Over the past decade, term loan Bs for merchant transactions have performed as intended--substituting default risk for refinancing risk. Even as an asset underperformed relative to expected cash flow sweeps, a benign financing environment allowed refinancing. Now, as forces of sustainability and disruption hover, it's time to pay the piper.

While coal-fired generation is an obvious victim of lower gas prices and receding lender interest because of sustainability mandates, we find some gas-fired assets leveraged to a higher gas price environment in distress as well. More than $2.5 billion in distressed merchant power debt matures in the next 14 months and we expect each of these generators to have difficulty refinancing. As a result, we rate these financings in the 'CCC' category.

These debt instruments were issued in 2013 and 2014 when natural gas prices were $3-$4 per million Btus (MMbtu) and a number of market participants believed capacity prices would be substantially higher at maturity. Instead, all-time low gas prices continue to drive energy margins ever lower. In addition, uncertainty around the future of the PJM Interconnection capacity market has created a difficult refinancing environment. Three of the five projects are coal-fired generators and represent more than $1.4 billion in debt maturities. As such, they face unique challenges related to environmental, social, and governance (ESG) factors and long-term competitiveness in the changing PJM market environment. The remaining two gas-fired plants (Panda Liberty LLC and Panda Patriot LLC) face approximately $1.1 billion in debt maturities. While we believe these assets continue to have intrinsic value as low-cost power producers, their capital structures are overleveraged. We do not believe they will be able to refinance it all.

Table 1

Although Longview Power LLC, Chief Power Finance LLC, and Sandy Creek Energy Associates L.P. are all distressed in our view and rated in the 'CCC' category, each has different credit drivers and likely paths to default. Sandy Creek is the only generator in this group not in the PJM power market and not purely merchant. It has long-term contracts through 2042 for 259 megawatts of capacity with two highly rated off-takers. As a coal-fired asset in the Electric Reliability Council of Texas (ERCOT) financed before the secular decline in gas prices began in 2014, the plant was expected to generate substantial merchant energy margin in addition to contracted cash flow such that debt outstanding at maturity would be about $375 million. The plant has not realized material merchant margin in the past seven years and still has about $900 million in outstanding debt (including the $100 million tax-exempt tranche).

Although we view the capital structure as distressed, we recognize Sandy Creek differs from its peers in that the long-term contract provisions provide substantial value. We view refinancing to be relatively less challenging than for purely merchant peers Chief Power and Longview. We think the project could still be refinanced on the strength of its contracted cash flows, although the field of lenders has significantly diminished owing to ESG-related factors. Coal-fired generators Chief Power and Longview in the PJM also face upcoming maturity cliffs. Chief Power's (CCC/Negative/--) term loan matures in December 2020, while Longview (CCC-/Negative/--) has a fully drawn revolver due in April 2020. Aside from modest capacity revenues, these merchant generators are fully exposed to market power prices, which have been low for a prolonged period because of cheap natural gas and, more recently, a mild winter. Given the ongoing replacement of base-load generation in the PJM by renewables and natural-gas plants, coal plants are being pushed further up the dispatch curve. This leaves them susceptible to cash flow stresses in periods of low natural gas prices. These periods lower the price of power across the regional transmission organization without providing coal operators the benefit of lower fuel costs. Despite important differences between these projects--Longview's recent free cash flow generation and near-term liquidity are materially weaker than those of Chief Power--both are vulnerable to the weakening economic outlook for coal plants.

In addition to weaker generation economics, increased investor concern over ESG risk factors have impaired the ability of all three S&P Global Ratings-rated coal projects to refinance their capital structures on acceptable terms. Because they are significant and visible contributors to anthropogenic climate change, we believe coal-fired generators face the long-term collapse of investor support, as several recent divestment announcements by high-profile asset managers illustrate. Investor concern over future regulatory costs (at both the state and federal levels) and the worsening public optics of owning coal assets significantly increase the potential cost of refinancing debt. In the cases of Sandy Creek, Longview, and Chief Power, we believe these cost increases are so significant that their capital structures are made unsustainable.

Panda Patriot and Panda Liberty are gas-fired combined-cycle gas turbines in the Pennsylvania region of the PJM market. As newer vintage plants (commercial operation date in 2016), they are among the newest, most efficient power plants in the U.S. Northeast with a sub-7,000 Btu per kilowatt-hour (kWh) heat rate and favorable year-round access to low-cost gas feedstock from the Marcellus shale play. Although both have faced difficulty with out-of-the-money hedges, which will mature in mid-2020, and higher-than-normal equivalent forced outage rate demand in periods of mechanical difficulty, or "teething", we believe they should operate economically for at least another 27 years.

Unlike those on the coal plants, both of our ratings are on CreditWatch with developing implications, which reflects our view that the rating could go up or down based on the outcome of a potential sale. A public U.S. Federal Energy Regulatory Commission filing on Jan. 17, 2020, highlighted the potential sale of the equity interests in Liberty and Patriot to a consortium of well-known energy investment firms. As such, we expect the rating and refinancing of both maturities will be contingent on this transaction.

We further note that approximately $1.5 billion of additional merchant power debt matures in 2021 for Panda Stonewall LLC and Astoria Energy LLC. However, these generators are not in distress and we believe they can refinance the outstanding debt at maturity.

Ultimately, lenders will face accepting more ESG risk to refinance coal-fired power plants and sponsors will face a decision to support them (not implied in our ratings) or lose their equity investment and relinquish control to lenders. For reference, we include the latest trading levels for these five generators, which show lenders' expectations for meaningful recovery for the two Panda assets and quite low recovery values for all PJM coal plants (Table 2).

Table 2

Finally, we believe certain generators should receive a higher recovery than others based on the fundamentals discussed above. For coal-fired generators, we recently revised our recovery assumptions downward to reflect ongoing economic challenges and ESG concerns faced by coal plants (see our update on recovery values for coal-fired projects, published Nov. 7, 2019). Since we believe the Patriot and Liberty assets have intrinsic value and a long remaining asset life, we estimate recovery above 90%. Sandy Creek's valuation is substantially higher than that of its peers because of the value of its underlying contracted cash flows through 2042.

Table 3