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Rating Action:

Moody's rates Star West Generation's secured credit facilities Ba3, outlook stable

25 Apr 2011

Approximately $750 million of senior secured credit facilities rated

New York, April 25, 2011 -- Moody's Investors Service assigned a Ba3 rating to Star West Generation LLC's (Star West or the Company) proposed $750 million credit facilities consisting of a $650 million senior secured 7-year term loan facility and a $100 million 5-year senior secured revolving credit facility. Star West is a newly created entity formed to acquire LS Power's ownership interest in the Griffith and Arlington Valley projects in Arizona and is an indirect subsidiary of Highstar Capital IV and its affiliates, a private equity fund managed by Highstar Capital. The rating outlook is stable.

RATINGS RATIONALE

The Ba3 rating is driven by the highly contracted nature of Star West's operations; the majority of the Company's gross margins will be derived from contracts with investor owned utilities, that generally extend through the term of the debt. The stability provided by the contracts works to offset Star West's sizeable debt burden which is evidenced by cash flow to debt metrics that are consistent with rating factor scores in the low B ranges indicated in Moody's Rating Methodology for Power Generation Projects (the Methodology). For at least the first several years of the financing, cash flow to debt is expected to remain in the neighborhood of 5% in the sponsor's base case, and to be lower in Moody's sensitivity cases. The potential for improvement in later years is dependent upon a strengthening of market conditions and operating profile.

The rating considers the efficiency proven technology and design of the projects which should position them well as the economies in Arizona and Nevada resume modest growth, although recently the plants have been run almost exclusively during the contracted periods. We expect Star West will be able to meet its required debt service obligations with a modest cushion even if the plants continue to run only during the summer months (under this assumption minimum debt service coverage ratios are projected in the range of 1.1-1.2 times). In this downside scenario, we estimate that approximately 70% of the term loan balance or approximately $400 per kW would be outstanding at maturity.

The 577 MW Arlington Valley facility is located approximately 50 miles southwest of Phoenix and is connected to the Palo Verde pricing hub. During the summer months 560 MWs of the project's capacity is sold to an investment grade investor owned regulated utility under a tolling agreement that extends to 2019. The 570 MW Griffith plant is located in Kingman, Arizona, near the Mead pricing hub and has a summer month tolling agreement with Nevada Power Company (NPC: Ba2 senior unsecured) that extends through 2017. Griffith also has a separate 25 MW capacity contract with an Arizona-based electric cooperative (not rated), the obligations of which Star West expects it would meet with market purchases if called.

Proceeds from the $650 million term loan, along with $300 million of equity capital (comprised of $250 million from Highstar Capital IV and its affiliates and approximately $50 million of third party financing provided to Star West's indirect parent) will be utilized to fund the purchase price, a maintenance reserve of $5 million, and the payment of fees and expenses. Up to $80 million of Star West's $100 million revolving credit facility may be used for letters of credit. Initially approximately $55 million of this facility will be utilized to post collateral for contractual obligations, approximately $23 million will be utilized to provide Star West's six month debt service reserve letter of credit, and approximately $22 million will remain available for working capital needs.

Key factor supporting the rating are:

• In the sponsor's base case scenario, approximately 74% of the Company's gross margins are expected to be provided by its tolling agreements. While the Griffith tolling agreement expires one year prior to the term loan maturity, the Arlington Valley contract will remain in place for two summer peaking periods beyond the term of the loan.

• Both projects have maintained high availability factors during their summer tolling months. Griffith's tolling period availability has averaged above 99% since 2008 while Arlington Valley's availability has averaged above 98%, which satisfy the required availability factors under their respective tolling agreements.

• The Company's holdings are diversified across two projects that are geographically separated within Arizona and have different off-takers. Contributions to gross margin are approximately equally divided between the two assets.

• Dividends are restricted via a cash flow sweep mechanism that requires 100% of excess cash be utilized to repay debt. The sweep percentage may be adjusted to 85% or 70% in the event that within 90 days of closing additional equity is contributed and the amount of the term loan outstanding is reduced below $600 million or $550 million, respectively.

• Excess cash flows will be swept on an annual basis in June of each year. This is intended to ensure that the projects retain sufficient liquidity to address working capital or maintenance expenditures as these needs will tend to be greatest in the non-tolling shoulder spring and fall months whereas the projects will generate the bulk of their cash during the summer tolling period. This liquidity feature helps to offset the lack of a cash funded debt service reserve and the limited look forward requirement on the maintenance reserve.

• There will be a major maintenance reserve, initially funded at $5 million which will be maintained at an amount equal to at least the next three months' planned major maintenance expenditures with the ability to reserve up to the next twelve months of major maintenance. The reserve will be funded quarterly. There will also be a six month debt service reserve which can be funded either with cash or a letter of credit. The Company expects to fund this intially with a letter of credit under the revolver.

