Fitch Affirms Kincaid Generation LLC's Senior Secured Bonds at 'BBB-'; Outlook Revised to Negative

CHICAGO--()--Fitch Ratings has affirmed the 'BBB-' rating on Kincaid Generation LLC's (Kincaid) $265 million ($145.3 million outstanding) senior secured bonds due 2020. The Rating Outlook is revised to Negative from Stable.

The Negative Outlook reflects the continued weakness in market prices that may lead to a materially lower liquidity position.

KEY RATING DRIVERS:

--Competitive Merchant Position: Kincaid will be fully exposed to capacity, energy, and coal market prices beginning in March 2013. Fitch recognizes that near-term energy prices are weak and may result in lower dispatch. However, Dominion Resources, the project sponsor, has entered into hedging agreements to help mitigate merchant price risk. Fitch believes the project's stable operating profile and competitive cost structure, as well as announced PJM plant closures, enhance the project's long-term merchant position. Further, the rating is reliant on the $145 million, as of December 2012, in project liquidity.

--Stable Operating Profile: The project has historically exhibited strong availability factors and consistently lower than forecasted operating costs. However, management has budgeted for higher than historical non-fuel O&M costs mainly due to a scheduled overhaul in 2013 and environmental control costs. Kincaid has historically maintained plant availability in the low-90% range in non-overhaul years.

--Uncertain Environmental Regulations: The magnitude and timing of new emissions regulations are uncertain, particularly after the courts vacated the Cross-State Air Pollution Rule governing sulphur dioxide and nitrogen oxide in 2012. Fitch recognizes that Kincaid is currently compliant with existing NOx and SO2 emissions regulations and views the project's installation of emission control equipment positively, which will help to mitigate potential future compliance costs.

--Strong Structural Features: Kincaid's structural features are generally stronger than similarly rated thermal power projects. Notably, the backward- and forward-looking equity distribution test of 1.75x ensures that liquidity remains at the project.

--Liquidity Mitigates Weak Near-Term Coverage: The $145 million in project liquidity is the primary mitigant to cash flow shortfalls and supports the current rating. The Fitch rating case forecasts debt service coverage ratios (DSCRs) below breakeven levels through 2016 with DSCRs reaching 1.3x or greater thereafter. Despite the project's near-term financial weakness, its liquidity position is generally adequate to meet fixed costs and scheduled debt service in the Fitch rating case. Fitch's alternative stress cases forecast minimum liquidity balances of greater than $45 million and average DSCRs of about 2x beginning in 2017.

RATING SENSITIVITIES:

--Weak Market Prices: Sustained weakness in the capacity and energy markets that results in a continued need to draw on liquidity.

--Operational Challenges: A major or serial forced outages leading to higher capital costs and a lower dispatch profile than forecast.

--Increased Environmental Costs: More stringent or incremental environmental regulation could lead to additional operating and capital costs for pollution control equipment and emission allowance costs.

SECURITY:

The senior secured bonds are secured with a first priority lien on substantially all of Kincaid's tangible and intangible assets, rights and interests in the financing and project documents, insurance policies and proceeds thereof, assignable permits and governmental approvals and any after-acquired property.

CREDIT UPDATE:

The Negative Outlook reflects the continued weakness in market prices that may lead to a materially lower liquidity position. Fitch believes that the project's liquidity position is adequate to prevent a default given the prospects for recovery. Further, the 1.75x backward- and forward-looking distribution test ensures that any available liquidity remains at the project. However, persistently low market prices, material operational challenges, and inadequate liquidity could trigger a rating action.

An unexpectedly low, sustained natural gas price and energy demand environment has contributed to a lower forecasted energy price over the next three to five years. Additionally, PJM capacity prices have fallen to historical lows due to forecasted lower peak demand and gas capacity bidding in to the capacity market below the minimum offer price. Fitch forecasts base case DSCRs to be below breakeven levels over the next two years with a gradual improvement in the DSCR profile to nearly 3x or greater beginning in 2017. The recovery in DSCRs is due to Fitch's expectation that uneconomic coal capacity will be taken offline by 2016 and energy demand improves. Fitch considers liquidity to be robust in the base case, which is forecast to reach a low of approximately $75 million in 2014, equal to nearly three years of debt service over the remaining 5.5 year debt term.

The Fitch rating case, which considers a low energy price environment with a long-term real gas price of about $3.50 per mmBtu and operational and costs stresses, generally forecasts the DSCR profile to remain below breakeven levels through 2016. Fitch believes that liquidity will be adequate if dispatch is properly managed. Coverage is forecast be approximately 1.3x or greater thereafter.

Kincaid Generation LLC consists of a 1,108 megawatt, coal-fired electric generation facility located in Kincaid, Illinois, 17-miles southeast of Springfield, Illinois. The plant was acquired by Dominion Energy Inc. in February 1998 from ComEd. Kincaid will sell 100% of its capacity and energy generation into the PJM merchant power market. Fitch notes that Dominion announced, in the third quarter of 2012, that it is actively marketing the Kincaid project. Currently, Fitch does not view the potential sale as a rating driver, but will review the credit impact as terms become available.

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

Applicable Criteria and Related Research:

--'Rating Criteria for Infrastructure and Project Finance' July 11, 2012;

--'Rating Criteria for Thermal Projects' June 18, 2012.

Applicable Criteria and Related Research:

Rating Criteria for Infrastructure and Project Finance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682867

Rating Criteria for Thermal Power Projects

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681297

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Contacts

Primary Analyst
Dino Kritikos
Director
+1-312-368-3150
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Cynthia Howells
Director
+1-212-908-0685
or
Committee Chairperson
Greg Remec
Senior Director
+1-312-606-2339
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Primary Analyst
Dino Kritikos
Director
+1-312-368-3150
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Cynthia Howells
Director
+1-212-908-0685
or
Committee Chairperson
Greg Remec
Senior Director
+1-312-606-2339
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
elizabeth.fogerty@fitchratings.com