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Rating Action:

Moody's affirms Covanta's ratings; Assigns Ba3 rating to senior unsecured notes; outlook stable

08 Mar 2012

Approximately $2.46 billion of debt securities and credit facilities affected

New York, March 08, 2012 -- Moody's Investors Service affirmed the ratings of Covanta Holdings Corporation (Covanta), including its Corporate Family Rating (CFR) and Probability of Default Rating at Ba2, and assigned a Ba3 rating to CVA's planned issuance of senior unsecured notes. Concurrent with this rating action, Moody's affirmed Covanta's senior unsecured notes at Ba3, its speculative grade liquidity rating at SGL-1, and assigned a Ba1 rating to the planned $900 million secured revolver and $300 million secured term loan to be issued by Covanta Energy Company (CEC), a Covanta subsidiary. The rating outlook for Covanta and CEC remains stable.

RATINGS RATIONALE

Today's rating action recognizes the continuation of relatively consistent credit metrics supported by a diversified, largely contracted portfolio of energy-from-waste (EfW) projects principally located throughout the US. The rating incorporates the strong operating performance of the portfolio and the relatively high barriers to entry for most competing technologies. These strengths are mitigated by the highly leveraged capital structure that remains in place as well as the degree of structural subordination that exists at the Covanta level. About $672 million of secured project level debt is senior to holding company debt at CEC and at Covanta. In most cases, documentation in the project level debt agreements includes a restricted payments test which must be satisfied in order for upstream dividends to be paid to CEC and Covanta.

The rating recognizes that a large portion of Covanta's project level debt has amortized over the past five years and such debt repayment will continue based upon the terms and conditions in the project documents. Moody's calculates that since 2007, about $564 million of project level debt has been repaid and through FYE 2013, 41% of the remaining project level debt or $275 million will amortize. While such amortization represents a sizeable required call on cash flow over that period, the debt repayment profile reduces the degree of structural subordination and strengthens overall credit quality. Covanta's current Ba2 CFR incorporates our view that such debt amortization will likely be replaced by additional project or corporate level debt to finance new development projects and/or acquisitions. To that end, we observe with the completion of refinancing contemplated in today's announcement, corporate level funded debt at the Covanta and CEC level will amount to $1.56 billion or nearly 70% of the consolidated company. We further observe that even with the substantial project debt amortization, the majority of the company's cash flow continues to be sourced by subsidiaries that still have project level debt.

The rating action further acknowledges this week's announcement of a 100% increase in the Covanta common dividend to 0.60 cents / share or approximately $80 million annually along with board authorization of an additional $100 million in share repurchases to be added to the existing share repurchase program. Moody's calculates that in the last two years, Covanta has utilized free cash flow and a portion of asset sales proceeds to repurchase $324 million of Covanta common stock and pay dividends of $265 million, including the one-time $233 million dividend in 2010. Moody's also observes that the new dividend level will, on an annualized basis, represent a very high payout ratio relative to the company's historical GAAP net income and management's 2012 earnings guidance of 0.55-0.65/share. While the implementation of high dividend payout ratio plus the authorization to increases share repurchases are not positive factors to credit quality and will weaken the balance sheet, we calculate that the new dividend level will represent about 50% of expected free cash flow in most years, when one factors in the mandatory repayment of project level debt as a use of cash. Moreover, we believe that the pace at which common shares will be repurchased will depend in large part on the success that the company may have in securing future development projects. In light of the highly contracted nature of Covanta's business, which we believe will not change appreciably in the future, we believe that this level of dividend can be sustained while maintaining the current "Ba" rating category.

Covanta's financial metrics remain fairly stable and well-positioned in the "Ba" rating category for unregulated power companies. For example, for the three period 2009-2011, cash flow (CFO-preW/C) to debt averaged 15.2%, retained cash flow to debt 12.3%, and free cash flow to debt 8.0% while cash flow interest coverage ratio remained consistent at around 4.0x. Prospectively, we believe that Covanta should be able to generate similar credit metrics over the next several years due to the high degree of contractual revenue coupled with the firm's unique competitive position, which has very high barriers for entry.

