Talen Energy Corp: Form 10-Q for the period ended Sep 30, 2016

This "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" is separately filed by Talen Energy Corporation and Talen Energy Supply. Any information contained herein relating to an individual registrant is filed by such registrant solely on its own behalf, and neither registrant makes any representation as to information relating to the other registrant except that information relating to Talen Energy Supply and its subsidiaries is also attributed to Talen Energy Corporation and information relating to the subsidiaries of Talen Energy Supply is also attributed to Talen Energy Supply. As Talen Energy Corporation is substantially comprised of Talen Energy Supply and its subsidiaries, most disclosures refer to Talen Energy and are intended to be applicable to both registrants. When identification of a particular entity is considered important to understanding the matter being disclosed, the specific entity's name is used, in particular, for those few disclosures that apply only to Talen Energy Corporation.

Talen Energy Supply is considered the accounting predecessor of Talen Energy Corporation. Therefore, the financial information prior to the June 2015 spinoff presented in this Quarterly Report on Form 10-Q for both registrants includes only legacy Talen Energy Supply information. From June 1, 2015, upon completion of the spinoff and acquisition, Talen Energy Corporation's and Talen Energy Supply's consolidated financial information also includes RJS. As such, Talen Energy Corporation's and Talen Energy Supply's consolidated financial information presented in this Quarterly Report on Form 10-Q for the 2015 periods represents three and nine months of legacy Talen Energy Supply information consolidated with three and four months of RJS information from June 1, 2015. See Note 1 in Talen Energy's 2015 Form 10-K for a discussion of the June 2015 spinoff from PPL and formation of Talen Energy.

The following should be read in conjunction with Talen Energy's Condensed Consolidated Financial Statements and accompanying Notes and with Talen Energy's 2015 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, except per share data, unless otherwise noted.

Overview

Introduction

Talen Energy is a North American competitive power generation and marketing company headquartered in Allentown, Pennsylvania. Talen Energy produces and sells electricity, capacity and ancillary services from its fleet of power plants totaling approximately 16,000 MW, principally located in the Northeast, Mid-Atlantic and Southwest regions of the U.S.

Business Strategy

Talen Energy seeks to optimize the value from its competitive power generation assets and marketing portfolios while mitigating near-term volatility in both cash flow and earnings metrics. Talen Energy endeavors to accomplish this by matching projected output from its generation assets with forward power sales in the wholesale and retail markets while effectively managing exposure to fuel price volatility, counterparty credit risk and operational risk. Talen Energy is focused on safe, reliable, and resilient operations, disciplined capital investment, portfolio optimization, cost management and the pursuit of value enhancing growth opportunities.

To manage financing costs and access to credit markets, and to fund capital expenditures and growth opportunities, a key objective of Talen Energy is to maintain adequate liquidity capacity. In addition, Talen Energy has a financial risk management policy and operational procedures that, among other things, are designed to monitor and manage exposure to earnings and cash flow volatility related to, as applicable, changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of generating units. To manage these risks, Talen Energy generally uses contracts such as forwards, options, swaps and insurance contracts primarily focused on mitigating cash flow volatility within the next 12 month period.

Merger Agreement

On June 2, 2016, Talen Energy Corporation entered into an Agreement and Plan of Merger (the Merger Agreement) with RPH Parent LLC, SPH Parent LLC, CRJ Parent LLC (each, an affiliate of Riverstone, and collectively referred to as "Parent"), and RJS Merger Sub Inc. (a wholly owned subsidiary of Parent referred to as "Merger Sub"), pursuant to which Merger Sub will merge with and into Talen Energy Corporation (the Merger), with Talen Energy Corporation continuing as the surviving corporation on the terms and conditions set forth in the Merger Agreement. On October 6, 2016, the stockholders of Talen Energy Corporation approved the Merger. Talen Energy Corporation currently expects the transaction to be completed by the end of 2016, subject to NRC approval and satisfaction of other customary closing conditions.

