-- U.S. solar power generator Topaz Solar Farms LLC has issued $850 million senior secured notes due 2039.
-- We are assigning our ‘BBB-’ rating to the issue.
-- The stable outlook reflects our assessment of current construction and operations phase arrangements and counterparty dependency assessments.
On Sept. 17, 2012, Standard & Poor’s Ratings Services assigned its ‘BBB-’ rating to project finance entity Topaz Solar Farms LLC’s $850 million series A senior secured notes due 2039. The outlook is stable.
Topaz is constructing a 586 megawatt (MW) solar power project in San Luis Obispo County, near Bakersfield, Calif. The total project cost is about $2.44 billion, funded initially with $850 million in notes and an equity commitment from indirect parent MidAmerican Energy Holdings Co. (BBB+/Stable) for the remainder, with the commitment reduced to the extent other permitted senior secured debt is issued and cash from operations prior to completion is earned.
Under the pro forma forecast, in early 2013 Topaz plans to issue another $430 million in senior secured notes maturing in 2039. We include both debt tranches in our analysis. Topaz began construction in December 2011 and plans to achieve operations in blocks at various dates, but is scheduled to achieve substantial completion in February 2015 and final completion in May 2015. The project’s power purchase and sale agreement (PPA) requires commercial operation from 550 MW by Aug. 18, 2015, giving several months of construction cushion.
Factors mitigating business risk are: -- A 25-year power purchase agreement (PPA) with investment-grade utility offtaker Pacific Gas & Electric Co. (PG&E; BBB/Stable/A-2), with performance requirements that -- Topaz will likely be able to meet, -- A proven panel technology, -- A solar resource that is fairly well characterized, -- Construction under an engineering, procurement, and construction (EPC) -- contract with proven contractor First Solar Inc. with incentives to -- achieve completion and with a contingency equal to 44% of non-fixed -- costs, and -- Low operational and maintenance (O&M) risk
While the PPA contains well-above-market prices, the California Public Utilities Commission has approved it and related transmission upgrade costs, and PG&E needs green energy from Topaz to meet California’s aggressive renewable portfolios standard. First Solar’s cadmium telluride thin film panels are a proven technology in our view, although with the drawback that the historical performance record of about 15 years is well short of the PPA term, which introduces the risk that panel performance may fall below expectations in the final third of the PPA’s term.
We assume a 0.9% annual degradation in our rating. The solar resource has a solid backing, including years of data collected at a nearby site. However, we analyzed cash flows under a P90 (one-year) probability of exceedance to account for potential variations. We note that performance at the P99 (one-year) level is above what we typically see for resource risk projects.
First Solar is building Topaz and providing the panels under a date-certain, fixed-price EPC contract that has some penalty and liquidated damages provisions to keep First Solar motivated to perform. There are several layers of milestone payments that should help to ensure that the project keeps on schedule. The construction is fairly simple--the modules are built in advance and are merely assembled at the site. The PPA and EPC incentive regimes are well aligned. First Solar will also perform O&M for a fixed fee with availability incentives.
Adding to business risk at the rating category is reliance on First Solar, which, as a firm in the highly competitive solar panel manufacturing space, has a credit profile below Topaz‘s, in our view, that could worsen over the three years of construction. However, we conclude that Topaz can replace First Solar and meet initial debt service and PPA requirements, and so, under our counterparty criteria, we can rate Topaz above our assessment of First Solar’s creditworthiness. Topaz will issue debt in two tranches, $850 million now and $430 million in early 2013, and we have factored the future tranche into the rating.
MidAmerican will contribute to Topaz as needed to fund construction up to a cap of $2.44 billion--which is the total estimated project cost, not just the EPC amount--with obligations reduced to the extent Topaz issues the second tranche of debt and earns the expected cash from operations before full commercial operations under the PPA as blocks come on line over time. This equity commitment meets our guarantee requirements and ranks equal to MidAmerican’s senior unsecured debt rating.
We conclude that equity will be provided to the project as needed in good and bad times and covers the modest risk that revenues from operations during construction will be inadequate. Importantly, we would view a failure of MidAmerican to contribute equity to Topaz on demand for any reason as a selective default by MidAmerican. Under the amortization profile, average debt service coverage ratios are roughly in the 1.3x to 1.4x range, depending on the stress and, in concert with the other business and financial risk exposures, adequate for the rating.
Compared with similar facilities, the sensitivity variation is modest. Topaz is a single-purpose entity with adequate operating and debt incurrence restrictions, but is not bankruptcy remote from higher rated MidAmerican. The cash management structure is essentially standard, with a trustee collecting and allocating revenues according to an appropriate waterfall and with distributions subject to forward and backward looking tests, with the forward test stronger than peers.
However, MidAmerican can borrow funds from the construction account at any time in exchange for a demand note--a mechanism that is atypical of project financing and unfavorable to project credit. Again, a failure of MidAmerican to repay borrowings on demand would be a selective default by MidAmerican. MidAmerican bought Topaz from First Solar, and Topaz is part of MidAmerican’s initial foray into the solar power market. To mitigate risk, MidAmerican relies on First Solar to build and maintain the project. First Solar is the world’s second-largest provider of such services.
We think MidAmerican has the ability to manage First Solar to achieve completion given its extensive record of utility scale construction management and deep experience with wind power projects. Liquidity Topaz has a $345 million letter of credit facility to provide credit support required under the PPA and transmission build agreements with PG&E for permitting obligations, and to provide debt service and O&M reserve requirements. The debt service reserve is sized to the highest six months obligation over a three-year look-ahead, an above-average test. The O&M reserve is funded to expenses six months forward. Outlook The outlook for the debt rating is stable based on our assessment of current construction arrangements and counterparty dependency assessments.
An improvement in the rating is not likely during construction, even if counterparty ratings increase, based on the construction, business, and financial risks. After construction, an improvement in the rating would require comfort that performance would well exceed our current expectations over the debt’s tenor. Factors that could lower the rating are major construction problems that seem remote presently or a decline in the creditworthiness of key counterparties.
Most exposure exists with First Solar; if our assessment of its creditworthiness declines substantially, we could lower the rating on the project based on our counterparty criteria.
Related Criteria And Research -- , Dec. 20, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks For -- Utility-Scale Solar Photovoltaic Projects,” Oct. 27, 2009 -- , Sept. 18, 2007 Ratings List New Rating Topaz Solar Farms LLC Senior Secured BBB-/Stable