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Rating Action:

Moody's downgrades Talen guaranteed debt to B1; CFR affirmed at B1, outlook remains stable

30 Mar 2017

Approximately $5.3 billion of debt and credit facilities affected

New York, March 30, 2017 -- Moody's Investors Service ("Moody's") today downgraded approximately $823 million of Talen Energy Supply, LLC's (Talen) senior unsecured guaranteed debt including about $592 million of notes due in 2025, and about $231 million of tax-exempt revenue bonds. At the same time Moody's affirmed Talen's B1 corporate family rating, its B1-PD probability of default (PD), its Ba1 senior secured rating, and the B3 rating on its senior unsecured, nonguaranteed debt. Talen's speculative grade liquidity rating (SGL) has been affirmed at SGL-2, and the outlook remains stable.

The rating action is a result of Talen's announced liability management program, which includes a plan to prepay approximately $900 million of unsecured nonguaranteed debt maturing in 2018, 2019 and 2021 with proceeds from a new $400 million seven year senior secured term loan and approximately $500 million of new five year unsecured guaranteed notes. Concurrent with today's action, Moody's assigned a Ba1 rating to the proposed senior secured term loan, and a B1 rating to the proposed guaranteed notes.

RATINGS RATIONALE

The downgrade of Talen's senior unsecured guaranteed notes is driven by a shift in Talen's capitalization structure, which will now include a larger percentage of higher ranking senior secured debt, and a smaller portion of lower ranking senior unsecured nonguaranteed debt. Upon closing of the proposed financing, the guaranteed notes will make up the preponderance of Talen's recourse debt, and the rating on these issues will be the same as its B1 CFR.

Talen's B1 CFR is driven by the inherent volatility of the merchant power markets in which it operates and the current weak conditions in those markets. The rating reflects the increased leverage and reduced financial flexibility that resulted from the company's December 2016 use of almost all of its balance sheet cash to effect a take-private merger with an affiliate of Riverstone Holdings LLC (Riverstone, not rated). Although we view management's current pro-active approach to its upcoming maturity ladder as credit positive, and we expect Talen will be able to successfully execute its liability management program, the use of secured/guaranteed debt to replace unsecured obligations as an enticement for the new lenders has resulted in a downgrade of the company's existing guaranteed debt obligations.

Based on current market conditions, we anticipate Talen's ratio of cash from operations excluding changes in working capital (CFO pre-W/C) to total debt will generally remain near 10%, which is commensurate with the "B" scoring range in our rating methodology for unregulated power companies. Our standard CFO pre-W/C to debt calculation reflects GAAP accounting treatment for nuclear fuel, which is capitalized and then depreciated over time. To ensure comparability with other generators who do not capitalize a portion of their fuel costs, we also calculate the ratio assuming nuclear fuel is an operating expense. Using this approach, the ratio would be about 200 basis points lower. The rating also considers the quality and diversity of Talen's generation assets, and free cash flow to debt metrics under 5%, which is weaker than those of its "Ba" rated merchant generating peers.

Approximately 70% of Talen's 16 GW generating portfolio is concentrated in the PJM Interconnection (PJM, Aa2 stable) region while another 3% is located in the New England ISO. Generators in these balancing areas benefit from transparent and competitive markets for the sale of energy and capacity and visibility of capacity revenues up to three years forward. On the other hand, Talen's PJM portfolio is heavily weighted toward coal and nuclear assets, which as a result of their higher fixed cost structure, are more susceptible to margin compression as a result of lower power prices. Management has been making progress in reducing costs, which has worked as an offset to persistently low wholesale market prices for energy and capacity in its regions. Continued focus in this area will be a key factor in maintaining credit metrics at or above their current levels.

Liquidity

Talen has an adequate liquidity position. As of year-end 2016, the company has about $135 million of unrestricted cash on its balance sheet and we expect it to remain slightly free cash flow positive over the next 12-18 months. Talen's external sources of liquidity include secured revolving credit facilities totaling about $1.3 billion (just reduced from $1.4 billion), that terminate in June 2020 and June 2022. Talen's nearest long-term debt maturities include $400 million of notes due May 2018, and approximately $1.2 billion due in July of 2019. As noted, Talen is in the process of refinancing approximately $900 million of these obligations with debt that will become due in 2022 and 2024.

Talen's current capital program does not require extensive use of its credit facilities, and as of December 31, 2016, there were no borrowings outstanding under the facility. In addition, Talen has a $1.3 billion secured trading facility that can be used to satisfy collateral posting needs, as of December 31, 2016 approximately $21 million was utilized. Talen's extended credit facility includes one financial covenant, a maximum senior secured net leverage ratio of 4.25x (just reduced from 4.5x). The leverage covenant compares Talen's secured recourse debt (which consists entirely of the credit facility, the existing $600 million term loan, and the new $400 million term loan) to consolidated EBITDA (as defined in the agreement); as of December 31, 2016, we estimate the covenant ratio to be about 0.55x; pro-forma for the refinancing, we estimate the ratio would be about 1.1x. Draws under the credit facility require representations of no material adverse change.