At the effective time of the Merger, each share of Talen Energy Corporation common stock outstanding immediately before the effective time of the Merger (excluding shares held by Parent, Merger Sub or certain affiliates of Riverstone and excluding shares pursuant to which dissenting rights under Delaware law have been properly exercised and not withdrawn or lost) will be automatically converted into the right to receive $14.00 in cash, without interest (the Merger Consideration). In addition, affiliates of Riverstone will convert, at the Effective Time, their existing ownership of approximately 35% of the issued and outstanding shares of Talen Energy Corporation common stock into shares of the surviving corporation.

The Merger Consideration will be funded by Talen Energy's cash on hand and the proceeds of a new senior secured term loan. The Talen Energy Supply RCF will be reduced from $1.85 billion to $1.4 billion upon closing of the transaction. See Note 6 for additional information on merger-related financing arrangements.

Consummation of the Merger is conditioned on Talen Energy Corporation's satisfaction or receipt of a waiver of certain requirements of the separation agreement entered into in connection with the spinoff of Talen Energy Corporation from PPL (and certain related transactions), generally requiring the delivery of an IRS ruling or a tax opinion from a tax expert to the effect that the Merger will not jeopardize the intended tax-free treatment of the spinoff and certain related transactions. Consummation of the Merger is not subject to a financing condition, but is subject to a condition that Talen Energy Corporation has unrestricted cash and cash equivalents and undrawn revolver capacity equal to at least $350 million at closing, subject to certain exceptions, and after taking into account the proceeds of the new senior secured term loan discussed above. Consummation of the Merger is also subject to the condition that immediately prior to the closing, certain specified defaults and events of default under the Talen Energy Supply RCF shall not have occurred. The Merger Agreement contains certain termination rights, including the right of Talen Energy Corporation to terminate the Merger Agreement to accept a superior proposal, subject to specified limitations, and provides that, upon termination of the Merger Agreement by Talen Energy Corporation or Parent upon specified conditions, Talen Energy Corporation will be required to pay Parent a termination fee of $50 million. Upon termination of the Merger Agreement by Talen Energy Corporation or Parent under specified conditions, Parent will be required to pay Talen Energy Corporation a termination fee of $85 million.

The Merger Agreement permitted Talen Energy Corporation and its advisors to actively solicit and negotiate alternative acquisition proposals from third parties during a "go-shop" period that began on June 2, 2016 and expired on July 12, 2016. No alternative proposals were received that would constitute a superior proposal under the Merger Agreement. Talen Energy Corporation is now subject to customary "no shop" restrictions prohibiting Talen Energy Corporation, its subsidiaries, directors, officers, employees and other representatives from soliciting alternative proposals from third parties or providing information to or participating in any discussions or negotiations with third parties regarding alternative proposals. These non-solicitation provisions are subject to a "fiduciary out" provision that allows Talen Energy Corporation to provide non-public information and participate in discussions and negotiations with respect to certain unsolicited written acquisition proposals and upon payment of the termination fee to terminate the Merger Agreement and enter into an alternative acquisition agreement if the Board of Directors determines in good faith after consultation with outside legal and financial advisors that such proposal constitutes a superior proposal under the terms of the Merger Agreement.

In connection with entering into the Merger Agreement, the Riverstone Holders entered into a support agreement pursuant to which such parties committed to vote their shares of Talen Energy Corporation common stock in favor of, and take certain other actions in furtherance of, the transactions contemplated by the Merger Agreement, including the Merger.

On June 2, 2016, the subsidiaries that guarantee the Talen Energy Supply RCF agreed to unconditionally guarantee, effective upon the closing of the Merger and the other transactions contemplated by the Merger Agreement, all of Talen Energy Supply's obligations with respect to its 6.5% Senior Notes due 2025 and Exempt Facilities Revenue Refunding Bonds, Series 2009A, Series 2009B and Series 2009C.

