TEXT-S&P affirms NRG Energy rating, raises GenOn rating

Wed Dec 19, 2012 1:23pm EST

Overview
     -- NRG Energy and GenOn Energy have completed their merger,
creating the largest independent power producer in the U.S. GenOn is now a
subsidiary of NRG of some strategic importance, but GenOn's debt remains
nonrecourse to NRG.
     -- We affirmed our corporate credit rating on NRG at 'BB-', based on 
consolidated financial measures.
     -- At the same time, we raised our corporate credit ratings on GenOn and 
its subsidiaries to 'B' from 'B-', reflecting the nonrecourse position of 
GenOn and evident optionality of its ownership by NRG.
     -- We are removing all NRG and GenOn ratings from CreditWatch. The 
outlook is stable.

Rating Action
On Dec. 19, 2012, Standard & Poor's Ratings Services affirmed its 'BB-' 
corporate credit rating on NRG Energy Inc. and removed the ratings from 
CreditWatch with negative implications, where we placed them on July 23, 2012. 
At the same time, we raised GenOn Energy Inc.'s ratings to 'B' from 'B-' and 
removed them from CreditWatch positive, where we placed them on July 23, 2012. 

Rationale
The rating actions follow the closing of NRG's merger with GenOn. Following 
the exchange, NRG's existing shareholders own about 71% of the pro forma 
company. 

NRG had about $11.3 billion of total debt as of Sept. 30, 2012. Recourse 
corporate debt was about $8.05 billion. GenOn has about $3.7 billion of 
outstanding debt pro forma after paying off the term loan B, but we impute 
about $1.8 billion in additional debt into our financial measures to reflect 
operating lease liabilities at key subsidiaries GenOn MidAtlantic LLC and 
GenOn REMA LLC.

A wholly owned excluded subsidiary of NRG has merged with and into GenOn, with 
GenOn continuing as the surviving corporation in the merger and becoming a 
wholly owned subsidiary of NRG. We note that GenOn has merged with NRG as an 
excluded project subsidiary largely because GenOn's holding company notes 
currently contain more restrictive covenants than NRG's. We consider the 
consolidated entity to have a "fair" business risk profile and an "aggressive" 
financial risk profile, which when factoring in our view that the company will 
have strong positive free cash flow over the next two to three years and 
above-average liquidity, results in a 'BB-' rating for NRG. We rate GenOn 
lower than NRG noting its higher stand-alone business and financial risk 
profiles than NRG and the ownership structure in the NRG hierarchy that would 
enable NRG to walk away from the heavily coal-based GenOn unit if warranted.

GenOn has become an excluded subsidiary under NRG's credit documents. NRG will 
not provide GenOn enhancements such as additional liens, mortgages, and/or 
guarantees and also has no obligation to commit cash to GenOn. GenOn's cash 
balances that remain after paydown of senior secured debt at GenOn will stay 
at GenOn. A shared-services agreement between both companies is expected to 
preserve all of the cash flow benefits of a merged structure, enabling NRG to 
capture synergies at the parent level even as the two companies operate at 
arm's length.

At the same time, GenOn's indentures and credit agreement did not envision a 
"parent" so there are no cross-defaults to NRG's debt, either. NRG and GenOn 
also cannot co-mingle cash as GenOn is still subject to its debt covenants and 
restricted payment restrictions. Although GenOn's debt will remain nonrecourse 
with respect to NRG's first-lien facilities, from an analytical perspective, 
we have consolidated GenOn's debt when assessing the company because we 
believe GenOn to be strategically important to NRG for now. 

We raised GenOn's corporate rating by one notch to 'B'. The upgrade reflects 
that the company benefits from optimization of its portfolio through scope and 
scale, lower operating and maintenance expenses, and the extension of a 
secured revolving credit facility (about $500 million) from NRG. While GenOn 
has repaid its $686 million term loan and improved its stand-alone financial 
measures, it has used to pay down the term loan and also reduced liquidity 
further by terminating the $788 million revolving facility. Finally, we have 
not equalized GenOn's ratings with NRG's to underscore the nonrecourse 
optionality NRG retains and its intention to operate the two businesses at 
arm's length. Over time, if we see a deeper relationship between the two units 
that could stand in times of stress, a lesser separation would follow.

Our "fair" business risk profile on NRG (which now includes GenOn's assets) 
mostly reflects the company's fundamental exposure to volatile commodity 
markets, balanced by a hedging program and ongoing efforts by the company to 
reduce the influence of natural gas price volatility on its cash flows. 
Although GenOn's stand-alone business risk profile was weaker than that of 
NRG, offsetting factors include benefits of wide geographic, fuel type, and 
technology diversity and scale that provide a power generation platform for 
NRG's retail business to expand in the Northeast with its large load centers 
and more stable capacity market revenues.