Financing Structure

All of Talen's secured term loan and revolving credit lenders benefit from guarantees and first lien security interests from all of Talen's material subsidiaries with the exception of the gas-fired MACH Gen, LLC assets (Athens, Millennium and Harquahala) acquired in late 2015. The existing $600 million secured term loan amortizes 1% per annum and requires mandatory prepayments equal to 50% of excess cash flow when the senior secured leverage ratio is greater than 3.25x; reducing to 25% of excess cash flow when the ratio is greater than 2.25x and 0% when the ratio is less than 2.25x.

The new $400 million secured term loan will have an amortization that escalates from 1.5% in year one to 3.5% in year seven, and in years 1-4, will require mandatory repayments equal to 50% of excess cash flow when the senior secured leverage ratio is greater than 3.0x. Post refinancing we estimate the senior secured net debt ratio would be about 1.1x. There are no financial covenants. There are limitations on additional liens, but with significant allowances and carve outs. For example incremental secured debt is allowed as long as the total pro-forma amount of secured debt and revolving credit facilities fit within a basket sized at 3x twelve month trailing consolidated EBITDA (as defined in the agreement) plus the greater of $300 million or 3% of consolidated total assets. As of December 2016, the basket size is estimated at about $3.2 billion, resulting in $1.2 billion of capacity. Post-closing of the new term loan, the basket size would be reduced to about $800 million.

The new guaranteed notes will be guaranteed by the subsidiaries backing Talen's secured term loans and revolving credit facilities (which exclude the MACH Gen, LLC entities) and which currently provide guarantees to its $600 million 6.5% notes due 2025, as well as about $231 million of outstanding Pennsylvania Economic Development Financing Authority revenue bonds. Moody's views the guaranteed debt as having a higher priority of payment, and better recovery prospects, vis-a-vis the remaining unsecured obligations in the event of a potential bankruptcy, and rank them accordingly in the liability waterfall used in our loss given default framework. As a result, ratings of the guaranteed debt are higher than the ratings of the unsecured unguaranteed bonds.

Talen's capital structure includes approximately $577 million of non-recourse debt assumed at MACH Gen LLC. The debt is includes a term loan with an approximate $469 million balance and a $108 million revolving credit balance and is secured by the 2.5 MW gas-fired MACH Gen assets which are located in New England, New York and Arizona. Following a Q4 2016 write-down, the book value of the MACH Gen assets is approximately equivalent to the amount of non-recourse debt outstanding. These assets are not expected to contribute meaningful cash flow to Talen, Talen does not intend to contribute additional capital to them, and they are not included in the liability waterfall used in our loss given default framework.

Rating Outlook

The stable outlook considers the company's updated capital structure and its ongoing cost savings efforts. The outlook reflects Moody's expectation that over the near to medium term Talen will demonstrate cash flow credit metrics that are appropriate for the B1 CFR. For example, we expect a ratio of CFO pre-W/C to debt in the range of 10%, or 8% counting nuclear fuel as a cash expense, and we expect the company to remain slightly free cash flow positive.

Factors that Could Lead to an Upgrade

It is not likely the corporate family rating would move upward over the next 12-18 months. Longer term, if the ratio of CFO pre-W/C to debt were to be maintained in the mid-teens, there could be upward pressure on the rating.

Factors that Could Lead to a Downgrade

If there were to be an increase in leverage, operational challenges, or declines in commodity prices such that we would expect the ratio of CFO pre-W/C to debt to remain below 7%, or the company to remain free cash flow negative, there could be downward pressure on Talen's corporate family rating. If there were to be refinancings that replace unsecured debt with a material amount of additional secured or guaranteed debt, there could be pressure on the ratings of the secured or guaranteed notes.

Affirmations:

..Issuer: Talen Energy Supply, LLC

....Corporate Family Rating, Affirmed B1

....Probability of Default Rating, Affirmed B1-PD

....Speculative Grade Liquidity Rating, Affirmed SGL-2

....Senior Secured Bank Credit Facility, Affirmed Ba1, LGD2

....Senior Unsecured Regular Bond/Debenture, Affirmed B3, LGD5

Downgrades:

..Issuer: Talen Energy Supply, LLC

....Guaranteed Senior Unsecured Regular Bond/Debenture, Downgraded to B1, LGD3 from Ba3, LGD3

..Issuer: Pennsylvania Economic Dev. Fin. Auth.

....Guaraneed Senior Unsecured Revenue Bonds, Downgraded to B1, LGD3 from Ba3, LGD3

Assignments:

..Issuer: Talen Energy Supply, LLC

....Senior Secured Bank Credit Facility, Assigned Ba1, LGD2

....Guaranteed Senior Unsecured Regular Bond/Debenture, Assigned B1, LGD3

Outlook Actions:

..Issuer: Talen Energy Supply, LLC

....Outlook, Remains Stable

Talen is an independent power producer with about 16 GW of generating capacity. Talen Energy Corporation, headquartered in Allentown, PA, is a privately owned holding company that owns 100% of Talen and conducts all its business activities through Talen.

The principal methodology used in these ratings was Unregulated Utilities and Unregulated Power Companies published in October 2014. 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.

Laura Schumacher
VP - Senior Credit Officer
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

Jim Hempstead
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

No Related Data.
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