Overview -- U.S. power generator LSP Madison Funding is proposing to remove two key power plants (Doswell and Riverside) from its portfolio and to make other changes to the project structure. -- The project would pay down debt as required under the lending document, but seeks to pay down a lower amount than currently defined, subject to required lender approval. The $750 million senior secured term loan would be reduced to $475 million. -- We are affirming our 'BB+' rating and '2' recovery rating on the debt, based on the proposed changes. -- The outlook remains stable. Rating Action On Jan. 18, 2013, Standard & Poor's Ratings Services affirmed its 'BB+' rating on LSP Madison Funding LLC's senior secured term loan, based on a planned removal of two key assets and a lower debt pay-down resulting in a new debt balance of $475 million. The recovery rating remains at '2', indicating our expectation of substantial recovery (70% to 90%) of principal in a default scenario. The outlook on the rating is stable. Rationale U.S. project finance entity LSP Madison is planning to remove two assets that provide nearly one-half of cash flow, Doswell and Riverside, from its power generation portfolio. Based on its credit agreement, in removing the two assets, LSP Madison must pay down specified debt amounts on each. For Doswell and Riverside, these amounts are $200 million and $220 million, respectively. Instead, LSP Madison is proposing to pay down a lower amount, resulting in a revised debt balance of $475 million. With the change to the portfolio, our primary concern is higher debt outstanding throughout the term of the loan and weaker financial metrics. Compared with the original deal (initial leverage at $209 per kilowatt (kW) excluding project debt, and $321/kW including it), in the amended transaction leverage would be $258/kW excluding project debt and $384/kW including it. Despite the higher debt on a unit basis, we still view overall debt as modest and, under our base case, the project pays down the term loan by maturity. Compared with the original deal (minimum debt service coverage ratio (DSCR) of 2.42x and 2013 to 2018 average DSCR of 6.42x), in the proposed transaction, the minimum DSCR is 1.98x and for 2013 to 2018 the average DSCR is 4.04x. Regarding business risk, we view the portfolio as being weaker with two major assets eliminated. However, diversification measures are similar. Compared with the current portfolio (3,582 megawatts (MW) of gas-fired and hydro assets across diverse markets), the portfolio after the asset removal will total 1,843 MW. Asset mix remains similar, with about one-third of the portfolio combined-cycle gas turbines assets, 60% combustion turbine assets, and the remaining a 139 MW hydropower asset in Pennsylvania. Contracted margins are also similar, with about 46% of gross margins contracted. With the Doswell removal, which had project-debt associated with the asset, encumbered cash flow reduces to 13% (from 19% originally). As before, revenue from cleared capacity prices, hedges, and power purchase agreements (PPA; 69% of total revenues through 2015) provides the primary credit support for the stable outlook. Two additional developments that support the rating through enhanced cash flow are an extension in the Cherokee PPA through 2020 (previously, through June 2013) and a lower tax distribution cap. In the current deal, the tax distribution cap is set at $7.5 million through 2012 and $15 million afterward. The revised tax distribution cap is set at $5 million for each of 2013 and 2014 and zero dollars afterward. Liquidity The project's liquidity includes a six-month debt service reserve that is backed by a letter of credit (LOC) from LS Power Equity Partner II, and is backed by the fund's credit facility. If drawn, repayment of the LOC is an obligation of LS Power Equity Partners II and not LSP Madison. A cash-funded major maintenance reserve equal to 12 months of major maintenance expenses will be put in place and replenished from project cash flow through the life of the term loan. Currently, the project has the option to issue a $50 million working capital credit facility after close, but this allowance is removed in the proposed change to the agreement. Recovery analysis Based on the proposed changes, the recovery rating on the term loan is '2', indicating our expectation for substantial (70% to 90%) recovery of principal if a payment default occurs. Outlook The stable rating outlook reflects our expectations that the project's more stable revenue streams, consisting of PPAs, hedged power prices, and capacity payments, will allow for significant deleveraging over the loan's tenor, even if merchant power revenues are weak. A ratings upgrade is unlikely given the limited asset diversity, the age of the assets, and the project's exposure to merchant power revenue. If the assets underperform operationally, causing energy gross margins and capacity payment revenue to fall below expectations, we could lower the ratings. We could also lower ratings if we materially lower our base-case assumptions, which would affect our expectations of merchant revenue. An adverse change to the business profile or developments that would lead to greater refinancing risk of over $100/kW or more could well lead to a downgrade. Related Criteria And Research -- Standard & Poor's Lowers Its U.S. Natural Gas Price Assumptions; Oil Price Assumptions Are Unchanged, April 18, 2012 -- Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007 -- Criteria for Special-Purpose Entities In Project Finance Transactions, Nov. 20, 2000 Ratings List Rating Affirmed; Recovery Rating Unchanged LSP Madison Funding LLC $750 mil sr secd term bank loan BB+/Stable 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.