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Rating Action:

Moody's assigns a first time Ba3 rating to St. Joseph Energy Center, LLC's senior secured credit facilities; outlook stable

22 Mar 2018

Approximately $449 million of credit facilities affected

New York, March 22, 2018 -- Moody's Investors Service, ("Moody's") assigned a Ba3 rating to St. Joseph Energy Center, LLC's $407.7 million senior secured term loan and $41 million revolving facility maturing in April 2025 and April 2023 respectively. The rating outlook is stable.

Proceeds from the secured term loan will be used to refinance an existing construction loan with no equity distribution, and the $41 million revolving facility will be utilized for committed project LCs and the DSR LC with a $7.9 million sublimit for working capital purposes.

RATINGS RATIONALE

The Ba3 rating on the $407.7 million senior secured term loan and $41 million revolving facility, together the credit facilities, of St. Joseph Energy Center, LLC (SJEC) reflect the anticipated substantial completion by March 24th of a brand new, highly efficient and competitive combined cycle gas turbine power plant, SJEC (or the project), expected to serve as a base load unit in PJM. The Ba3 rating factors in the known capacity revenues through May 2021 derived from past PJM base residual auctions as well as transparency into future revenues which collectively provide up to three years of some revenue visibility. The Ba3 rating further acknowledges the existence of a revenue put which provides downside protection to the project from weak energy margins. Together, we calculate that these two sources of revenue provide more than 50% of gross margin in most years. The rating recognizes the cost competitive position of the asset relative to other generation resources in PJM providing it with the potential for sustained high capacity factors and meaningful energy margins over the life of the transaction. The rating factors in the achievement of substantial completion as a requirement for financial close, our comfort level with the track record associated with the plant's technology, the quality of the counterparties that will provide service to SJEC, particularly the project's reliance on affiliates of Siemens AG (Siemens: A1 stable) and a suite of warranty protections intended to mitigate ramp-up risk. Given the expected dispatch profile of the plant, financial performance is highly dependent upon the robustness and volatility of the PJM merchant energy market which will be influenced by several factors including the demand for electricity, expected plant retirements, including coal-fired generation, and anticipated plant additions throughout the region.

Operating and Financial Profile

SJEC is expected to receive about $82 million of capacity revenues through May 2021 from capacity cleared in PJM's base residual auction, representing around 52% of cash flow available for debt service (CFADs) for the period, per Moody's calculations. Importantly, in order to mitigate risks associated with capacity performance penalties from PJM, the project has contracted for firm natural gas supply and transportation, a credit positive. Natural gas transportation is contracted via the Vector pipeline for 90,400 MMBtu/day under a long-term agreement, and the residual transportation capacity will be secured by DTE from their transportation rights on the pipeline. Additional gas supply will be made available to the project and the region through Vector's interconnection with the Nexus and Rover pipelines which are expected to be completed later this year, providing cheaper gas from the Marcellus/Utica shales. The five-year gas supply agreement for 120,000 MMBtu/day with DTE is indexed to the MichCon price hub which has historically traded at small discounts to Henry Hub. However, the market consultant indicates that at least 68% of natural gas power plants in the AEP-Dayton region source gas from the Dominion-South hub and others, which trade at even greater discounts to Henry Hub versus MichCon and will also benefit from the cheaper gas. As such, while SJEC is more efficient than most of the existing gas power plants in the pricing region, its fuel costs are higher than other natural gas plants, which will somewhat narrow SJEC's competitive advantage.

That said, the project is expected to benefit from higher sparks spreads or wider margins in this continuing environment of low natural gas prices given the large number of coal power plants remaining within the AEP-Dayton region where SJEC is expected to dispatch, and where coal is still on the margin primarily during peak hours. Further, the market consultant anticipates that a number of coal retirements in both PJM and MISO will occur which will positively impact the supply/demand balance in the region benefitting SJEC over the medium to long term. There are at least 7.8 gigawatts (GWs) of firm retirements based on filed deactivation notices in the 2018-2020 period. However, there are also 13.8 GWs of new builds, primarily fueled with natural gas, entering the system in the same period resulting in an over-supply dynamic that is not expected to dissipate in the short-term, and likely to be a factor in near term capacity price auctions and in energy margins.

