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Rating Action:

Moody's assigns Ba3 to Covanta's $400 million unsecured bonds offering; outlook stable

20 Feb 2014

Approximately $400 million of debt affected

New York, February 20, 2014 -- Moody's Investors Service today assigned a Ba3 rating to Covanta Holdings Corporation's (Covanta) planned issuance of approximately $400 million in senior unsecured bonds due 2024. Concurrent with this rating action, Moody's affirmed all of Covanta's remaining ratings, including its Corporate Family Rating (CFR) and Probability of Default Rating at Ba2 and Ba2-PD respectively, as well as its speculative grade liquidity rating at SGL-1. The rating outlook for Covanta is stable.

The proceeds from this transaction are to be used to repay approximately $460 in convertible senior unsecured notes due June 2014. These convertible notes are not callable prior to their stated June 1, 2014 maturity. In the interim, proceeds will be utilized to pay down any outstanding amounts on the revolver with the balance held as cash. Upon maturity of the convertible notes, Covanta will use the remaining proceeds along with additional borrowings on their revolver to fund that redemption.

RATINGS RATIONALE

Covanta's Ba2 CFR reflects the continuation of relatively consistent cash flow and credit metrics supported by a portfolio of Energy-from-Waste (EfW) projects, the majority of which are underpinned by intermediate and long-term contracts with credit-worthy counterparties. This rating also considers Covanta's successful track record in continuing to lengthen the duration of its contract portfolio through contract extensions; approximately 1.5 million tons of waste contracts were extended with average terms of five years during 2013. While contract relative tenors have shortened, they still provides highly visible and dependable sources of operating income for the intermediate-term. The rating also incorporates the strong operating performance across the portfolio and the high barriers to entry for most competing technologies. These strengths are mitigated by relatively shorter tenor contracts at less favorable terms, an increasing exposure to weak wholesale energy markets, a levered capital structure, an aging fleet with increasing operating expenses, and persistent challenges to grow the business.

The rating actions acknowledge the credit benefits to Covanta by further extending their debt maturity profile for the foreseeable future. Upon repayment of the senior unsecured convertible notes on June 1st, Covanta's next significant maturity is a $900 million senior secured revolving credit facility due 2017; however, Covanta is expected to amend and extend the maturity on the revolver until 2019, in line with the $300 million term loan due in the same year, a credit positive as Covanta will not have any significant maturities for five years. While we continue to acknowledge management's successful historical track record in contract extensions, continued uncertainty surrounding future contract extensions and an increasing exposure to the wholesale energy markets over the next five years are potential constraints on the ratings.

Approximately 7.6 million tons of waste contracts (39% of total waste processed in 2013) are expiring through 2018, including approximately 2.3 million tons under service fee contracts at facilities that Covanta owns. These contracts are expected to convert to Tip Fee contracts upon expiration which provides Covanta with revenues from the energy produced and sold. As a result, these contract conversions, coupled with expiring purchase power agreements, are expected to increase Covanta's exposure to the wholesale power markets by a factor of at least 4 times over the next four years. Specifically, in 2013, Covanta sold around 5.4 million megawatt hours (MWh) of energy in North America, with about 1 million MWh or 18% sold at spot prices into the wholesale markets. In 2018, Covanta expects to sell approximately 6.6 million MWh in total with approximately 4.7 million MWh or 70% exposed to spot market pricing.

While the company is expected to continue to employ a 3-year hedging program to mitigate their increasing exposure to the spot market, their vulnerability to an already soft wholesale power market further reduces visibility on future cash flows from energy, a credit negative. However, in the near-term, we are confident they have enough waste and energy revenues contracted to remain comfortably within their "Ba" rating category.

Since 2009, Covanta has reduced project level debt by approximately75% to $236 million at year-end 2013, but consolidated debt has in fact remained fairly constant at approximately $2.3 billion. As expected and incorporated in the "Ba" CFR, Covanta has replaced the amortizing project debt with corporate level debt. On a positive note, Covanta's creditors benefit from this transition as the level of structural subordination that now exists in the capital structure has been substantially reduced. By the end of 2015 and assuming that no new project finance debt is incurred, project level debt will be reduced to $145 million or about 6% of Covanta's current balance sheet. That being said, cash flow coverage is expected to weaken and become more volatile given the change in the makeup and tenor of the company's contracts and its increased exposure to the power markets.

Financial metrics remain reasonably well positioned in the "Ba" rating category for unregulated power companies. Specifically, for the three-year period 2011-2013, their cash flow (CFO-preW/C) to debt averaged approximately 14.3%, retained cash flow (RCF) to debt averaged 11.5%, free cash flow (FCF) to debt averaged 4.4% while the cash flow interest coverage ratio averaged 3.3x. However, Covanta recorded slightly lower metrics in 2013 with cash flow to debt of approximately 13.8%, RCF to debt of 10% , FCF to debt of -0.5%, and cash flow interest coverage at 3.1x. The decline can be attributed primarily to increased maintenance capital expenditures (capex) and operating expenses caused by unplanned outages, as well as decreased earnings as a result of contract expirations and renewals since 2012. Prospectively, we expect Covanta's metrics to remain at these lower levels for the near-to-intermediate term as the company continues to renegotiate expiring contracts and seeks new growth opportunities. However, due to the high degree of contractual revenue coupled with the firm's unique competitive position, which has very high barriers for entry, Covanta will remain well-positioned in the "Ba" category.

