News Column

Fitch Places Kleen Energy Systems on Rating Watch Negative

June 27, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has placed the following Kleen Energy Systems, LLC (Kleen) debt on Rating Watch Negative:

--$435 million ($267.9 million outstanding) term loan A due 2018 'BB';

--$295 million ($272.5 million outstanding) term loan B due 2024 'BB'.

Prior to today's rating action, the Rating Outlook was Negative.

The Negative Watch reflects the potential for further operational disruptions or cost volatility to exacerbate deficiencies in project liquidity over the short term. Kleen's inability to repay its outstanding working capital facility loan or deferred target amortization in a timely manner as a result of weak operating cash flow could result in additional borrowing. Fitch remains concerned that the uncertain volatility of Kleen's cost structure and persistent operational failures could reduce financial performance over the long-term. Resolution of the Watch is dependent upon further clarification of Kleen's cost profile and demonstrated progress toward repayment of the working capital facility loan.

KEY RATING DRIVERS

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. (Revenue Risk: Midrange)

Lack of Operational History: Kleen has not yet established a stable cost profile or demonstrated a pattern of consistent operating performance. Fitch anticipates that actual costs will exceed original projections by a wide margin, heightening the potential impact of operational underperformance going forward. 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. (Operation Risk: Weaker)

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. (Supply Risk: 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. (Debt Structure: Midrange)

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

Cost Stability: 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.

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.

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.

CREDIT UPDATE

Revenues fell far below Fitch's expectations following two severe forced outages in the first quarter of 2014. Kleen was forced to draw $16 million under its working capital facility and forgo $5.8 million of target amortization payments, as operating cash flow was insufficient to meet the first two payments of scheduled debt service. Kleen has resolved the technical problems and the facility recently resumed normal operations.

A severe outage of the steam turbine resulted in approximately $25 million of lower revenue due to tolling agreement penalties and an additional $3 million of repair costs. The market-based penalties were especially onerous due to the extreme winter weather during the outage. The entire facility was shut down between December 23rd and February 4th, when Kleen took the steam turbine offline following several weeks of unusual vibrations. The steam turbine has operating normally since the repairs were completed.

In a separate incident, one of the combustion turbines caught fire and was taken out of service on February 12th. Kleen estimates approximately $6 million of lost net revenue due to the timing of the outage. The other combustion turbine, which has not demonstrated any technical problems and the steam turbine, remained fully operational during the outage. Insurance has thus far paid for the repairs, which Kleen believes have permanently resolved the issue. The combustion turbine was placed back into service at full load on June 7th.

Fitch believes that, assuming no further operational disruptions, Kleen may have sufficient financial capacity to repay the working capital facility loan and remain current on debt service through the end of the year. It is unlikely that Kleen will make target amortization payments until 2015. Fitch expects the 2014 DSCR could range between 1.0x and 1.2x taking into consideration repair costs, insurance reimbursements, additional interest costs and repayment of the working capital loan.

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 CL&P. Exelon Generation Company (ExGen, Fitch IDR 'BBB+' with a Negative Watch) purchases the facility's energy output under a seven-year tolling agreement. Exelon Corp. Fitch 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' (June 17, 2013).

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=710786

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=836972

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.



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, New York

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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