SJEC benefits from a revenue put with an affiliate of BP plc (A1 positive) which provides an energy margin and ancillary revenues' floor of around $30 million per year over the next five years starting in September 2018. Through the mechanics of the agreement which settles quarterly and trues-up annually, the revenue put will likely be triggered in the event spark spreads or margins decline to around $6.50/MWh versus the $9-10/MWh observed during 2017 (before nodal discounts). However, we note that it is possible that the revenue put may not be triggered in some cases where the project's actual annual energy margin and ancillary revenues are below $30 million. Specifically, SJEC will connect to the Elderberry node, which itself is connected to the Olive-Dumont nodes and have historically traded at discounts of at least 4% below AEP-Dayton's hub over the past five years. As the revenue put is indexed to AEP-Dayton Hub less $0.5, it is possible that the revenue put would not be triggered even though the project's actual energy margin is below $30 million. These discounts stem from node marginal losses owing to historical west-to-east power flows and the proximity to the Donald C. Cook nuclear facility, which are expected to decrease in the medium term as coal retirements take place and additional generation comes online in the east side of PJM decreasing the west-east power flows. In the unlikely event energy margins were to reach such low levels, the project debt service coverage ratio (DSCR) would likely be at or around 1.0x assuming no improvement in capacity prices, providing a degree of downside protection.

Project Description

SJEC is located in Indiana, in PJM's RTO capacity zone. As mentioned, substantial completion is a condition precedent to financial close, and the project is on target to meet substantial completion on March 24, 2018, enabling it to meet PJM's capacity delivery starting June 1, 2018. In order to achieve substantial completion, the project must meet minimal performance requirements, as well as performance guarantees provided by the contractor. SJEC utilizes well known technology from Siemens consisting of a 2x1 combined-cycle unit with two Siemens SGT6-5000F (5ee) combustions turbines and generators (CTGs), two heat recovery steam generators (HRSGs) and a Siemens steam turbine generator (STG). There are 15 power plants in operations today utilizing the same Siemens CTGs and we would expect typical ramp up of operations in the first year or so.

The project will benefit from a one year warranty (upon achieving substantial completion) under its EPC agreement with Kiewit Power Constructions, Co., an experienced contractor in the field. The project has contracted with Siemens for operations and maintenance of the project for an initial term of five years from COD. Siemens in turn has subcontracted much of the on-site labor to WorleyParsons, an engineering services company with significant international experience and who has worked together with Siemens on at least three other similar projects in the US. Siemens will remain responsible for the overall management and administration of the project and remains fully responsible for the subcontracted work under the O&M agreement. In addition, the project has a long-term program contract (LTP) with Siemens for major maintenance services for the combustion turbines. The LTP however does not cover the generators, steam turbine generator unit or the heat recovery steam generators, which per the independent engineer's opinion is common to exclude. In the event of any major maintenance and/or replacement associated with these units were to be required, the project would have to contract for these services separately at the time. The project has contracted with an experienced energy manager, Tenaska Power Services through 2020, subject to one year contract renewals, and asset management services will be provided by Power Plant Management Services, LLC.

Financing Structure & Expected Financial Performance

The project has a 75% excess cash flow sweep, and with distributions permitted on a quarterly basis subject to a 1.10x financial covenant (calculated on a trailing 12 month basis). We view having quarterly distributions of dividends as a credit weakness since distributions can be made on any given quarter even if on an annual basis, the project may not meet be able to meet the financial covenant. Liquidity is provided by a $7.9 million working capital facility and supported by a 6-month debt service reserve backed by a L/C. There are L/C requirements (provided under the revolving facility), associated with both the firm supply and transportation agreements with some step-downs starting in April 2019 and 2020 which will provide additional availability under the revolving facility of $2.5 million and $5 million respectively. The major maintenance reserve is discretionary.

