July 16, 2012 / 9:34 PM / 5 years ago

TEXT-S&P cuts Panda Temple Power rating to 'B'

Overview
     -- Panda Temple Power LLC is issuing $340.16 million of senior secured 
debt to build a 758 megawatt natural gas-fired power plant in Temple, Texas. 
This represents a $35 million increase from our previous assumptions.
     -- We are lowering our preliminary issue rating to 'B' from 'B+' and 
changing the preliminary recovery rating to '3' from '2'. 
     -- The stable outlook reflects our expectation that the project will be 
built on time and within budget, and that near-term hedges will provide 
adequate cash flow for debt service at the rated level.

Rating Action
On July 16, 2012, Standard & Poor's Ratings Services lowered its preliminary 
rating to 'B' from 'B+' and changed the preliminary recovery rating to '3' 
from '2' on Panda Temple Power LLC's (Temple) $75 million first-lien term loan 
A, $255 million term loan B, and $10.16 million letter of credit facility. The 
preliminary '3' recovery rating indicates meaningful recovery (50% to 70%) of 
principal in a default scenario. Cross-acceleration provisions exist between 
the term loan A and term loan B and all the debt is pari passu. The outlook is 
stable.

Rationale
The change in ratings reflects a higher amount of total debt and cumulative 
interest payments that are likely to be considerably higher than our previous 
assumptions. Our rating also reflects the project's construction risk, 
exposure to merchant energy prices, and a high degree of sensitivity to 
capacity factors and market heat rates. 

The project will use loan proceeds to build the Panda Temple Power Plant, a 
nominal 758 megawatt (MW) natural gas-fired facility in Temple, Texas. The 
unit will dispatch into the North sub-region of the Electric Reliability 
Council of Texas (ERCOT) interconnect. The preliminary ratings are subject to 
final structure and document review.

Temple is a special-purpose, bankruptcy-remote operating entity. Panda Power 
Generation Infrastructure Funds and a consortium of other equity investors 
together own the equity in the project.

Temple will service its debt from merchant energy revenues, buttressed by 
near-term revenue put hedges. The main risk to the project is the exposure to 
merchant energy markets, in our opinion, and limited refinancing risk. The 
initial debt is about $463 per kilowatt (kW), which falls to about $390 per kW 
under our assumptions by 2019. 

The 'B' rating results from high initial debt, greenfield construction risk, 
exposure to market prices, and high sensitivity to heat rate and spark 
spreads. Lack of diversity in cash flows also adds to cash flow volatility. 

Bechtel Power Corp. and Siemens Energy Inc. will build the project jointly and 
severally, under a fixed-price, date-certain turnkey engineering, procurement, 
and construction (EPC) contract. Given their long track record, market 
leadership in this industry, and the project's requirements, Standard & Poor's 
is comfortable that the creditworthiness of these counterparties will not 
limit the rating on Temple's debt. We view the fixed EPC arrangement as 
supportive of credit because it mitigates construction risk. 

Although the plant is completely exposed to merchant risk, it benefits from a 
revenue put option for 600 MW of generation capacity, which provides 
underlying supports for margins of $41 million per year between 2015 and 2018. 
The hedges provide a floor even as the project retains the upside should spark 
spreads widen or heat rates expand. Standard & Poor's believes this hedging 
strategy will improve the stability of margins during the initial hedged 
period. However, the hedges are financially settled and they may not be 
completely effective because gas is not perfectly correlated to on-peak 
electricity, and if gas is on the margin less frequently than expected, the 
ineffectiveness of the hedge would likely widen. In addition, the hedges do 
not cover for lower margins arising from weaker-than-expected operational 
performance. In addition, in various stress case assumptions, the debt service 
coverage that the hedges provide is considerably lower given our expectations 
of higher interest rates.

Because there are no capacity markets in the ERCOT region, we expect plant 
cash flows to be highly volatile for the unhedged portion of the capacity, and 
starting in 2019 for the all the capacity once hedges roll off. However, we 
expect the realized margins will continue to strengthen due to declining 
reserve margins from increasing load and the planned retirement of coal units 
that is helping to improve market heat rates. We expect reserve margins in the 
ERCOT region to fall consistently below 5% after 2018, especially if current 
trends continue. 

