Fitch Expects to Rate Kleen Energy Systems, LLC's Term Loans 'BBB-'

2008-05-06 23:53:59 -

- Fitch Ratings expects to assign ratings of 'BBB-' with a Stable Outlook to Kleen Energy Systems, LLC's (Kleen) proposed issuance of a $450 million, term loan A and a $315 million term loan B (the term loans). The proceeds of the proposed issuance will be used to finance the construction of a generating facility (the project) near the city of Middletown, Connecticut. The term loan A and the term loan B will mature eight and 14 years, respectively, after the commercial operation date. Energy Investors Funds will indirectly own an 80%-90% interest in Kleen through its subsidiaries United States Power Fund II LP, USPF II Institutional Fund LP, and United States Power Fund III LP. The balance of the ownership interests will be held by O&G Industries (O&G) and White Rock Holdings Associates LLC, a project development company owned by O&G and individual investors.

Kleen is a special-purpose company created solely to develop, own and operate the project, which will consist of a 620-MW dual-fuel, combined-cycle electric generating facility. O&G will construct the facility under a fixed-price, turnkey EPC contract with a guaranteed completion date of Nov. 30, 2010. Once commercial operation is achieved, North American Energy Services will operate the facility under an O&M agreement. The sponsors are currently negotiating with the turbine manufacturer, Siemens Power Generation, to perform major maintenance services.

Kleen has entered into a 15-year capacity agreement for 620 MW with Connecticut Light and Power (CL&P). The capacity agreement includes a price reopener provision that allows for amendment of the contract under certain circumstances. The facility's energy output will be purchased by a tolling counterparty under a seven-year tolling agreement. The sponsors have indicated that they will identify the tolling counterparty prior to the proposed issuance. The parent company of the tolling counterparty will partially guarantee the tolling counterparty's obligations under the tolling agreement. The terms of the tolling agreement have not been finalized, though the sponsors intend to execute the agreement prior to the proposed issuance. The sponsors' financial projections reflect Kleen's performance as a merchant facility once the tolling agreement expires.

Fitch has evaluated Kleen's credit quality on a stand-alone basis, independent of the credit quality of its owners. The expected ratings are based on Kleen's financial performance during the term of the tolling agreement, between 2010 and 2017. Kleen's credit quality is not constrained by the project's financial performance during the post-2017 merchant period, as Kleen's total debt service burden will decline sharply after the term loan A matures and the tolling agreement expires. Fitch assessed Kleen's financial performance using cash coverage of consolidated scheduled debt service, defined as scheduled amortization and interest on both of the term loans. Fitch regards the risk of payment default as identical for both of the term loans.

Base case debt service coverage ratios (DSCRs) range between 1.55 - 1.60 times (x) throughout the tolling period. The lenders will be exposed to completion risks, as the EPC contractor could deliver a facility that falls short of projected technical performance without paying liquidated damages. If completion risks are taken into account, potential reductions in projected operating performance could lower DSCRs to the 1.45x - 1.50x range due to performance-linked, market-based penalties in the tolling agreement. However, DSCRs remain above 1.4x under both low availability and high natural gas price conditions when combined with the effects of weaker than projected operating performance.

Kleen will derive 60% of its cash flow from the capacity agreement with CL&P during the tolling period. If CL&P's credit quality falls below Kleen's credit quality on a stand-alone basis, the increased counterparty risk could lead to a downgrade in Kleen's rating. Fitch has assigned CL&P a long-term Issuer Default Rating of 'BBB' with a Stable Outlook. Similarly, the credit quality of the tolling counterparty's parent is considered a potential constraint on Kleen's credit quality during the tolling period, when the tolling counterparty is the source of 40% of Kleen's cash flow. The sponsors have indicated that the parent company of the tolling counterparty will be a publicly-rated entity with an Issuer Default Rating of 'BBB+' and a Stable Outlook.

Primary credit strengths:

-- Fixed-price capacity and tolling agreements with investment-grade counterparties.

-- Proven, reliable technology.

Primary credit concerns:

-- Partial exposure to completion risks.

-- The capacity agreement includes a price reopener provision.

-- The parent of the tolling counterparty will provide a partial guarantee under the tolling agreement.

For more information see the Kleen Energy Systems, LLC presale report, available to all investors on the Fitch Ratings web site: corporate site, www.fitchratings.com.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 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
Chris Joassin, +1-312-368-3166 (Chicago)
Doug Harvin, +1-312-368-3120 (Chicago)
Cindy Stoller, +1-212-908-0526
(Media Relations, New York)