Fitch Affirms Calpine's Ratings at 'B+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed Calpine Corp.'s Long-term Issuer Default Rating (IDR) at 'B+'. The Rating Outlook is Stable. Fitch has affirmed Calpine's first lien senior secured debt at 'BB+' with a Recovery Rating (RR) of 'RR1' (implying 91% - 100% recovery). The first lien senior secured debt includes first lien term loans, first lien senior secured notes and the revolving credit facility, all of which are pari passu. Fitch has also affirmed Calpine's senior unsecured debt at 'BB-/RR3'. The 'RR3' rating implies a 51% - 70% recovery.

In addition, Fitch has affirmed Calpine Construction Finance Company, L.P.'s (CCFC) Long-term IDR at 'B+' and senior secured debt rating at 'BB+/RR1'. The Outlook is Stable.

The affirmation reflects Fitch's view that Calpine can continue to generate stable levels of EBITDA even during periods of extremely low natural gas prices. Given the relative efficiency of Calpine's fleet compared to the market, low natural gas prices can boost the run times for its generation fleet, thus, offsetting the compression in generation margins to a large extent. Fitch's base deck for natural gas prices has seen a series of revisions over the last few months and currently stands at $2.25/$2.50/$2.75 per MMBtu in 2016/2017/2018, respectively. At these prices, Fitch expects Calpine to generate 2016 adjusted EBITDA within its stated guidance range of $1.8 billion - $1.95 billion, which compares with 2015 adjusted EBITDA of $1.98 billion. Beyond 2016, Fitch expects adjusted EBITDA to modestly increase reflecting Fitch's expectations of modest improvement in natural gas prices and contribution from the already announced new generation projects and recently completed Granite Ridge acquisition.

Fitch's rating concern primarily lies with Calpine's high leverage; in particular the net adjusted Debt/EBITDA has consistently trailed management's stated 4.5x target. Calpine's year-end 2015 gross adjusted Debt/EBITDA was 6.1x and the net adjusted debt/EBITDA was 5.7x. The timing of the debt issuance for Granite Ridge acquisition does have a bearing; however, in general, management has opted to operate at or above net adjusted debt/EBITDA of 5.5x. Any deterioration in the EBITDA outlook from factors such as: a further drop in natural gas prices, adverse capacity auction outcomes, compression in heat rates or expiration of above-market contracts, would be worrisome and bear negative rating pressure if not accompanied by commensurate debt reduction.

The individual security ratings at Calpine are notched above or below the IDR, as a result of the relative recovery prospects in a hypothetical default scenario. Fitch values Calpine's power generation assets using a net present value (NPV) analysis. Fitch's updated NPV analysis has seen a material degradation in value, in particular for Calpine's California portfolio. Any incremental first lien issuance and/ or further degradation in power generation values will put downward rating pressure on the senior unsecured ratings.

KEY RATING DRIVERS

EBITDA Resiliency Through Cycles

Calpine's adjusted EBITDA has proved to be resilient in different natural gas price scenarios. While Calpine's adjusted EBITDA remains biased towards higher natural gas prices given the relative efficiency of its fleet compared to the market, low natural gas prices have boosted the generation output as gas-fired generation displaces coal. This level of adjusted EBITDA stability is quite unique among merchant generation companies and is usually seen for those generators that sell under long-term contracts with minimum fuel risk.

Measured Approach to Growth

Fitch has a positive view of management's measured approach to growth, which has been largely geared towards new generation that is backed with long-term power purchase agreements with credit worthy counterparties, and merchant facilities where Calpine has significant cost advantages over other new entrants. Calpine has also been an active and opportunistic buyer and seller of generation assets, monetizing non-core assets and increasing scale in core regions. Enhancements to annual capacity auctions in PJM and New England will benefit Calpine's existing dual-fuel generation fleet and support Calpine's strategy of targeting new builds and acquisitions in these regions. Fitch expects management to continue to monetize its assets in non-core regions. Any asset purchases are likely to be measured, as demonstrated by management's past actions, and will probably consist of natural gas fired assets so as to maintain the company's relatively clean environmental profile. Any large scale, predominantly debt funded acquisition is likely to put a downward pressure on ratings given the minimal headroom in credit metrics. Fitch's current view does not incorporate any major foray by Calpine into the renewable sector, such as wind and solar over the near-term.

Favorable Generation Mix

The combination of efficient natural-gas fired combined cycle plants and Geysers (geothermal) assets make Calpine's fleet cleaner than other coal heavy IPPs. Calpine's fleet is also much younger than its peers. As a result, Calpine is comparatively much less vulnerable to both existing and potential stringent environment regulations addressing greenhouse gas emissions, other air emissions including SOx, NOx, Mercury and coal ash as well as water use. For these reasons, Fitch views Calpine's business mix as relatively strong compared with other merchant generators. Over the medium to long term Calpine's dependence on natural gas could be a disadvantage given the rapid penetration and growing threat from renewables, particularly in California and Texas.

