Fitch Affirms Choctaw Generation LP, LLLP's $294.9MM Lessor Notes; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed Choctaw Generation Limited Partnership, LLLP's (CGLP) combined $294.9 million of pari passu lessor notes as follows:
--$235.9 million ($226.3 million outstanding) series 1 lessor notes due December 2031 at 'B', Outlook Stable;
--$59 million ($69.4 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 efforts to improve its operational profile. 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 Yet to Achieve Expected Performance - Operation Risk: Weaker
The owner-lessor, a subsidiary of Southern Company (Southern), funded substantial modifications to improve plant performance. The operator, also a Southern subsidiary, is considered strong but the facility has not yet achieved expected operating performance following completion of 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.
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.
SUMMARY OF CREDIT
Owner-lessor SE Choctaw has made significant progress on the essential projects and the baghouse retrofit. Given that the projects have been completed within budget, SE Choctaw has added some minor additional-scope projects to further improve facility efficiency and performance. However, operating performance since completion of the modifications has not yet met expectations. Turbine performance testing measured below guaranteed limits, the baghouse retrofit has not met specifications for bag wear and mechanical reliability, and the project suffered several outages due to refractory failure. The operator plans to resolve these issues through warranty claims and further repairs during the spring 2016 outage.
Overall, project performance has been mixed in 2015. The equivalent availability and capacity factors, at 88.8% and 85%, respectively, through August, are both below rating-case expectations of 94% and 86%. However, the project heat rate has met expectations at just under 11,000 Btu/kWh. The operator expects to further improve reliability, as outstanding issues are resolved, and has not changed its long-term expectation for operations.
Although operating performance has been lower-than-expected in 2015, the capacity factor increased significantly from the 2014 level of 64%, as there are no further outages planned to implement plant modifications. This facilitated a significant increase in capacity revenue, while operating costs have stayed steady. The six-month debt service coverage ratio (DSCR) based on the June 2015 payment reached 1.74x, compared with 2014's annual DSCR of 1.25x. Series 2 payments are being deferred through a mandatory payment-in-kind (PIK) feature through 2017.
Fitch anticipates operational performance will eventually meet management's expectation and has not altered the base- and rating-case assumptions. However, the lack of any dedicated debt service reserve fund heightens vulnerability to a shortfall in expected performance. Furthermore, CGLP is already behind on the funding schedule for its series 2 retained cash flow account. The 'B-' rating considers the potential for deferred series 2 payments, though continued 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 notes were restructured to reduce interest rates, extend the debt term, and introduce a PIK feature to series 2. 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.