October 17, 2022
This is a tricky one. Homer City Generation LP is a 2 GW coal burning power station, located in Pennsylvania. The key words here are "coal" and "Pennsylvania". As you might know, coal fired power plants are not popular these days. It seems the State of Pennsylvania wants to join a Northeast Green initiative that might make Homer City's continuing operation untenable. In fact, just a few months ago, the owners of the plant were considering throwing in the towel and ending operations in 2023. In the interim, an almighty legal battle is underway seeking to keep Pennsylvania from joining its neighbors in a Green alliance.
With that issue unresolved, the owners of Homer City Generation decided in the spring to continue operating. For the BDC Credit Reporter, this still leaves us concerned. Already, as of the IIQ 2022, the only BDC with exposure - Cion Investment (CION) - had discounted its $11.3mn first lien loan to Homer City by (25%). We can only imagine what would happen to the value of an old (built in 1969), non-operational coal-fired plant should the legal battle be resolved in the favor of the state of Pennsylvania, which is seeking to join the green group.
As a result - and to underscore the risk involved - we've just downgraded the company from CCR 3 to CCR 4. Also worrying is that CION is charging a very high rate of interest - 15.0% per annum - and that the borrower is paying this obligation in kind ("PIK"). Those kind of yields typically reflect higher than usual risk, as does the decision of the borrower to PIK the payment.
Frankly, we don't understand why a large BDC like CION would risk itself in a single power plant, and one that has already filed for Chapter 11 bankruptcy twice before. We'd have expected - without taking any sort of political position - that any lender would have run the other way when being offered the opportunity to lend to anything fueled by coal - one of the most unpopular of fossil fuels from a regulatory perspective. Unfortunately, the first lien status of the loan won't help much if the plant is de-commissioned.
The CION loan expires in April 2023. We'll be very interested to see if the facility gets refinanced by a third party or the BDC itself and what happens in the courts. There's ($1.7mn) of annual investment income at risk here, and the possibility of a much bigger ultimate write-down than the (25%) already reserved.