TEXT-S&P cuts L.S. Power Funding rating to 'BBB-'

Fri Dec 14, 2012 3:21pm EST

-- Standard & Poor's is lowering its rating on L.S. Power Funding Corp.'s 
$226.49 million ($175.1 million outstanding as of Sept. 30, 2012) senior 
secured notes to 'BBB-' from 'BBB'.
     -- The lowered rating reflects a debt service coverage ratio (DSCR) at 
Cottage Grove LP that has been below 1.4x since 2010 and our expectations that 
it will remain below 1.4x on average until debt maturity in 2016. Coverage in 
this range is typical of a 'BBB-' rating. Lower energy payments given lower 
power prices in the Midwest Independent System Operator (MISO) region and 
higher debt service (averaging $22 million at Cottage Grove until 2016 versus 
$18.5 million in the preceding five years) are the two main factors 
contributing to the lower coverage. 
     -- The outlook is stable and reflects our view that capacity payments 
received are adequate to meet annual amortizing debt payments. While we expect 
the capacity factor to improve to around 20%. We forecast DSCR to average 
1.35x at Cottage Grove and 1.45x at Whitewater until debt maturity at 2016.
    
     Dec 14 - Standard and Poor's Ratings Services today lowered its rating on
L.S. Power Funding Corp.'s $226.49 million ($175.1 million outstanding as of
Sept. 30, 2012) senior secured notes to 'BBB-' from 'BBB'. The lowered rating
reflects a DSCR at Cottage Grove LP that has been below 1.4x since 2010 and our
expectations that it will remain below 1.4x on average until debt maturity in
2016. Coverage in this range is typical of a 'BBB-' rating. 

LS Power Funding is a special-purpose corporation formed to issue the two 
series of senior secured bonds in June 1995 and to use the $332 million of 
proceeds to purchase first-mortgage bonds from the two projects -- $155 
million from Cottage Grove and $177 million from Whitewater. The first 
mortgage bond proceeds funded construction of the Cottage Grove and Whitewater 
cogeneration projects, which are two 245 megawatt (MW) combined-cycle, natural 
gas-fired power plants. The first mortgage bonds secure the senior secured 
bonds. The Cottage Grove and Whitewater first mortgage bonds are each secured 
separately by the individual projects, with revenue mainly coming from a long 
term power purchase agreement (PPA) at each project. The rating on the bonds 
is determined by the weaker of the two partnerships because the legal 
structure allocates a portion of the debt to each partnership rather than 
combining cash flow from both plants to meet a common debt service. 

The 'BBB-' rating on LS Power Funding's senior secured bonds reflects the 
following credit strengths: 
     -- Revenue comes from PPAs with stable availability-based capacity 
payments that cover debt service and other fixed expenses under most stress 
scenarios. The PPAs pass most variable operating expenses through to offtakers 
and do not terminate on a loss of qualifying facility (QF) status; 
     -- Investment grade-rated purchasing utilities are PPA counterparties;   
     -- The availability history for both plants is high, above 98%. 
Availability at Whitewater fell to 85.2% in 2011 because of a forced outage 
event. We expect availability to remain above 98% through 2016. 
     -- Liquidity is adequate, with letters of credit equal to six months of a 
debt service reserve. Long term service agreements, with Siemens Energy Inc., 
for each plant provide additional stability of cash flows.

However, the rating also reflects the following credit risks: 
     -- Continued low power prices could affect energy payments, leading to 
lower coverages even though the capacity payments do cover debt service and 
fixed operations and maintenance expenses.
     -- Outages at Whitewater and Cottage Grove could impact payments as they 
are based on availability at the respective plants.
     -- Steam supply contracts for Whitewater are subject to renegotiation and 
renewal before the senior bonds mature. Steam constitutes only 1% of the 
Whitewater plant's revenue.  

The two plants are located in Cottage Grove, Minn. and Whitewater, Wis., 
respectively, and began commercial operations in late 1997. Cottage Grove has 
a 30-year PPA with Northern States Power Co. (A-/Stable/A-2) and a thermal 
sales agreement with 3M Co. (AA-/Stable/A-1+), which both run through October 
2027. Whitewater has a 25-year PPA with Wisconsin Electric Power Co. (WEPCO; 
A-/Positive/A-2) that runs through May 2022. Whitewater sells steam to the 
University of Wisconsin-Whitewater under an agreement that runs through June 
2013, with extension options. 