• Each project benefits from a long term services agreement (LTSA) with GE, the gas turbine manufacturer, which covers major overhauls and inspections of the gas turbines. This arrangement mitigates the cost risk associated with major maintenance for both projects and also results in some smoothing of major expenditures. The LTSAs require the projects to post collateral. These obligations will be met with letters of credit from the Star West credit facility.

• O&M services are provided by NAES, a well known third party operator.

• The project financing structure includes features such as: a first lien security package including underlying assets, contracts, accounts and equity interests; limitations on additional debt; prohibitions on sale of assets; downstream guarantees from operating companies and upstream guarantees from Star West's direct parent; a trustee administered cash flow waterfall; dividend restrictions; and a cash flow sweep for the repayment of debt.

The above factors are balanced against the following credit challenges:

• The Projects are mid-merit assets which have historically run almost exclusively during their summer contracted months. The average capacity factor over the past three years for Griffith was approximately 33%; for Arlington Valley it was about 20%. Going forward, the sponsor's anticipate the plants annual capacity factors will be in the range of 60-70%.

• Cash flow metrics correspond to the 'B' or "Caa" categories under the Methodology. Over the first three years of the financing, under various conservative cases considered by Moody's, the average FFO/Debt ratio is below 5% while over the term of the debt the average ratios are in the range of 8% to 10%. These metrics compare to about 6.5% and over 18% in the sponsor's base case. Debt service coverage ratios in Moody's cases average about 1.3x to 1.4x in the first three years versus 1.65x in the sponsor's base case. Over the life of the term loan, Moody's scenarios produced average debt service coverage ratios in the range of 1.5x to 2.0x compared with approximately 2.5x in the sponsor's case.

• The amount of the term loan that will need to be refinanced at maturity will vary depending on market conditions and the extent to which the plants are able to operate economically. Under Star West's base case, refinancing risk is expected to be limited with approximately 32% of the original outstanding balance (approximately $180 kW) outstanding at the maturity of the term loan. Under more conservative cases considered by Moody's, approximately 50% of the term loan balance would remain outstanding. In a more stringent scenario where the projects continue to operate only during their contract periods, approximately 70% of the original debt balance would remain at the maturity of the term loan.

• There will be a six month reserve for interest and required principal; however, the reserve is expected to be funded via a letter of credit written off of Star West's $100 million five-year revolving credit facility. Moody's views this as providing significantly less protection to the lenders than a cash funded debt service reserve.

• As is true of all power projects, Star West's financial performance, cash flow and credit metrics are sensitive to higher operating costs, operating heat rates and realized merchant energy and capacity margins.

• Although some maintenance spending is smoothed via the payment scheme of the long term service agreements, major outages will still require about 65% of the costs to be paid around the time of the outage.

Star West's stable outlook reflects the highly contracted nature of the company's cash flows and our expectation that the operational issues facing the plants have been largely addressed. The stable outlook assumes the projects will be operated on an economic basis so that there is likely to be some increase in plant capacity factors. The outlook assumes Highstar IV and its affiliates will be successful in raising additional equity funds such that the $50 million in third party financing provided to Star West's indirect parent is repaid as anticipated over the near-to-medium term.

In Moody's view the rating is well placed and has limited prospects for a rating upgrade in the near term. Over the longer term, positive trends that could lead to an upgrade include greater than expected debt repayment, additional contracts that maintain or improve cash flow, and sustained cash flow credit metrics solidly in the 'Ba' category under the Methodology.

There could be downward pressure on the rating or outlook if there were to be a deterioration in the credit quality of either tolling agreement off-taker, if the projects do not operate as anticipated, if cash flow credit metrics or debt amortization are materially lower than anticipated, or if the $50 million in third party financing provided to Star West's indirect parent is not repaid as generally anticipated.

The ratings are predicated upon final documentation in accordance with Moody's current understanding of the transaction and final debt sizing and model outputs consistent with initially projected credit metrics and cash flows.

Star West is a wholly owned subsidiary of private equity funds managed by Highstar Capital IV and its affilliates which, after closing, will own two gas fired combined cycle power projects totaling approximately 1,147 MW. The 577 MW Arlington Valley project and the 570 MW Griffith project are both located in Arizona. Arlington Valley has a summer month tolling agreement with an investment grade investor owned regulated utility utility while Griffith has a summer month tolling agreement with NPC and a separate 25 MW contract with an Arizona based electric cooperative. Highstar Capital is an independently owned and operated private equity fund manager with over $5 billion invested across 18 platform investments since its inception in 1998. Highstar Capital focuses its investments in the energy, environmental services and transportation sectors.

The principal methodology used in this rating was Power Generation Projects Industry Methodology, published in December 2008.

REGULATORY DISCLOSURES

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

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating 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 ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service 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 the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

New York
Laura Schumacher
Vice President - Senior Analyst
Project Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

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

Moody's rates Star West Generation's secured credit facilities Ba3, outlook stable
No Related Data.
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