Fitch Affirms Choctaw GLP, LLLP's $294.9MM Lessor Notes; Outlook Stable

SAN FRANCISCO--()--Fitch affirms Choctaw Generation Limited Partnership, LLLP's (CGLP) combined $294.9 million of pari passu lessor notes as follows:

-- $235.9 million ($231.7 million outstanding) series 1 lessor notes due December 2031 at 'B', Outlook Stable;

-- $59 million ($65 million outstanding) series 2 lessor notes due December 2040 at 'B-', Outlook Stable.

KEY RATING DRIVERS

The ratings on CGLP's lessor notes reflect the susceptibility to underperformance of a facility reliant on ongoing modifications to improve its operational profile, which exhibits near breakeven coverage. Series 1 lacks a debt service reserve to support potential shortfalls in operating cash, which may occur under rating-case conditions. The series 2 notes face the additional risk that deferred principal amortization extends repayment beyond the purchase power agreement (PPA) expiration.

Operations Reliant On Forthcoming Modifications - Operation Risk: Weaker

The owner-lessor, a subsidiary of Southern Company (Southern), has agreed to fund modifications to improve plant performance. The operator, also a Southern subsidiary, is considered strong but the facility continues to perform poorly while performing needed repairs and maintenance and implementing ongoing modifications.

Adequate Mine-mouth Coal Supply - Supply Risk: Weaker

CGLP's mine-mouth location and a reputable fuel supplier reduce supply risk. However, early termination or expiration of the supply agreement in 2032 with potentially less favorable pricing could lead to inadequate fuel cost recovery.

Revenue Contract with Strong Counterparty - Series 1 Revenue Risk: Midrange

CGLP has a PPA with federally owned Tennessee Valley Authority (rated 'AAA', Stable Outlook by Fitch) for the project's full capacity and energy output through mid-2032. The series 1 notes mature four months prior to PPA termination.

Potential for Significant Merchant Exposure - Series 2 Revenue Risk: Weaker

Under a variety of sensitivity scenarios, a significant portion of series 2 debt would remain unpaid prior to PPA expiration. There is a high level of uncertainty regarding CGLP's ability to operate economically in a fully merchant environment.

Debt Structure Lacks Typical Support Features - Debt Structure: Weaker

Both series lack a dedicated debt service reserve, relying instead on draws from other project accounts to fund series 1 payment shortfalls. The ability to defer series 2 target interest and principal payments introduces the risk of a high outstanding balance to be repaid after the PPA expires.

RATING SENSITIVITIES

Positive: Successful completion of facility modifications and stable operations exceeding base-case projections could result in positive rating action.

Negative: Operating performance below rating-case projections after completion of facility modifications would erode limited financial cushion and lead to negative rating action.

SECURITY

The lessor notes are senior ranking and pari-passu. The security interests are typical of project finance transactions and include all project revenues and accounts, all project agreements (PPA and supply agreements), as well as the physical assets of CGLP.

TRANSACTION SUMMARY

Owner-lessor SE Choctaw has made significant progress on the essential projects and baghouse retrofit that aim to improve efficiency, reduce long-term O&M costs, and enhance facility performance. Final installation of major new equipment is occurring during the fall outage from September through November 2014. Start-up and commissioning during the first quarter of 2015 will begin to establish the new baseline for performance. The cost of these projects, in aggregate, has remained within budget. Favorably for CGLP, SE Choctaw is responsible for funding any cost overruns that could occur during the final stages of modifications.

Operating performance over the past year remained weak. Overall, contract availability was 87.3% over the past year through September compared with expectations in the mid-90%-range. Completion of facility modifications is expected to improve reliability and move the operational profile in line with projections.

Low contract availability resulted in lower-than-expected capacity revenue and weak financial performance. Debt service payments for 2013 benefited from the receipt of withheld funds at the closing of the restructuring, but the June 2014 debt service coverage ratio (DSCR), based only on operational cash flow, fell short of breakeven at 0.98x. The shortfall was fulfilled with available cash in the revenue account. Series 2 payments are being deferred through a mandatory payment-in-kind (PIK) feature through 2017.

Fitch anticipates improved operational performance pending implementation of the facility modifications and has not altered the base- and rating-case expectations. However, the lack of any dedicated debt service reserve fund heightens vulnerability to further erosion of limited financial cushion before expected improvements are realized. Furthermore, CGLP is already behind on the funding schedule for its series 2 retained cash flow account. Continuing funding shortfalls could reduce the likelihood that series 2 is able to repay deferred balances by the maturity date.

In December 2002, SE Choctaw purchased the 440MW lignite-fired Red Hills Generation Facility from CGLP. Immediately following the acquisition, the owner leased the facility back to CGLP under a 45-year lease, expiring Dec. 20, 2047. Lessor notes were issued in accordance with the lease, but steady declines in performance prompted a restructuring of the original lessor notes. The lessor notes were restructured to reduce interest rates, extend the debt term, and introduce a PIK feature to series 2 of the notes. As part of the lease restructuring, the owner-lessor agreed to make approximately $60 million in equity investments for needed repairs and maintenance and to implement various modifications to improve the performance of the facility. The restructuring also included a new operator and new refined coal purchase agreement. Along with the lease restructuring, the ownership interest in lessee Choctaw was sold to two indirect wholly owned subsidiaries of PurEnergy I, LLC.

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 Power Projects' (July 30, 2014).

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=753208

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=919536

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.

Contacts

Fitch Ratings, Inc.
Primary Analyst
Andrew Joynt, +1-415-732-5622
Associate Director
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Yvette Dennis, +1-212-908-0668
Director
or
Committee Chairperson
Gregory Remec, +1-312-606-2339
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Andrew Joynt, +1-415-732-5622
Associate Director
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Yvette Dennis, +1-212-908-0668
Director
or
Committee Chairperson
Gregory Remec, +1-312-606-2339
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com