Research: Rating Action: Moody’s downgrades Heritage Power, LLC to Caa2 from B2; outlook remains negative


Approximately $560 million of debt affected

New York, July 06, 2022 — Moody’s Investors Service, Inc (“Moody’s”) downgraded Heritage Power, LLC’s (HEP) senior secured credit facilities to Caa2 from B2, including its senior secured term loan due 2026, senior secured revolving credit facility due 2024, and a senior secured letter of credit facility due 2023. The outlook remains negative.

RATINGS RATIONALE

“Heritage Power’s rating downgrade to Caa2 reflects our expectation that the power project portfolio will experience a substantial drop off in cash flow starting in June 2022 due to significantly lower capacity payments from recent PJM auctions,” said Clifford Kim, Vice President – Senior Credit Officer . “This has increased the likelihood of a default on its debt obligations within the next 12 to 18 months without a large, unexpected liquidity infusion” added Kim.

The rating action also considers HEP’s near term refinancing risk that further increases default risk as well as the company’s untenable capital structure given the recent fall in capacity prices and unfavorable hedges. Most immediately, HEP has a $46 million letter of credit facility maturing on July 30, 2023 under which approximately $43 million of letters of credit were outstanding as of March 31, 2022. We expect that extending this facility will be challenging given HEP’s likely financial distress position going forward, raising the prospects of a default.

If HEP were to default, senior secured lenders are exposed to the potential for substantial losses given our expectations for negative operating cash flow during the 2023-2024 capacity period and considering the old age of the portfolio with a weighted average age exceeding 50 years. That said, the ultimate recovery for the company’s senior secured debt will also depend on the pace and trajectory of future capacity prices after May 2024. We expect greater clarity on future capacity prices in the next PJM capacity auction scheduled for January 2023 that will cover the 2024/2025 capacity period. To the extent that prices do not substantially improve in this auction, a further downgrade is likely.

Furthermore, while power prices have risen sharply since mid-2021, we do not incorporate an assumption that substantially higher energy margins will be sufficient to offset the revenue capacity loss. For example, HEP’s Shawville and New Castle plants, which represent over 90% of the portfolio’s historical power production, are fully or partially under heat rate call options (HRCOs) through the end of March 2024. We view these HRCOs as a net negative given the significant basis exposure and the lack of a pass through carbon costs. These two plants are subject to these costs as of July 1, 2022 unless a pending challenge challenging Pennsylvania’s entry into the regional gas greenhouse market initiative (RGGI) and an associated injunction are successful. Additionally, HEP’s assets typically operate as peaking assets with a historical capacity factor averaging less than 8% since 2020, severely limiting the prospect of higher energy margins.

The main driver of the expected cash flow declines are lower weighted average capacity prices at around $86/MW-day that apply from June 1, 2022 through May 31, 2023 compared to $136/MW-day for the prior period. As capacity revenues decline, HEP may have to draw on its debt service reserve account within the next 12 months given the company’s historically tight financial performance with a 2020-2021 average DSCR of 1.18x and Project CFO to a Debt of 1.8%. The company could also violate its minimum 1.10x DSCR financial covenant requirement over this time as financial metrics decline after likely peaking in June 2022. Starting on June 1, 2023, the weighted average capacity prices are set to further decline by almost 50%, which we view as unsustainable relative to HEP’s leverage.

Rating Outlook

The negative outlook factors in the increased likelihood of a default over the next 12-18 months given our expectation for rapidly declining cash flow leading to a likely financial covenant violation, potential depletion of the debt service reserve account, and ultimately a payment default. The negative outlook also considers heightened uncertainty regarding the refinancing of HEP’s letter of credit facility in July 2023 and around lender recovery if HEP defaults.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING

In light of the negative outlook, limited prospects exist for the rating to be upgraded in the short-term. The outlook could be revised to stable if HEP is able to implement a plan to address refinancing risk while also ensuring the sufficiency of cash flow to meet its obligations on a sustained basis or if the January 2023 PJM capacity auction results in a substantial improvement to prices that significantly enhances recovery prospects.

The rating could be downgraded if the next PJM capacity auctions results in no material improvement in prices, the company experiences a major operating problem on any of its key assets or if our debt recovery expectations decline.

Corporate Profile

HEP owns a 2,389 MW portfolio of 16 gas or oil-fired power plants located in New Jersey, Ohio, and Pennsylvania. The company is an indirectly, wholly owned subsidiary of GenOn.

The principal methodology used in these ratings was Power Generation Projects Methodology published in January 2022 and available at https://ratings.moodys.com/api/rmc-documents/361400. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a issued bond or note of the same series, category/class of debt, security 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 issuer/deal page for the respective issuer on https://ratings.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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the UK and is endorsed by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK . Further information on the UK endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.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 issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.

Clifford J Kim
VP – Senior Credit Officer
Project Finance Group
Moody’s Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
USA
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

AJ Sabatelle
Associate Managing Director
Project Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Release Office:
Moody’s Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
USA
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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