Fitch Affirms Kleen Energy Systems' Ratings at 'BB'; Outlook Negative

CHICAGO--()--Fitch Ratings has affirmed at 'BB' the ratings for Kleen Energy Systems, LLC's (Kleen) $435 million ($244 million outstanding) term loan A due 2018 and $295 million ($268.4 million outstanding) term loan B due 2024. The Rating Outlook is Negative.

The Negative Outlook reflects the uncertain volatility of Kleen's cost structure and dependence on favorable operating performance to pay deferred target amortization. The project's near-term liquidity position is stabilizing, but Fitch remains concerned that further cost escalation and persistent operational failures could reduce financial performance over the long-term. Resolution of the Negative Outlook is contingent upon Kleen's actual financial performance relative to Fitch's rating case projections.

KEY RATING DRIVERS

Revenue Risk: Midrange

Fixed Price Agreements: Kleen's revenues are initially derived from fixed-price tolling and capacity agreements with investment-grade counterparties, partially mitigating price risks through 2017. The project remains subject to replacement power costs in the event of a forced outage under the tolling agreement. Kleen is vulnerable to margin risks during the post-2017 merchant period but is not entirely dependent on market-based revenues, as capacity payments alone should be sufficient to meet debt service requirements. A scheduled step-down in debt service should moderate Kleen's energy price exposure after the tolling agreement expires.

Operation Risk: Weaker

Volatile Operational History: Kleen has not yet established a stable cost profile or demonstrated a pattern of consistent operating performance. Actual costs have exceeded original projections by a wide margin, heightening the potential impact of operational underperformance. It is uncertain whether Kleen can reliably meet target availability and heat rate requirements to avoid contractual penalties and maximize revenues, based on Kleen's history of forced outages. Favorably, Kleen benefits from commercially proven technology operated and maintained by experienced O&M providers.

Supply Risk: Midrange

Low Supply Risk: Volumetric risks are minimal, as the project is situated in a highly liquid and competitive natural gas market. The tolling counterparty bears natural gas supply risks in the medium term.

Debt Structure: Midrange

Mitigated refinancing risk: Fitch believes it is likely that Kleen will fully prepay the term loan A balloon payment prior to maturity, absent persistent operational challenges. The supplemental amortization mechanism relies upon contracted revenues during the tolling period, and catch-up provisions provide some protection against temporary interruptions in cash flow. Kleen's debt structure otherwise incorporates standard terms and conditions with adequate liquidity provisions.

Financial Metrics

Weakened financial profile: Fitch-projected debt service coverage ratios (DSCRs) range between 1.25x and 1.35x during the tolling period under a Fitch rating case that considers a combination of low availability, technical underperformance, and further increases to a deteriorating cost profile. The rating is not constrained by financial performance during the merchant period, primarily due to declining debt service relative to higher projected revenues.

Peer comparison: Kleen's credit quality is consistent with that of other thermal projects in the 'BB' rating category. Comparable projects often demonstrate an uncertain cost profile, heightened operating risks, and/or elements of merchant exposure. Investment-grade projects with fully contracted output exhibit considerably stronger financial profiles with rating case DSCRs that consistently exceed 1.4x.

RATING SENSITIVITIES

Negative - Cost Volatility: Demonstration of a stable cost profile would be consistent with the rating, while further increases in costs would heighten the project's vulnerability to operating event risks.

Negative - Performance Shortfalls: Persistently low availability, repeated forced outages, or an accelerated degradation in heat rates could reduce revenue and subject the project to contractual penalties.

Negative - Inability to Refinance: In the event that an outstanding balance remains on the term loan A at maturity, market conditions and/or project-specific factors could prevent Kleen from refinancing.

SECURITY

The collateral includes a first-priority security interest in the ownership interests in Kleen, all real and personal property, including Kleen's rights under the project documents, the project accounts, and all revenues.

TRANSACTION SUMMARY

Kleen's financial performance has improved over the past six months, allowing the project to accumulate liquidity sufficient to fully repay its $16 million working capital facility loan on the December 31st debt service payment date. Kleen estimates an annual DSCR of 1.05x for YE 2014 and expects to catch up on deferred target amortization in early 2015, assuming the facility experiences no further technical issues. Thus, Kleen's annualized DSCR will likely exceed breakeven despite elevated operating costs and a revenue reduction of 26% year-over-year.

The project will not have cash on hand adequate to pay deferred target amortization and will be unable to pay the next installment of target principal on December 31st. Kleen's 2015 budget indicates that the project should have enough excess cash flow to fully repay the projected $11.6 million of accumulated Term Loan A deferrals in the first half of 2015. Fitch's evaluation of Kleen's refinance risk is contingent upon satisfaction of target amortization requirements, which remain manageable relative to projected cash flow even taking into account currently stressed conditions.

Kleen has triggered a negative covenant under the credit agreement that includes a 1.1x DSCR threshold on a rolling four quarter basis. Lenders have thus far waived two consecutive technical defaults, and Kleen believes that a third technical default will be waived on the upcoming debt service payment date. Fitch views the technical defaults as credit neutral events absent lender exercise of remedies. Absent any operational issues and inclusive of the current elevated cost profile, Kleen projects that the 2015 DSCR would improve to 1.36x.

Operational performance is currently favorable, as Kleen has maintained availability of nearly 100% since June (excepting a planned October outage). Fitch considers the financial impact of the Q1 2014 turbine outages resolved, though Kleen expects to receive approximately $3 million of insurance proceeds in the near term. The project has operated with relatively high utilization for the fall season, and heat rates remain well below contractual requirements.

Kleen's long-term cost profile remains uncertain, and Fitch will reevaluate its financial projections once YE 2014 financial information is available. Fitch's projections will consider recent increases in insurance premiums, Connecticut Gross Receipts Tax payments, and Regional Greenhouse Gas Initiative (RGGI) costs. Favorably, Fitch understands that Kleen will pay lower fees under the Long Term Services Agreement with Siemens Energy Inc.

Kleen is a special-purpose company created to own and operate the project, which consists of a 620-megawatt combined-cycle electric generating facility located near Middletown, CT. Kleen sells capacity under a 15-year agreement with Connecticut Light & Power (Fitch IDR 'BBB+' with a Stable Outlook). Exelon Generation Company (ExGen, IDR 'BBB+' with a Negative Outlook) purchases the facility's energy output under a seven-year tolling agreement. Exelon Corp. (IDR 'BBB+' with a Negative Watch), ExGen's parent, has partially guaranteed ExGen's contractual obligations.

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

Applicable Criteria and Related Research:

--'Rating Criteria for Infrastructure and Project Finance' (July 12, 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=950295

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Contacts

Fitch Ratings
Primary Analyst
Christopher Joassin
Director
+1 312-368-3166
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Andrew Joynt
Associate Director
+1 415-732-5622
or
Committee Chairperson
Gregory Remec
Senior Director
+1 312-606-2339
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Christopher Joassin
Director
+1 312-368-3166
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Andrew Joynt
Associate Director
+1 415-732-5622
or
Committee Chairperson
Gregory Remec
Senior Director
+1 312-606-2339
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com