The following strengths support the combined credit quality at the 'BB-' level:
     -- Very large scale. The combined company has a capacity of more than 47 
gigawatts and offers geographical diversity and scale across several markets, 
providing it the opportunity to participate in PJM Interconnection, 
California, Electric Reliability Council of Texas (ERCOT), and New England 
Power Pool--the largest deregulated power markets in the U.S.
     -- Dispatch diversity. The combination has an improved dispatch profile 
with a better mix of base load, mid-merit, and peaking facilities in regions 
where it owns generation, with the ability to better capitalize on wholesale 
market movements. 
     -- Economies of scale. Cost-reduction through merger synergies will 
result in a better cost structure and improve its position in competitive 
electricity commodity markets. Management estimates that the pro forma 
combination will result in $300 million in annual savings, and we estimate 
merger savings will be a significant 35% of GenOn's EBITDA levels. We have 
assumed a lower $225 million to $250 million of cost improvements in our 
analysis.
     -- Each company still has excess cash on hand and the stand-alone NRG 
continues to generate free cash flow, even under our natural gas, power, and 
capacity pricing assumptions.

Over the next two years, we expect expanding heat rates in ERCOT, improved New 
York capacity prices, and higher heat rates in the West to result in higher 
power market prices in NRG's market than the low levels seen this year due to 
lower demand and depressed natural gas prices. We also expect The Public 
Utilities Commission of Texas's additional market design changes to benefit 
NRG's cash flows in that region. Market heat rates have responded to the 
systemwide price caps increase to $5,000 per megawatt-hour (MWh) (starting 
June 1, 2013), $7,000 per MWh in 2014, and $9,000 per MWh in 2015 (from $3,000 
per MWh in January 2012; raised to $4,500 per MWh in July 2012). Other upside 
opportunities include retail expansion in the Northeast, future repowering 
projects in New York and California, and monetization of the solar power 
portfolio in which NRG has infused about $1.5 billion of equity to date. 

Still, with all the potential upside, risks to the long-term pro forma margins 
remain from a potential lengthy suppression in natural gas prices and 
differences in power prices throughout the Mid-Atlantic region, reduction in 
capacity revenues from additional aged coal plant retirements at GenOn, or 
contraction in retail margins in ERCOT. We also believe weather-driven demand 
remains weak, and that the commodity environment is uncertain, which had 
resulted in increasing pressure on NRG's financial profile. Our negative 
outlook on NRG earlier in the year reflected the potential for a negative 
rating action given two weak quarters as natural gas prices plunged and the 
company's weakening financial measures. We lowered GenOn's rating earlier this 
year due to the same cash flow risk reasons. However, the second and third 
quarters ended strong, and natural gas prices seem to be edging up from low 
2012 levels. NRG has generated free cash flow before strategic growth 
investments of about $806 million year-to-date through September 2012. 

NRG's hedging program has bolstered cash flow protection measures in the past 
two years and has allowed the company to maintain a relatively stronger 
financial profile compared with other independent power producers. Still, 
while NRG has aggressively hedged its base-load generation into 2015, these 
hedges are at significantly lower prices, resulting in a declining EBITDA 
profile for its wholesale business. In our forecast, we stress market heat 
rates and gas prices. We assume natural gas prices remain low ($3.00 and $3.50 
per million Btu in 2013 and 2014, respectively, and growing with inflation 
thereafter) and market heat rates fall by about 1,000 Btu per kilowatt-hour 
(kWh) than current implied forward heat rates. We expect cash flow from 
operations to interest of about 2.0x and cash flow to debt of  between 12.5% 
to 13.5% in the 2012-2014 period (we consider Cash flow from operations 
instead of funds from operations for NRG as we record some distributions, such 
as the ones from its solar portfolio, in its working capital swings). 
Important from the financial risk profile perspective is that the company 
remains free cash flow positive under our price sensitivities, with free cash 
flow estimates at a low of $200 million in 2012, but rising to about $900 
million by 2014. Debt to EBITDA is high for an aggressive financial profile, 
but will remain under 5.75x through 2014, even under Standard & Poor's 
sensitivity. Notably, leverage does not decline as much as in earlier years 
because of the elimination of the 50% excess cash flow sweep as part of the 
refinancing of NRG's first-lien facilities. 

Although risk practices are largely prudent, we believe execution risks are 
still meaningful, given the setback NRG had in its retail operations in Texas 
last summer because of extended hot weather. We currently score management as 
"fair" under our new management and governance criteria. A reasonable mix of 
executives from both companies will run the new conglomerate with strategy and 
operations run by leadership from the former NRG side and finance functions by 
leadership from the GenOn side.  

Liquidity
We consider NRG's liquidity to be "adequate." The company has abundant 
liquidity for its operations and growth investments over the next 12 to 24 
months, even  if moderate, unforeseen EBITDA declines occur. As of Sept. 30, 
2012, NRG had about $1.6 billion of cash on hand and $1.1 billion available 
under its bank and letter of credit facilities. Similarly, as of Sept. 30, 
2012, GenOn has about $1.9 billion of cash on hand. Management has used 
cash-on-hand to retire the outstanding $686 million term loan at GenOn, but 
the combination still has more than $2.8 billion of cash available on hand at 
various entities. 