We forecast DSCR to average 1.35x at Cottage Grove and 1.45x at Whitewater 
until debt maturity at 2016.

The project's operational management changed during July and August 2010, when 
North American Energy Services replaced Cogentrix Energy LLC and its operating 
subsidiaries. We do not expect this to have a significant effect on operations 
in the near term, as most plant staff remained in place.

Restricted and unrestricted cash at Cottage Grove totaled $9.22 million at 
Sept. 30, 2012, similar to $8.79 million at Sept. 30, 2011. Restricted and 
unrestricted cash at Cottage Grove totaled $1.85 million at Dec. 31, 2011, 
down from $3.5 million at Dec. 31, 2010, following debt service payments on 
Dec. 30. 

Restricted and unrestricted cash at Whitewater totaled $10.7 million at Sept. 
30, 2012, similar to $9.5 million at Sept. 30, 2011. Restricted and 
unrestricted cash at Whitewater totaled $4.1 million at Dec. 31, 2011, down 
from $3.2 million at Dec. 31, 2010. Very little cash is held at LS Power 
Funding Corp. 

The Cottage Grove and Whitewater partnerships must maintain a six month. first 
mortgage bond debt service reserve fund equal to the maximum semiannual debt 
service in the next 18 months. As of Sept. 30, 2012, these reserves equaled 
about $10.5 million and $12 million, respectively. Since 1999, the debt 
service reserves have been held by equity owners in exchange for a promissory 
note supported by a letter of credit (LOC) from a bank. The current LOCs are 
provided by Credit Agricole (A/Negative/A-1) for the EIF Calypso fund (80%) 
and by Citibank (A/Negative/A-1) for the EIF Calypso II fund (20%). Both LOCs 
expire in Feb 2014. Neither LS Power Funding nor the partnerships are 
responsible for repayment of any draws on the LOCs. 

Each partnership maintains a credit facility with Credit Agricole that expires 
in February 2014. These facilities provide working capital loans of up to $3 
million for each of the two partnerships and LOC commitments of up to $5 
million for Whitewater, as well as $5.5 million for Cottage Grove. No working 
capital loans were outstanding as of Sept. 30, 2012. $500,000 of the LOC 
facility for Cottage Grove has remained drawn since before 2006 to secure its 
obligations to Northern States Power under the PPA. 

Each partnership must maintain a major maintenance reserve funded to $400,000 
in the initial year (currently escalated to about $571,000), which it funds in 
equal monthly installments throughout the year. Any unused reserve amounts are 
returned to the revenue account at the end of each year. The reserve balance 
is included in unrestricted cash on the balance sheet. 

The distribution test for each of the two partnerships is adequate at the 
rating level. It requires a 1.2x debt service coverage ratio for four 
quarters, historic and projected.  Distributions to cover the partners' 
income-tax deficiency are allowed at 1.15x.

Debt service is paid on Dec. 30 and June 30. Total annual debt service 
increases fairly steadily by about $1 million to $2 million per year in most 
years, from about $30 million in 2002 to about $45 million in 2013, about $44 
million in 2014, about $48 million in 2015, and $56 million in 2016. The final 
payment is due Dec. 30, 2016. Cottage Grove pays about 47% of debt service on 
each payment date, and Whitewater pays about 53%, in proportion to their share 
of first mortgage bonds outstanding. 

The stable outlook reflects our view that capacity payments received are 
adequate to meet annual amortizing debt payments. While we expect the capacity 
factor to improve to around 20%, DSCR at Cottage Grove will remain below 1.40x 
till 2016, with the exception of 2014 when DSCR is above 1.4x due to the lower 
debt payment. We expect coverage levels at Whitewater will also likely be 
above 1.40x through the 2016 debt maturity. Low coverage at either partnership 
could result in a downgrade because the debt structure does not provide for 
high coverage at one partnership to subsidize low coverage at the other. 

We could lower the rating if lower availability due to plant outages or a 
decline in capacity factor to below 10% lead to a DSCR of below 1.25x until 
debt maturity. We could raise the rating if higher capacity factors, along 
with high plant efficiencies, lead to a DSCR above 1.40x through 2016.

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

RATING LIST

Ratings Lowered
                        To        From

LS Power Funding Corp.
  Senior secured notes        BBB-/Stable    BBB/Negative


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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