Capital Allocation Geared Toward growth and Share Repurchases

Fitch expects Calpine to generate approximately $500 million of free cash flow in 2016; annual free cash flow could increase to more than $700 million by 2017. These free cash flow estimates incorporate both maintenance and growth capex based on announced new projects. Significant covenant cushion, incremental first-lien debt capacity and robust free cash flow generation even in commodity trough affords Calpine tremendous financial flexibility to deploy capital. The pace of share repurchases has been tracking above Fitch's expectations. As of December 31, 2015, Calpine had repurchased ~$2.25 billion in stock over 2013-2015. This elevated level was, in part, driven by asset sales. Reinvestment of capital in new generation projects under long-term contracts would be viewed positively by Fitch.

Improvement in Credit Metrics

Fitch expects Adjusted Debt to EBITDAR ratio to be 6.5x in 2016 and improve to 5.5x in 2018. The improvement is driven by scheduled debt amortizations, incremental debt reduction as contemplated by management and modest improvement in EBITDA from new generation projects coming on line. FFO adjusted leverage is expected to be 6.8x in 2016 and improve to 5.7x in 2018. Coverage ratios have deteriorated somewhat in 2015 with the timing of debt issuance to finance the Granite Ridge acquisition and are likely to remain in the 2.75x - 3.25x range over 2016-2018, in line with its 'B+' credit profile.

Rating Linkages

There are strong contractual, operational and management ties between Calpine and CCFC. CCFC sells a majority of its power plant output under a long-term tolling arrangement with Calpine's wholly owned marketing subsidiary. CCFC is also a party to a master operation and maintenance agreement and a master maintenance services agreement with another wholly owned Calpine subsidiary. For these reasons, in accordance with its Parent and Subsidiary Rating Linkage Criteria, Fitch assigns the same IDR to CCFC as the parent even though its standalone credit profile is stronger.

RECOVERY ANALYSIS

Fitch values the power generation assets that guarantee the parent debt using a NPV analysis. A similar NPV analysis is used to value the generation assets that reside in non-guarantor subs and the excess equity value is added to the parent recovery prospects. The generation asset NPVs vary significantly based on future gas price assumptions and other variables, such as the discount rate and heat rate forecasts in California, ERCOT and the Northeast. For the NPV of generation assets used in Fitch's recovery analysis, Fitch uses the plant valuation provided by its third-party power market consultant, Wood Mackenzie as well as Fitch's own gas price deck and other assumptions. The NPV analysis for Calpine's generation portfolio yields approximately $1,100/kw for the geothermal assets and an average of $425/kw for the natural gas generation assets.

KEY ASSUMPTIONS

--Natural gas prices of $2.25/$2.50/$2.75 per MMBtu for 2016/2017/2018, respectively;

--Expected generation hedged per management estimates of 80%, 38% and 25% for 2016, 2017 and 2018, respectively. Hedged margin of $19/27/34 per MWh for 2016/2017/201817, respectively;

--Growth and maintenance capex of approximately $1.9 billion over 2016-18;

--No additional growth projects except those already announced and under construction;

--In absence of additional growth projects, Fitch has assumed that free cash flow generation can support approximately $300 million stock buyback program annually.

RATING SENSITIVITIES

Positive: Positive rating actions for Calpine and CCFC appear unlikely unless there is material and sustainable improvement in Calpine's credit metrics compared with Fitch's current expectations. Management's net leverage target of 4.5x effectively caps Calpine's IDR at the 'B+' category.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Weak wholesale prices due to unfavorable power demand and supply dynamics, regulatory interference and /or distortion in market pricing signals that depress Calpine's EBITDA and FFO below Fitch's expectations on a sustained basis;

--An enhanced pace of share repurchases without hitting or sustaining the stated net leverage target of 4.5x;

--An aggressive growth strategy that diverts significant proportion of growth capex towards merchant assets and/ or inability to renew its expiring long-term contracts leading to a higher open position;

--Inability to reduce its FFO adjusted leverage to below 7.0x, and total adjusted debt/EBITDAR below 6.0x over Fitch's forecast period; and

--Incremental first lien leverage and/or further deterioration in NPV of the generation portfolio that leads to downward rating pressure on the unsecured debt.

LIQUIDITY

Calpine's liquidity position is adequate. Calpine recently extended the maturity of its $1.5 billion revolver to June 2020 and increased the size by $178 million until June 2018. As of Dec. 31, 2015, Calpine had approximately $906 million of cash and cash equivalents at the corporate level and ~$1.2 billion of availability under the corporate revolver. There is no corporate debt maturity until 2019 when Calpine's first lien term loan of $800 million matures. The scheduled project debt amortizations approximate $200 million annually.

FULL LIST OF RATING ACTIONS

Fitch affirms the following with Stable Outlook:

Calpine Corp.

--IDR at 'B+';

--First Lien Term Loans at 'BB+/RR1';

--First Lien Senior Secured Notes at 'BB+/RR1';

--Revolving Credit Facility at 'BB+/RR1';

--Senior Unsecured Notes at 'BB-/RR3'.

Calpine Construction Finance Company, L.P.

--IDR at 'B+';

--First Lien Term Loans at 'BB+/RR1'.

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

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Contacts

Fitch Ratings
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Philip Smyth, CFA
Senior Director
+1-212-908-0531
or
Monica Bonar
Senior Director
+1-212-908-0579
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Philip Smyth, CFA
Senior Director
+1-212-908-0531
or
Monica Bonar
Senior Director
+1-212-908-0579
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com