For more information on Covanta, please refer to the most recent Credit Opinion, which can be found on moodys.com.

Covanta`s 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. However, the company's free cash flows are expected to be constrained during 2014 as a result of increased maintenance expense and capex spending. At December 31,2013, Covanta had approximately $198 million of unrestricted cash, although we understand that 87% is invested in non-US accounts to be used for future international investment. In addition to the cash on hand, Covanta had access to availability of around $519 million under their $900 million credit facility. During fiscal year 2014, we understand that Covanta has $54 million in required project debt maturities due, a portion of which has been funded with restricted cash available for debt service. As of December 31, 2013, Covanta was comfortably in compliance with the financial covenants under its credit facilities.

The stable outlook on Covanta's rating reflects Moody's expectation that: (i) the EfW project 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 albeit at lower prices and shorter tenors; (ii) Covanta will manage its increasing exposure to the wholesale energy markets in a manner that provides cash flow visibility and stability; and (iii) Covanta's management will continue to operate the plants at high availability levels and maintain stability with regard to operating and maintenance expenses.

A rating upgrade is unlikely in the near-term in light of depressed key financial metrics, uncertainty surrounding contract extensions and increased exposure to wholesale energy markets. However, upward rating pressure could surface if Covanta successfully extends its contracts on favorable terms, finances new growth or development in a reasonably conservative fashion leading to some de-levering and 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 Covanta is unable to renew or extend its EfW project contracts at competitive terms; if the increasing exposure to energy markets hurts earnings, if leverage is significantly increased to finance an acquisition or return capital to shareholders; or 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.

Assignments:

..Issuer: Covanta Holding Corporation

....Senior Unsecured Regular Bond/Debenture, Assigned Ba3, LGD5, 79 %

Outlook Actions:

..Issuer: Covanta Energy Corporation

....Outlook, Remains Stable

..Issuer: Covanta Holding Corporation

....Outlook, Remains Stable

Affirmations:

..Issuer: Connecticut Resources Recovery Authority

....Senior Unsecured Revenue Bonds Nov 15, 2015, Affirmed Ba1

....Senior Unsecured Revenue Bonds Nov 15, 2015, Affirmed Ba1

....Senior Unsecured Revenue Bonds Nov 15, 2022, Affirmed Ba1

..Issuer: Covanta Energy Corporation

....Senior Secured Bank Credit Facility Mar 28, 2017, Affirmed Baa3, LGD2, 14 % from a range of LGD2, 13 %

....Senior Secured Bank Credit Facility Mar 28, 2019, Affirmed Baa3, LGD2, 14 % from a range of LGD2, 13 %

..Issuer: Covanta Holding Corporation

.... Probability of Default Rating, Affirmed Ba2-PD

.... Speculative Grade Liquidity Rating, Affirmed SGL-1

.... Corporate Family Rating, Affirmed Ba2

....Multiple Seniority Shelf Dec 14, 2014, Affirmed (P)B2

....Multiple Seniority Shelf Dec 14, 2014, Affirmed (P)Ba3

....Senior Unsecured Conv./Exch. Bond/Debenture Jun 1, 2014, Affirmed Ba3

....Senior Unsecured Regular Bond/Debenture Oct 1, 2022, Affirmed Ba3

....Senior Unsecured Regular Bond/Debenture Dec 1, 2020, Affirmed Ba3

..Issuer: Delaware County Industrial Dev. Auth., PA

....Senior Unsecured Revenue Bonds Jul 1, 2019, Affirmed Ba1

..Issuer: Massachusetts Development Finance Agency

....Senior Unsecured Revenue Bonds Nov 1, 2027, Affirmed Ba2, LGD3, 46 % from a range of LGD3, 45 %

....Senior Unsecured Revenue Bonds Nov 1, 2042, Affirmed Ba2, LGD3, 46 % from a range of LGD3, 45 %

....Senior Unsecured Revenue Bonds Nov 1, 2042, Affirmed Ba2, LGD3, 46 % from a range of LGD3, 45 %

..Issuer: Niagara Area Development Corporation

....Senior Unsecured Revenue Bonds Nov 1, 2042, Affirmed Ba2, 46 % from a range of LGD3, 45 %

....Senior Unsecured Revenue Bonds Nov 1, 2024, Affirmed Ba2, 46 % from a range of LGD3, 45 %

The methodologies used in these ratings were Unregulated Utilities and Power Companies published in August 2009. Other methodologies used include 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. At year-end 2013, Covanta reported operating revenues that approximated $1.6 billion.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain 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 certain 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 certain 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

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.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Lesley Ritter
Analyst
Corporate 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 assigns Ba3 to Covanta's $400 million unsecured bonds offering; outlook stable
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