Under the terms of GenOn Energy Holdings Inc.'s debt, about $2.5 billion in 
senior unsecured notes has a change-of-control acceleration event at the 
option of the lenders. The merger may require refinancing or repricing of this 
debt. The combination has cash-on-hand and a $1 billion bridge loan to address 
additional liquidity requirements if lenders exercise the put option. However, 
we believe that risk is low given where the debt is currently trading. 

GenOn's $788 million revolving credit facility has been eliminated. NRG has 
replaced the bank revolver and has provided GenOn a $500 million secured 
revolver. The revolver is not funded, but is backstopped by NRG's $2.3 billion 
revolver and is meant to be mostly used to provide letters of credit for 
trading collateral needs. As of Dec. 14, 2012, there was about $280 million of 
letters of credit issued under this new revolver. We will continue to monitor 
if this reduced level of credit facilities is appropriate for the size of the 
business. 

We believe sources would substantially exceed uses even with a 20% decline in 
EBITDA. NRG's ability to use "right-way risk" asset pledges to collateralize 
counterparties in lieu of cash or letters of credit significantly mitigates 
liquidity risks when commodity prices rise. The EBITDA cushion in NRG's 
covenants is about 25%. Management has been prudent about liquidity, having 
maintained substantial cash balances in addition to unused bank lines and 
right-way-risk facilities during the past two years. 

Overall, NRG's ratio of sources to uses is strong at about 1.75x over the next 
12 months (includes all expected capital spending), substantially more than 
the 1.2x required for the "adequate" category. Yet, we consider NRG's 
liquidity position as adequate because of more qualitative factors such as its 
average standing in credit markets. The company's credit default swap spreads 
have generally widened as gas prices have declined. In July 2011, NRG replaced 
its senior credit facility, consisting of its term loan facility, revolving 
credit facility, and funded letter of credit facility, with a new senior 
secured facility that included a $2.3 billion revolver maturing July 2016 and 
$1.6 billion term loan maturing July 2018.

Recovery analysis
There are no changes to the recovery scores at both entities. Please see 
latest recovery reports on NRG and GenOn published June 28, 2012 Dec. 16, 
2011, respectively. An updated GenOn stand-alone recovery analysis will be 
published shortly. We note that GenOn's unsecured debt rating recovery score 
of 4 did not change with the retirement of the term loan and elimination of 
the revolver. The reason for this is two-fold: we performed our recovery 
analysis on a discrete asset basis and have reduced the $-per-kilowatt values 
for coal plants given the low natural gas prices; and, GenOn has announced 
several additional coal plant retirements, thus reducing the enterprise 
valuation assessment.

Outlook
The stable outlook reflects our view that the business risk profile, financial 
risk profile, free cash flow, and liquidity are not likely to change from our 
expectations over the next two years. There is no upside potential for NRG's 
ratings through 2014 given that we expect the company's consolidated cash flow 
from operations to debt ratio to be at the weaker end for the rated level, at 
about 12% to 13% through 2013. We will likely lower NRG's ratings if its cash 
flow to debt measures decline consistently below 12%. Still, free operating 
cash flow to debt and discretionary cash flow to debt ratios remain strong, at 
about 7% and 6%, respectively, indicating the large free cash flow generation 
potential, which will allow the company to internally fund both its capital 
spending and distributions even under our price deck. We believe GenOn's 
operations are strategically important to NRG, but will maintain the rating 
differential because NRG retains the optionality of walking away from GenOn's 
nonrecourse debt. Over time, if we see a deeper relationship between the two 
units that could stand in times of stress, a lesser separation would follow. 
Ratings would also be affected--with NRG's likely declining--if NRG extends 
support to GenOn if its credit quality deteriorates. 

Related Criteria And Research
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
May 27, 2009
     -- Credit FAQ: Standard & Poor's New Approach To Speculative-Grade 
Ratings, May 13, 2008
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Ratings Affirmed; Off CreditWatch
NRG Energy Inc.
                            To                 From
Corporate Credit Rating     BB-/Stable/--    BB-/Watch Neg/--
Senior Secured              BB+              BB+/Watch Neg   
 Recovery Rating            1                1
Senior Unsecured            BB-              BB-/Watch Neg      
 Recovery Rating            3                3

Ratings Raised; Off CreditWatch
GenOn Energy Inc.
GenOn Americas LLC
GenOn REMA LLC
GenOn Energy Holdings Inc.
 Corporate Credit Rating     B/Stable/--      B-/Watch Pos/--   

GenOn Energy Inc.
 Senior Unsecured            B                B-/Watch Pos     
  Recovery Rating            4                4

GenOn Americas LLC
 Senior Unsecured            BB-              B+/Watch Pos    
   Recovery Rating           1                1

GenOn Mid-Atlantic LLC
 Senior Secured              BB-              B+/Watch Pos 
   Recovery Rating           1                1

Ratings Affirmed, Off Watch; New Recovery Rating
GenOn REMA LLC
Senior Secured               B+               B+/Watch Pos
   Recovery Rating           2


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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