OREANDA-NEWS. S&P Global Ratings said today that it affirmed its 'CCC' corporate credit ratings and all issue-level ratings on GenOn Energy Inc. and its affiliates: GenOn Energy Holdings Inc., GenOn Americas LLC, GenOn Mid-Atlantic LLC, and GenOn REMA LLC. The outlook remains negative. Our corporate credit rating on GenOn is consistent with our corporate criteria for 'CCC' ratings. The rating is based on our assessment of the company's liquidity burn rate and the likelihood of a potential default--or distressed exchange--within the next nine months. As of June 30, 2016, we estimate that GenOn had about $2.6 billion of on-balance-sheet debt and just over $1 billion (present value) of off-balance-sheet operating leases at GenOn Mid-Atlantic LLC (GenMA) and GenOn REMA LLC. (Against these, about $680 million of pass-through certificates are outstanding.) GenOn's credit profile has deteriorated following a progressively weaker forward power curve because of depressed natural gas prices as well as lower gross margins due to stagnating demand and milder weather patterns. These factors have resulted in an accelerated weakening of GenOn's financial measures. While PJM Interconnections' capacity performance base and incremental auction results bolster margins somewhat, they do not fully offset the energy margin compression, and the most recently cleared auctions do not meaningfully take effect until 2019. This leads us to place more emphasis on the company's liquidity profile, which is increasingly tenuous. Although we estimate that the company currently has over $1.05 billion of cash on hand and about $285 million under its revolver, GenMA and REMA have about $200 million of lease payments through July 2017. Also, the company faces a $725 million maturity ($690 million outstanding) at GenOn Energy in June 2017 amid weaker cash flows. GenOn also has large maturities in 2018. We believe that GenOn would not likely have ready access to capital markets under similar market conditions, resulting in a less than adequate liquidity assessment, despite sources exceeding uses over the next year. We believe that GenOn is vulnerable under the current forward curve to default prospects that exceed a 50% likelihood, which results in the negative outlook. GenOn's longer-term prospects appear unsustainable without favorable business, financial, and economic conditions. We also see the prospects of a distressed exchange as increasingly likely. According to our criteria, if an issuer credit rating is 'B-' or lower, we would ordinarily view an exchange as distressed and, hence, as a de facto restructuring. We assess GenOn purely on the merits of its stand-alone credit profile (SACP), with no enhancement from parent NRG Energy Inc., as we continue to consider GenOn non-strategic to NRG. GenOn's stand-alone vulnerable business risk profile has weakened further due to shifting pricing differentials that have caused power prices to decline during the past year. For GenOn's Midwest and Mid-Atlantic power plants, this has meant declining profitability and a significantly backwardated EBITDA profile, as high-priced legacy hedges have rolled off. We estimate GenOn's 2016 and 2017 base-load generation to be hedged at about 70% and 54%, respectively. We flag significant backwardation in its EBITDA from 2016 onward, and we believe that the company will have difficulty hedging at competitive prices beyond 2016. We estimate GenOn's EBITDA to be about $425 million in 2016 if power prices stay at current levels, but this is significantly lower than in 2015. Also, our current estimate of 2016 EBITDA is higher than our estimate in February 2016. While the forward curve has risen somewhat, the increase in EBITDA is also because counterparties that provided financial hedges for 2017 and 2018 have paid GenOn to unwind those hedges and reduce exposure to the company. This has resulted in an increase in EBITDA for 2016 but will result in lower EBITDA in future years. We expect some improvement in margins from the improvement in the PJM Interconnection market's incremental capacity prices, higher capacity price expectations in future base residual auctions, and upward pressure on natural gas prices. However, we still expect margins to compress because GenOn cannot hedge its generation at historical prices. Despite the company's announcement of cost-cutting measures and better-than-expected asset-sale proceeds, we expect negative funds from operations (FFO) from 2017. We view GenOn's stand-alone financial risk profile as highly leveraged, reflecting our expectation of weaker operating cash flows resulting from several plant closures and declining spark spreads as natural gas prices trend lower. Although GenOn has gas-fired assets that should pick up capacity factors when natural gas prices are low, much of its natural gas-fired portfolio of plants consists of mid-merit and peaking units that do not generate significant spark spreads (as they are not as efficient as average regional gas-fired plants) and which are exposed to variability in capacity pricing. We expect financial performance to weaken, even if forward prices continue to hold. On a consolidated basis, we expect adjusted FFO to debt to become negative in 2017 following a decline to about 2% in 2016 from about 16% in 2014. As a result of lower margins, cash continues to be trapped at the REMA and GenMA levels (these entities have a 12-month backward-looking and a 24-month forward-looking fixed-charge test at 1.7x). We project GenOn REMA's fixed-charge coverage ratio (FCCR) to be modestly above 1x through 2018 (excluding capex spending). However, without any adjustment to the shared service charge allocation, GenMA's FCCR will likely decline below 1x by 2017 under the current forward prices. We consider GenOn, and its subsidiaries, to be nonstrategic to parent NRG. Within the GenOn group, we consider all entities core to parent GenOn. The negative outlook reflects the continuing pressure on financial measures, which we believe will weaken further. While we do not expect a default in 2016 because of significant cash balances, the negative outlook also reflects the prospects that GenOn might consider distressed exchange offers over the next six months given the price decline in its debt issues. The negative outlook also factors in the $725 million maturity in June 2017, which puts additional pressure on the company to restructure. Even absent a restructuring or distressed exchange, we anticipate that within the next year, the issuer could face an inevitable default in the form of an inability to refinance 2018 maturities, which would be commensurate with a 'CC' rating.

Downside scenarioConsistent with our criteria, we see the probability of a downgrade to 'CCC-' as likely by year-end because we see increasing probability of the company defaulting prior to, or by, June 2017, when it faces a large refinancing. The ratings are not currently 'CCC-' because we do not see a distressed exchange as inevitable over the next six months. GenOn's downside risks stem from the backwardated cash flow profile as hedges fall away in 2016 under the prevailing forward prices. We expect GenOn to be disproportionately affected relative to peers, as the loss in dark spreads is not offset by increasing spark spreads or an expansion in market heat rates. We would downgrade GenOn on announcement of any distressed exchange.

Upside scenarioThough unlikely, we could revise the outlook to stable if potential asset sales mitigate liquidity needs to address 2017 maturities and the forward power prices improve such that GenOn can maintain an adjusted FFO to debt ratio of about 4%-5%. An upgrade, currently not under consideration, could occur if a rebound in capacity and energy markets auctions supports the operations of its coal plants or if environmental regulations are not as stringent as we expect. In particular, we will monitor the hedges that the company is able to place to underpin its financial performance. However, an upgrade would require FFO to debt ratios that are consistently over 5%.