In summary, the 'B' debt rating reflects these risks:
     -- High overall debt at origination of about $463/kW. In our stress case, 
total debt declines to about $390/kW in 2019, which still constitutes 
considerable refinancing risk. 
     -- Higher-than-expected interest rates that lower the debt service 
coverage ratio to between 1x and 1.1x for several periods.
     -- Cash flow is highly sensitive to changes in operating heat rates and 
spark spreads.
     -- Greenfield construction.
     -- The project is exposed to merchant power prices for all of its 
capacity. 
     -- In our sensitivities, power prices and capacity factors (which are 
partially influenced by reserve margins and the relative position of 
new-builds in the ERCOT stack) have the most effect. The project has no power 
purchase agreements and there are no capacity markets in ERCOT.
     -- Lack of diversity and being a single asset that relies on natural gas 
to back all cash flows. 
     -- Exposure to losses arising from operational underperformance. 
     -- Unhedged natural gas prices. 

The following strengths mitigate weaknesses at the 'B' rating level:
     -- Merchant exposure is mitigated with counterparty hedges from 3M 
Employee Retirement Income Plan for roughly all the base capacity from 2015 to 
2018. 
     -- A 100% excess cash flow sweep for term loan A reduces refinance risk. 
Term loan LB will also benefit from a 100% cash flow sweep after term loan A 
is paid off as long as its outstanding balance is above $100 million.
     -- Low reserve margin expectations in the ERCOT region falling from 13.5% 
in 2012 to below 5% from 2018 onward. If this trend holds, there could be 
considerable support for higher prices, which in turn would likely promote 
development of new power plants. 
     -- The EPC contractors are market leaders with a strong track record of 
delivering on time and within budget. 
     -- The sponsors have considerable experience in the industry, with more 
than 9 gigawatts of large power generation projects. A subsidiary of the 
sponsor also will provide operating and maintenance services.

We use our current assumptions from our corporate natural gas price deck ($2 
per million Btu in 2012, $2.75 in 2013, $3.50 in 2014, and rising with 
inflation thereafter) in our financial forecast. Debt coverage service ratios 
in this case averages about 1.1x during this period and is about 1.15x in 
2019, on a consolidated debt basis. 

We also believe that the projected debt burden at maturity of about $390 per 
kW on a consolidated basis under our rated case assumptions, and is likely to 
be refinanced at reasonable terms given our recent experience.

Liquidity
Liquidity is limited to a debt service reserve covering six months of 
principal and interest, funded from cash, or backed with a bank letter of 
credit from 2015 onward. The transaction also has a maintenance account ($10 
million), a working capital account ($4 million), and letter of credit funding 
($10.2 million). During the construction phase, contingency fees and EPC 
contractor credit-support deposits also add liquidity. 

Recovery analysis
The preliminary '3' recovery rating on the debt indicates expectations of a 
meaningful (50% to 70%) recovery if a default occurs.

Outlook
The stable outlook on the debt ratings reflects fairly steady cash flow 
through 2018 due to hedging positions and favorable cash flow prospects 
thereafter given asset efficiency and expected retirement of aged coal 
capacity. A downgrade is possible if our expectation of debt at maturity 
changes to greater than $400 per kW and if debt service coverage ratios 
steadily decline below 1.1x. This would likely result from construction 
delays, lower-than-expected spark spreads or operational performance, or 
higher operating and maintenance costs. An upgrade would require a large and 
sustainable improvement in merchant market prices that would reduce refinance 
risk to below $100 per kW.

Related Criteria And Research
Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007

Ratings List
Issue-Level Rating Lowered; Recovery Rating Changed
                                 To                  From
Panda Temple Power LLC 
Senior Secured:
$75 mil term loan A              B(prelim)/Stable    B+(prelim)/Stable
  Recovery rating                3(prelim)           2(prelim)
$255 mil term loan B             B(prelim)/Stable    B+(prelim)/Stable
  Recovery rating                3(prelim)           2(prelim)
$10.16 million LOC facility      B(prelim)/Stable    B+(prelim)/Stable
  Recovery rating                3(prelim)           2(prelim)



Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

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