Initial leverage is moderately high with Debt to EBITDA of around 7x in the first year of operations based upon Moody's sensitivities, and $575 debt/kW at financial close. Credit metrics are expected to be in the B/Ba range under our case, which assumes similar spark spreads as those observed during 2016 and most of 2017, moderate improvement in capacity auction prices in the near to medium term, and capacity factors in the low 80% in the early years giving the plant time for plant operation ramp-up to take place. Average annual DSCR approximates 1.73x and FFO/debt averages 7.7% during most years of the financing. By comparison, management's case results in 2.61x average DSCR and a 16.6% FFO/Debt over the entire forecasted period. Given known capacity auction results in the 2019-2021 period and our expectation for a mild improvement in the upcoming capacity auction results, financial performance for years 2020 and 2021 are expected to be weak relative to the remaining forecasted period with DSCR and FFO/Debt over this period approximating 1.4x and 4.2% respectively.

Our rating incorporates an expectation of stronger financial performance in most other years owing to a gradual and moderate strengthening in capacity auction prices, consistently high dispatch levels, and moderately increasing energy margins as capacity leaves the system. To the extent that the regional excess capacity dissipates faster, SJEC's energy margins and credit metrics will strengthen measurably given its competitive positioning. From a refinancing perspective, we calculate that approximately 70% of the original debt is expected to remain outstanding at maturity versus the 41.5% assumed in management's case. The project's DSCR is expected to remain comfortably above the 1.10x financial covenant throughout the forecasted period.

Security is typical of project financing structures, comprised of a first priority security interest in all tangible and intangible assets, as well as a pledge of equity interests, and change of control provisions. Additional indebtedness is subject to a rating affirmation. Receipt from insurance proceeds are to be applied towards mandatory prepayments and there is a maximum 18 month business interruption insurance subject to a 60 day deductible. There is a financial maintenance covenant of 1.10x, subject to no more than two equity cures during any rolling four quarters, and not more than five times in the aggregate.

Outlook

The stable outlook assumes SJEC achieves substantial completion on March 24th, 2018 and is fully operational by May 31, 2018 in order to provide capacity into PJM as of June 1st, and that operations during the first year of operations will closely align to performance expectations of heat rates in the 6,800 range and around 80% capacity factors during operating ramp up.

What could change the rating up

The rating is unlikely to move up at this time in the near term given no operating history and our expectations for near-term financial performance owing in large part to the impact of known capacity auction results in 2020 and 2021. In the event that actual performance, particularly on the energy margin side appreciably exceeds current expectations, resulting in financial performance more in line with management case of a DSCR that is greater than 2.5x and an FFO/Debt that is greater than 15%, there could be upward pressure on the rating.

What could change the rating down

The rating could move down if the project experiences significant and prolonged operating issues during the first year of operations which are either not covered by warranty or insurance or that could lead to significantly lower than expected cash flow generation and debt service coverage over the next 12-18 months.

Project Background

SJEC is located in St. Joseph County, Indiana, near the Town of New Carlisle. The project consists of two Siemens SGT6-5000F(5ee) CTGs, two Nooter/Eriksen HRSGs, and one Siemens STG with a nameplate capacity of approximately 709 megawatts. The HRSGs are equipped with duct burners to supplement plant capacity, subject to permit fuel throughput restrictions.

The project is on target to achieve substantial completion by March 24th, 2018 and was constructed by Kiewit Power Constructors Co. under a Lump Sum Turnkey Agreement for the Engineering, Procurement, and Construction of SJEC. The CTGs, HRSGs, and STG are wrapped under the EPC Agreement.

The project's sponsors include two separate funds managed by Ares EIF Management, LLC for 80% of the equity, with Toyota Tsusho America Inc. holding the remaining 20%. Both sponsors have experience in the US market, in particular through investments in combined cycle power plants.

The principal methodology used in these ratings was Power Generation Projects published in May 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Jennifer Chang
Asst Vice President - Analyst
Project Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Michael J. Mulvaney
MD - Project Finance
Project Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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