The Merger Agreement and the above summary of certain of its terms have been included to provide information regarding the terms of the Merger Agreement. Factual disclosures about Talen Energy Corporation contained in this report may supplement, update or modify the factual disclosures about Talen Energy Corporation contained in the Merger Agreement. The representations, warranties and covenants made in the Merger Agreement by Talen Energy Corporation, Parent and Merger Sub were qualified and subject to important limitations agreed to by Talen Energy Corporation, Parent and Merger Sub in connection with negotiating the terms of the Merger Agreement. The representations and warranties contained in the Merger Agreement were negotiated with the principal purposes of establishing the circumstances in which a party to the Merger Agreement may have the right not to close the Merger if the representations and warranties of the other party prove to be untrue due to a change in circumstance or otherwise, and allocating risk between the parties to the Merger Agreement, rather than establishing matters as facts. The representations and warranties may also be subject to a contractual standard of materiality different from those generally applicable to stockholders and reports and documents filed with the SEC. Moreover, information concerning the subject matter of the representations and warranties, which do not purport to be accurate as of the date of this report, (i) is contained, in part, on schedules to the Merger Agreement that have not been filed with the SEC in reliance upon applicable SEC regulations and (ii) may have changed since the date of the Merger Agreement and subsequent developments or new information qualifying a representation or warranty may or may not have been included in this report.

For further information on the Merger, the Merger Agreement, the consent agreement, the support agreement and other Merger-related agreements, please refer to the Current Report on Form 8-K filed on June 6, 2016 and the proxy statement filed on September 2, 2016 by Talen Energy Corporation. The foregoing descriptions of the Merger Agreement, the consent agreement and the support agreement are subject to, and qualified in their entirety by, the full text of those agreements as attached as exhibits to the Form 8-K filed on June 6, 2016, each of which is incorporated by reference herein.

The Merger poses certain risks to Talen Energy during the pendency of the transaction. See "Item 1A. Risk Factors" in Part II of this Form 10-Q for additional information.

Key Performance Measures

In addition to operating income (loss), Talen Energy utilizes Adjusted EBITDA and Margins, both non-GAAP financial measures, as indicators of performance for its business, with Adjusted EBITDA as the primary financial performance measure used by management to evaluate its business and monitor results of operations. Results for the periods ended September 30 were as follows:

See "Results of Operations" and for a detailed analysis of Talen Energy's results, the definitions of Margins and Adjusted EBITDA and reconciliation of these non-GAAP measures to related GAAP measures.

Executive Summary

For the three months ended September 30, 2016 compared with 2015, net income (loss) and operating income (loss) increased primarily due to the impact of non-recurring, non-cash goodwill and asset impairment charges of $588 million and a coal contract modification charge of $41 million, both pre-tax, that were recorded during the 2015 period, and unrealized gains from hedging activities of $46 million, partially offset by factors that affected Adjusted EBITDA, as described below. Net income (loss) was negatively impacted by the $53 million increase in income tax expense primarily due to higher 2016 pre-tax income resulting from changes in asset impairments mentioned above.

For the three months ended September 30, 2016 compared with 2015, Adjusted EBITDA decreased primarily due to lower margins as described below, partially offset by lower operation and maintenance expenses resulting from reduced non-outage costs at the Susquehanna plant and lower expenses associated with plants sold in 2016 as described below and offset by additional costs associated with the MACH Gen assets acquired in 2015.

The decrease in Margins, a primary driver to changes in the other three earnings measures reflected above, for the three months ended September 30, 2016 compared with 2015, was primarily due to lower realized energy prices and spark spreads of $70 million and lost energy and capacity of $50 million from plants sold in 2016 as described below, and lower capacity prices of $49 million. Offsetting these decreases was $47 million of additional margins from the MACH Gen assets acquired in 2015.

