not maintain sound financial metrics due to rates not being raised sufficiently or the utility faces any exposure from CEG's unregulated businesses.

What Could Change the Rating Up:

The rating could be raised should financial metrics improve including consistent sound debt service coverage margins in excess of 1.50 range and further separation of any risks to the essential services of CEG.

Wastewater

The downgrade of the CWA's first lien revenue bonds to A2 from A1 and its second lien bonds to A3 from A2 considers the significant new leverage and resulting substantial increase in customer bills starting in 2014; the regulated rate-setting process; a relatively weak rate covenant; and the broad corporate mission of CEG which allows for a more complicated and uncertain governance structure related to the unregulated businesses of CEG's Citizens Resources. While the CWA indenture is typical for a municipal revenue bond, there is potential for exposure since CEG governs all the utilities and Citizens Resource's unregulated businesses. Also the enterprises for water, wastewater and gas provide services to generally the same ratepayers now subject to higher rates for essential services.

CWA provides sewer services to most of the developed area of the city and also areas outside city boundaries. There are no dominant customers. Recognition that the city could not adequately manage meeting the environmental challenges ahead of it, the city agreed that CWA acquire the sewer system, and CWA assume the obligation to comply with federal regulations including a Federal Consent Decree. The Consent Decree required investment in 32 CSO control measures along 5 waterways designed to reduce raw sewage overflows by 2025. Also by 2015, the Decree requires the elimination of chronic overflows from 7 locations in the separation of the sanitary sewer system. The investment is projected at $1.6 billion of capital projects including the 16,000 feet Deep Rock Tunnel system.

The Long Term Control Plan to carry out meeting the Federal Consent Decree was approved by a IURC order, which included a tracker mechanism to automatically approve increases in rates related to debt service to fund the plan starting in 2014. The IURC rate administrative process is underway with an increase of 31.7% starting in 2014. The wastewater utility had a debt service coverage ratio in 2012 of 1.23 times. In 2013, sewage volume was down by 5.6% but new rates which were 10.75% higher became effective in 2013 which is expected to result in an estimated debt service coverage in 1.2 to 1.4 times range. The debt service schedule begins to ramp up with debt service doubling between 2013 and 2016. Forecasts indicate 1.4 times debt service coverage assuming revenues from automatic rate increases are sufficient.

Rating Outlook

Moody's believes the outlook is stable but much will depend on the implementation of the substantial rate increases and how it and ratepayers manage the leverage the utility will face over the next several years.

What Could Change Rating Down:

The rating could be downgraded if regulatory supportiveness wavers in face of significant rate increase requirements or the utility faces significant penalties should it not meet the consent decree timetable. Or the utility faces any negative exposure from CEG's unregulated businesses.

What Could Change the Rating Up:

The rating could be upgraded if the utility meets sound financial metrics as the major capital improvement program is implemented and it builds more certainty into its rate setting process through an established record.

Thermal

The downgrade of Thermal's revenue bonds to A3 from A2 reflects the weaker financial profile of the consolidated CEG financial position and the corporate strategy which has more risk appetite factored into the rating. Previously weighted in the rating of the thermal system bonds was the availability of significant CEG financial reserves which could be utilized to support the thermal business operations. The original equity contribution by CEG helped to position the thermal business at its startup.

While the thermal business has a strong market position as a provider of chilled water and steam to its customers in the downtown area of the City of Indianapolis (rated Aaa), the pledged revenues are a narrow revenue stream with very significant customer concentration. The largest customer in excess of 10% of revenues could present significant stress to the thermal business finances if it left the system. There is also state regulation of the steam system's rates. Rate regulation remains a key rating factor given the potential for regulatory lag in the rate approval process for the steam system.

Thermal's debt service coverage has averaged in the 1.50 times range since being formed in 2001. Over the past four years, debt service coverage has averaged 1.60 times and is forecasted to be in the 1.80 times range. The Thermal system fund flow is open loop with any surplus available to CEG.

Rating Outlook

Moody's believes the outlook is stable given the thermal system's sound record of managing the business and the forecasted finances which indicate improved financial metrics.

What Could Change Rating Down:

The rating could be downgraded should the thermal system lose any of its major customers or the steam system has any cost recovery issues with the regulatory board.

What Could Change the Rating Up:

The rating could be raised should the thermal system meet the stronger financial metrics reflected in its forecasted financial position and it further mitigates financial impact from any large customer loss.

Gas

Moody's downgrade of the Gas Utility System first lien bonds to A2 from Aa3 reflects the more direct risks related to the role that Citizens Resources plays since Citizens Resources revenue are pledged to the first lien bonds.

The downgrade of Gas Distribution's second lien bonds to A3 from A2 recognizes the CEG's corporate-like business strategy through its Citizens Resource business and the regulated rate- setting process. The rating further reflects the diverse mix of residential, commercial and industrial customers; there are no dominant customers; and there is stable contracted gas supply arrangements. Citizens Gas has an exclusive right to serve customers in its service area. We do note the improved rate-setting record of the distribution system that has provided generally sound financial metrics despite being regulated by the state's regulatory board. The cost recovery process is different than other U.S. municipal gas utilities since Citizens Gas has the requirement to seek state regulatory board approval for rate increases, which could result in weakening financial metrics if rate petitions are either not approved on a timely basis or not approved for the full amount requested. While Gas Distribution's debt service coverage fell to 1.49 times in 2011 due to lower sales margins, a rate increase did provide improved coverage in 2012. Stable debt service coverage of 1.80 times is anticipated by CEG through 2018. The Gas system fund flow is open loop with any surplus available to CEG.

Rating Outlook

The CEG gas utility has had a record of sound financial metrics and an improvement in its cost recovery process with forecasted financial results showing an improvement in debt service coverage.

What Could Change Rating Down:

The rating could be downgraded if on a combined first and second lien basis debt service coverage falls below 1.50 times on a three-year basis; or that the utility faces any negative exposure from CEG's unconsolidated businesses. Citizen Resources revenues are pledged to the senior lien bonds.

What Could Change the Rating Up:

The rating could be upgraded should the potential for negative exposure from the Citizens Resources be significantly narrowed.

RATING METHODOLOGY

The principal methodology used in rating the Thermal and Gas Distribution debt was U.S. Public Power Electric Utilities published in April 2008.

The principal methodology used in rating the Water System and CWA debt was Analytical Framework For Water And Sewer System Ratings published in August 1999.

The principal methodology used in rating the bond anticipation notes was Bond Anticipation Notes and Other Short-Term Capital Financings published in May 2007.

Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Dan Aschenbach
Senior Vice President
Public Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Chee Mee Hu
MD - Project Finance
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Downgrades Indianapolis Citizens Energy Group Water, Gas and Thermal and CWA Wastewater Revenue Bonds; Outlook Stable
No Related Data.
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