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Rating Action:

Moody's confirms KGen's B1 rating

23 Apr 2009

Outlook revised to negative

New York, April 23, 2009 -- Moody's Investors Service has confirmed the B1 rating on KGen LLC's senior secured credit facilities and revised the outlook to negative. This concludes the review for possible downgrade initiated on December 2 in conjunction with the downgrade of KGen's rating to B1 from Ba3. The confirmation reflects Moody's expectation that the company is no longer likely to underperform its budget for fiscal year 2009 by a significant amount, nor is the company expected to draw on its debt service reserve. While it has made a draw on its revolving credit facility, this demonstrates that the company has the ability to access a substantial amount of committed external liquidity, significantly increasing its operating flexibility. The negative outlook considers the possibility that the company will experience a compression of merchant margins due to lower gas prices, as well as reduced demand for electricity in the current economic climate.

While the company has clearly been underperforming, it should be able to continue servicing its debt from operating cash flows even if market conditions do not improve. However, no meaningful degree of debt pay down will occur unless a substantial improvement in market conditions occurs. The company's financial metrics are very narrow for its current rating, but this is counterbalanced by its substantial liquidity. This significantly improves the company's operating flexibility and should enable it to withstand a significant decline in merchant margins for a limited period of time. The project's assigned rating is consistent with the indicated rating determined by Moody's Power Generation Projects methodology.

Based upon the company's performance through the first two quarters of the current fiscal year, Moody's expects that there will be a shortfall of approximately $8 million in cash available for debt service relative to debt service requirements for the year, after factoring in required deposits to the major maintenance reserve necessary to fund next year's scheduled major maintenance expenses. The company already made this up through a $10 million draw on its revolving credit facility in March. There is nearly $60 million of available capacity remaining under this facility.

Moody's estimates the company could have $12 million in unrestricted cash at the end of the current fiscal year, its annual cash low point. In addition, KGen Power, the company's parent, had approximately $36 million in unrestricted cash as of March 31 (which does not vary significantly by season), which could potentially be made available to KGen if necessary. Taken together, these potential sources of liquidity significantly enhance the company's operating flexibility.

Cash flows have remained fairly stable for the past four years (including the current fiscal year), with cash gross margins ranging between a low of approximately $90 million in 2007 to a high of $100 million in 2008. Roughly $50 million of this is derived from the company's tolling agreement with Georgia Power Company (sr. unsec. A2) for the full output of Murray unit 1 (one of the company's combined cycle units), equal to 630 MW. This toll extends through May 31, 2012. The balance of the company's gross margin is derived from a combination of merchant sales and short term hedging agreements. Moody's estimates that the company could withstand a decline in these cash flows of approximately 50% over the next fiscal year before it is forced to access its revolver again or draw on its debt service reserve fund, though this would leave it with virtually no other cash.

If market conditions remain roughly stable, Moody's estimates that the company could actually generate $14 million in excess cash flow next year, more than enough to repay the draw on the revolver, despite an increase in expected major maintenance costs to nearly $27 in fiscal year 2010 from $17 million this year . Because of a decline in scheduled major maintenance the following year, coupled with the requirement that major maintenance be funded a year in advance, the project will be able to finance expected major maintenance expenditures in FY 2010 through draws on its major maintenance reserve. However, Moody's expects future major maintenance expenses will limit the company's ability to accumulate cash or pay down debt barring an improvement in market conditions.

Only after the company accumulates a balance of $50 million in unrestricted cash will it begin to repay debt or make distributions to equity. At that point, the cash sweep will be limited to a maximum of 75% of excess cash flow (or such lower amount as is necessary for it to achieve its targeted debt amortization, subject to a minimum of 50%), with the balance distributed to equity. While any unrestricted cash balances will ultimately be available to lenders, the cash sweep provisions are somewhat weaker than many comparable transactions.

Management has indicated an increased willingness to enter into short-to-medium term hedges at below replacement cost. To date, however, the company has only entered into a few hedges covering relatively limited portions of its capacity for limited periods of time, such as a 4.5 year PPA for 250-280 MWs of capacity from Sandersville, the company's peaking unit, commencing in 2011 and a four month toll for 50% of Murray II's capacity.

The negative outlook reflects Moody's expectation that the company may experience a meaningful decline in merchant margins in the coming fiscal year due the decline in gas prices coupled with decreases in demand for electricity stemming from the current economic downturn. Depending upon the extent of this margin compression and the degree to which the company has to rely on its balance sheet or further draws on its revolver, the rating could face downward pressure. The rating is unlikely to be upgraded unless market conditions improve sufficiently to permit the company to pay down a substantial portion of its debt and it enters into additional hedges for meaningful periods and amounts of its generating capacity.

The last rating action on the project debt occurred on December 2, 2008 when the rating downgraded to B1 from Ba3 and placed under review for possible further downgrade.

The principal methodology used in rating this issuer was Power Generation Projects, which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

Based in Houston, Texas, KGen is a power generating company formed in 2004 as a vehicle to purchase and hold a portfolio of power generation assets from Duke Energy. KGen owns a portfolio of one simple cycle and four combined cycle gas fired generating facilities serving the Entergy, Southern, and TVA subregions of SERC, with a total capacity of 3,030 MWs. One of the facilities comprising approximately 20% of the total capacity is under contract with Georgia Power (Senior Unsecured debt rated A2) until 2012. The other facilities are completely merchant. The project benefits from very low leverage relative to similar power projects rated by Moody's located in other parts of the country. However, this is not sufficient to mitigate its significant merchant exposure and the generally unfavorable nature of the SERC market, which is the least deregulated wholesale energy market in the country and is characterized by significant market power exercised by the load serving entities, a lack of transparency and liquidity, and an excess of gas-fired generating capacity.

New York
Chee Mee Hu
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Aaron Freedman
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's confirms KGen's B1 rating
No Related Data.
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