-- U.S. independent power producer Edison Mission Energy (EME) faces greater refinancing risk in 2013. Medium-term cash flow prospects from coal-fueled assets are lower due to low natural gas prices and large environmental capital expenditures.
-- We are lowering the corporate credit rating on EME and its subsidiaries Midwest Generation and Edison Mission Marketing & Trading to ‘CCC+’ from ‘B-',
-- We are also lowering the debt rating on Homer City Funding ‘B’ from ‘B+’ and placing it on CreditWatch negative due to the potential transaction stress, poor financial performance, and large environmental capital spending.
-- The negative outlook reflects higher refinancing risk due to a tightening liquidity situation and declining financial performance.
On Feb. 29, 2012, Standard & Poor’s Ratings Services lowered its corporate credit rating on Edison Mission Energy (EME) and its subsidiaries Midwest Generation LLC (Midwest Gen) and Edison Mission Marketing & Trading, Inc. (EMMT), to ‘CCC+’ from ‘B-’ based on greater refinance risk in 2013 due to lower cash flow over the medium term and reduced liquidity. The outlook is negative. We lowered our issue rating on Homer City Funding LLC’s senior secured notes to ‘B’ from ‘B+’ based on our expectations of transaction stress because Homer City is unlikely to make the equity rent payment in April 2012 and exhibits low future debt service coverage ratios based on our base case forecast.
We have placed the rating on CreditWatch negative pending further analysis. Rationale We think the risk that EME will be unable to refinance its $500 million notes in June 2013 on reasonable terms is greater because of reduced future cash flows driven by low natural gas prices and lower company liquidity.
The company’s decision to terminate the $564 million revolver at EME matures in summer 2012 worsens its liquidity position, which we already viewed as less than adequate. Other factors negatively affecting liquidity build-up are much higher coal costs at Midwest Gen under new supply contracts and the $185 million refund payment in 2012 from EME to parent Edison International (EIX) under their tax-sharing agreement.
Offsetting some of this liquidity reduction is the decline in capital expenditures from previous estimates to meet environmental requirements at Midwest Gen. EME forecasts compliance with emission regulations will require capital expenditures of up to about $628 million for the large units (Powerton, Joliet 7 and 8, and Will County) and an additional $235 million for Joliet 6 and Waukegan. Also, EME has levered up some wind power assets that it had funded fully with equity, improving the current EME corporate cash and cash equivalent position to $951 million.
Importantly, EME forecasts that it will be able to monetize its tax benefits under the EIX tax-sharing agreement from 2013 to 2016. As of Dec. 31, 2011, EME had recorded deferred tax assets of $520 million related to loss carry--forwards and unused credits--which, if realized, would provide a huge liquidity boost.
Finally, the company benefits from a portion of earnings from other assets and activities that are more predictable. Homer City remains a challenge, due to lower cash flow prospects with current low natural gas prices and a large capital expenditures requirement for environmental compliance.
We do not assume EME will receive any significant cash flow from Homer City over the next few years given the project’s low cash flow expectations. We think it likely that Homer City will be unable to meet all of its debt obligations in the next few years given low cash flow prospects and high rent service. Favorably, total rent service declines substantially in 2015 from current levels. A failure to pay the April 2012 equity rent will not enable Homer City debt holders to accelerate repayment, but could result in a transaction stress that we are investigating further.
The failure of Homer City to pay the equity rent could lead to a termination of the letter of credit (LOC) backing up the senior rent payment reserve. If that LOC is terminated, we think Homer City would be unable to fund this reserve from cash or a replacement LOC, and that may lead to a lease termination in the worst scenario. EME and GE Capital are discussing options. In addition, the project needs sulfur dioxide and particulate emissions control investments, currently projected to cost about $700 to 750 million. EME is not able or willing to fund any equity component of such an investment and is discussing the funding of capital improvements at Homer City with GE Capital. Recovery analysis The issue-level is ‘CCC+'.
The recovery rating on EME’s debt is ‘3’, indicating meaningful (50% to 70%) recovery if a default occurs. See the full recovery report published Dec. 27, 2011. Outlook The negative outlook on EME, Midwest Gen, and EMMT reflects higher refinancing risk due to tightening liquidity situation and declining financial performance. Developments that could lead to a rating decline include further deterioration in financial performance or increased uncertainty about EME’s ability to roll over its $500 million notes maturing in June 2013. CreditWatch The negative CreditWatch listing on Homer City’s debt reflects weaker financial performance, heightened risk from the expected failure to make the equity rent payment in April 2012, and uncertainty of obtaining funding for the required emissions reductions.