Covanta`s speculative grade liquidity rating of SGL-1 is driven by our expectation that the company will maintain a very good liquidity profile over the next 4 quarters as a result of its generation of strong internal cash flows, continuance of cash balances and access to committed credit availability. At December 31, 2011, Covanta had approximately $232 million of unrestricted cash, although we understand that more than half of this cash remains invested in non-US accounts to be used for investment in future international development projects. In addition to the cash on hand, at year-end 2011, Covanta had access to availability of around $343 million under two credit facilities that expire in 2013 and 2014. We understand that Covanta is in the process of replacing these two facilities with a new $900 million revolving credit facility (rated Ba1) due 2016. Moody's intends to withdraw the existing Ba1 ratings on the two existing credit facilities upon execution of the larger revolver. As of December 31, 2011, Covanta was comfortably in compliance with the financial covenants under its credit facilities.

For the next twelve months, Covanta has $144 million in required project debt maturities. We understand that at 12/31/2011 Covanta had $125 million in restricted cash available for debt service. The next large debt maturity at Covanta is the $460 million of senior notes due in June 2014.

Net proceeds from the note offering will be primarily used to partially refinance a $619 million secured term loan at CEC due 2014. The secured CEC term loan will be fully retired with the planned completion of a new $300 million CEC term loan due 2019. Moody's intends to withdraw the rating on the existing $619 million CEC term loan when the refinancing is completed. The new Covanta unsecured notes will rank pari-passu with all present ($860 million) and future senior unsecured indebtedness of Covanta and will be structurally subordinate to indebtedness of CEC and to the approximate $672 million of project level debt.

The stable outlook on Covanta's rating reflects Moody's expectation that: (i) the EfW projects' contracts with the respective municipalities and utilities will remain in place through their current maturities and that the company will continue to have success extending the terms on expiring EfW contracts; (ii) Covanta's management will continue to operate the plants at high availability levels and maintain stability with regard to administrative, operating, and maintenance expenses; and (iii) Covanta will finance its development projects, acquisitions, and future shareholder return strategies in a manner neutral to credit quality.

Upward rating pressure could surface if Covanta successfully extends its contracts on favorable terms, and finances new development in a reasonably conservatively fashion leading to some de-levering and resulting in a financial improvement such that cash flow to debt exceeds 18% and cash flow coverage of interest expense exceeds 4.5x on a sustainable basis.

The ratings could be lowered if the company significantly increases leverage to finance an acquisition or return capital to shareholders; if several projects are subject to unforeseen capital expenditure requirements, particularly with regard to environmental regulatory compliance; if several key projects have extended outages; resulting in a decline in key financial metrics including the ratio of cash flow to debt falling below 12% and cash interest coverage declining to below 3.0x for an extended period.

Ratings Affected Include:

Ratings Affirmed :

..Issuer: Covanta Holding Corporation

...Corporate Family Rating at Ba2

...Probability of Default Rating at Ba2

...Speculative Grade Liquidity Rating at SGL-1

Rating Assigned

..Issuer: Covanta Holding Corporation

Senior Unsecured Conv./Exch. Bond/Debenture, Assigned Ba3 (75 - LGD5)

..Issuer: Covanta Energy Corporation

Senior Secured Term Loan and Revolving Credit Facility, Assigned Ba1 (23 --LGD2)

Ratings Affirmed / LGD assessments revised:

..Issuer: Covanta Holding Corporation

Senior Unsecured Conv./Exch. Bond/Debenture to Ba3 (75 - LGD5) from Ba3 (81 - LGD5)

..Guarantor: Covanta ARC LLC

....Niagara County Industrial Devel. Agency, NY, Series 2001 IRBs at Baa2 (LGD1, 1% from LGD2, 10%)

....Delaware County Industrial Dev. Auth., PA, Series 1997-A IRBs at Ba1 (LGD3, 32% from LGD2, 29%)

....Connecticut Resources Recovery Authority, Ser. A and Ser. 1992 A IRBs at Ba1 (LGD3, 32% from LGD2, 29%)

The methodologies used in these ratings were Unregulated Utilities and Power Companies published published in August 2009, and Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Headquartered in Morristown, NJ, Covanta is primarily an owner and operator of Energy-from-Waste (EfW) and renewable energy projects. During 2011, operating revenues was approximately $1.6 billion.

REGULATORY DISCLOSURES

Although these credit ratings have been issued in a non-EU country which has not been recognized as endorsable at this date, the credit ratings are deemed "EU qualified by extension" and may still be used by financial institutions for regulatory purposes until 30 April 2012. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare each of the ratings are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entities, obligations or credits satisfactory for the purposes of issuing these ratings.

Moody's adopts all necessary measures so that the information it uses in assigning the ratings is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

A.J. Sabatelle
Senior Vice President
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

William L. Hess
MD - Utilities
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's affirms Covanta's ratings; Assigns Ba3 rating to senior unsecured notes; outlook stable
No Related Data.
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