Market Overview

Fitch Downgrades Homer City Funding, LLCP to 'BB-'; Outlook Negative

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NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has downgraded Homer City Funding, LLC's (HCF) $300 million and $530 million pass-through bonds to 'BB-' from 'BB'. The Rating Outlook is Negative.

The downgrade is due to ongoing challenges at the project as a merchant coal facility in a low gas environment as well as the increasing costs associated with environmental emissions allowances. The Negative Outlook reflects the uncertainty regarding the magnitude of new emissions restrictions recently placed on Homer City.

Key Rating Drivers

--Dark Spreads: Continued strained margins due to high coal costs and low energy prices, which is heightened as project hedges begin to roll off in 2012. Per the Fitch rating case, senior rent reserve is expected to be used to support debt service in 2013;

--Environmental: Expected increased costs and/or decreased dispatch associated with obtaining additional allowances due to the newly finalized Environmental Protection Agency Cross-State Air Pollution Rule (CSAPR);

--Capital Expenditures: Up to $700 million anticipated in equipment additions in relation to CSAPR which will need to be funded through additional debt or other financing sources as projected cash flow is insufficient;

--Utilization of equity rent service reserves following a February 2011 steam pipe rupture, leaving approximately $8 million in the $20 million reserve; six-month senior rent service reserve is still intact.

What Could Trigger a Rating Action?

--Severe cost increases and/or decreased dispatch limiting project economics;

--Impact of the effects of the new emissions rules such as the inability to obtain additional financing for retrofits and equipment additions;

--Further strain on dark spreads.

Security

The bondholders receive a first priority mortgage lien on all right, title and interest in HCF's property, including the Homer City generating facility, the site lease, cash accounts, and project documents. HCF's undivided interest in the facility and certain specified general intangibles are also pledged to the bondholders.

Credit Update

During 2011, there were unplanned outages at Units 1 and 2 which lasted for roughly two and three months respectively. These outages and the continuation of low power prices have negatively impacted Homer City's cash flows and liquidity. As a result, in order to have sufficient working capital available for operating expenses and to pay the equity portion of Homer City's rent payment that was due April 1, 2011 to the owner-lessors, Homer City deferred certain fuel deliveries, arranged for accelerated payments by EMMT for future energy deliveries under an intercompany arrangement in place between EMMT and Homer City, and drew $12 million from the $20 million equity rent reserve.

As of June 30, the equity rent reserve remained at the drawn balance of $8 million, although the Sponsor believes that the reserve will be replenished in the future. Fitch notes that the six-month senior debt service reserve has not been utilized.

To further stabilize Homer City's liquidity, effective April 1, 2011, EMMT assigned to Homer City the benefit of an arrangement that allows EMMT to deliver power into the NYISO from Homer City. Accordingly, effective April 1, 2011, these revenues will now be recorded as part of Homer City's revenues in lieu of their prior classification as EMMT trading revenues.

The Project has operated at a capacity factor of 50.9% through 2Q'11 despite the steam pipe rupture, indicating that the financial impact for 2011 revenues should not be severe enough to constrain the Project's ability to repay debt. The impact of the outage is reflected in the 2011 and 2012 projections.

On July 6, 2011, the EPA finalized CSAPR. This rule replaces EPA's 2005 Clean Air Interstate Rule (CAIR) and directly impacts Homer City. Per the Sponsor, the SO2 allowances allocated to Homer City in CSAPR Phase I (25,797 tons in 2012 and 2013) are significantly lower than the amount that would be required based on Homer City's historical emissions (2010 SO2 emissions were 112,951 tons). Consequently, increased expenses and/or decreased dispatch are expected going forward although it is unclear to what degree this new regulation will impact cash flow.

EME Homer City Generation L.P. (HCG) leases and operates a single facility with three coal-fired electric generating units in western Pennsylvania with an aggregate capacity of 1,884 MW. HCG is an indirect, wholly owned subsidiary of Edison Mission Energy (EME; 'B', Outlook Negative). EME is a wholly owned subsidiary of Mission Energy Holding Company and is an indirect wholly owned subsidiary of Edison International. In May 1999, EME refinanced $830 million of acquisition debt secured by the facility. In 2001, General Electric Capital Corp. (GECC) purchased the facility for cash and assumed the rated debt as part of a sale-leaseback transaction with HCG. The debt was exchanged for the pass-through bonds, which were assumed by a special purpose vehicle, Homer City Funding LLC (HCF), indirectly owned by GECC. HCF bondholders rely solely on rent payments received from HCG.

HCG sells energy and capacity into the PJM Interconnection and NYISO on a merchant basis. HCG has a contract with Edison Mission Marketing & Trading, Inc. (EMMT), an affiliated marketing entity, to sell energy and capacity. EMMT engages in forward sales and hedging transactions to manage electricity price exposure.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

--'Rating Criteria for Infrastructure and Project Finance' (Aug. 16, 2010);

--'Rating Criteria for Thermal Power Projects' (June 20, 2011).

Applicable Criteria and Related Research:

Rating Criteria for Infrastructure and Project Finance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548345

Rating Criteria for Thermal Power Projects

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=639073

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.

Fitch Ratings
Primary Analyst
Nicole Farucci, +1-212-908-0684
Analyst
One State Street Plaza
New York, NY 10002
or
Secondary Analyst
Timothy Ononiwu, +1-212-908-0879
Senior Director
or
Committee Chairperson
Gregory Remec, +1-312-606-2339
Senior Director
or
Media Relations:
Cindy Stoller, +1-212-908-0526
Email: cindy.stoller@fitchratings.com

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