For the nine months ended September 30, 2016 compared with 2015, net income (loss) and operating income (loss) increased primarily due to pre-tax gains of $563 million on plants sold in 2016 as described below, and the impact of pre-tax changes between the periods of non-recurring, non-cash goodwill and asset impairment charges of $377 million, and a coal contract modification charge of $41 million that was recorded in the third quarter of 2015, partially offset by unrealized losses from hedging activities of $71 million, higher depreciation of $71 million driven by assets acquired in 2015, and factors that affected Adjusted EBITDA, as described below.

In addition, net income (loss) for the nine months ended September 30, 2016 compared with 2015 was negatively impacted from higher interest and income tax expenses. Interest expense increased by $34 million partially as a result of the assumption through consolidation of RJS and MACH Gen related debt. Income tax expense increased by $146 million primarily from an increase in 2016 pre-tax income due to changes in impairments in 2016 compared with 2015 and due to net gains from the plants sold in 2016 as described below.

For the nine months ended September 30, 2016 compared with 2015, Adjusted EBITDA decreased primarily due to lower margins as described below and higher operation and maintenance expenses. Operation and maintenance expenses increased primarily due to the RJS and MACH Gen assets acquired in 2015, partially offset by lower expenses associated with plants sold in 2016 as described below.

The decrease in Margins for the nine months ended September 30, 2016 compared with 2015 was due to a $254 million decrease from Talen Energy's legacy assets, partially due to lost energy and capacity from plants sold in 2016 described below of $111 million, lower realized energy prices and spark spreads of $98 million and lower nuclear plant availability of $36 million. Offsetting these decreases was $160 million of additional margins from the RJS and MACH Gen assets acquired in 2015.

The key financial and operational developments that impacted results in 2016 were as follows:

• Merger Agreement- In June 2016, Talen Energy Corporation entered into the Merger Agreement. In connection with the Merger:
• In June 2016, the Antitrust Division of the U.S. Department of Justice and the U.S. Federal Trade Commission granted early termination of the mandatory waiting period under the Hart-Scott Rodino Antitrust Improvements Act of 1976, as amended, expiration or early termination of which was a condition to consummation of the Merger.
• Merger approvals were received from the New York Public Service Commission in September 2016 and the FERC in October 2016. NRC approval is the final regulatory approval remaining.
• In October 2016, Talen Energy Corporation's stockholders approved the Merger.
• Parent and Merger Sub entered into a "best efforts" financing arrangement with lenders to arrange a $600 million senior secured Term Loan B that will be funded substantially concurrently with the closing of the Merger. The arrangement was successfully priced and allocated in October 2016 and is an alternative to a June 2016 commitment obtained. See Note 6 to the Financial Statements for information on merger-related financing arrangements.
• For the three and nine months ended September 30, 2016, an insignificant amount and $15 million of costs related to the transaction, primarily for investment banking, legal and other professional services, were recorded in "Operation and maintenance" on Talen Energy Corporation's Statement of Income.
• Divestitures of Ironwood, C.P. Crane, Holtwood and Lake Wallenpaupack Power Plants - In October 2015, Talen Energy announced agreements for the sales of these plants, with an aggregate generating capacity of approximately 1,400 MW, to satisfy a December 2014 FERC order approving the combination of Talen Energy Supply and RJS Power. The sales of the Ironwood and C.P. Crane plants were completed in February 2016 and the Holtwood and Lake Wallenpaupack sale was completed in April 2016. Talen Energy generated $1.5 billion in pre-tax cash proceeds from these sales. Talen Energy used $600 million of these proceeds during the first quarter of 2016 to repay short-term debt. Talen Energy's operating results for the nine months ended September 30, 2016 include net pre-tax gains of $563 million ($338 million after-tax) related to the sales. See Note 8 to the Financial Statements for additional information.
• Bell Bend COLA - For the nine months ended September 30, 2016, Talen Energy recorded a pre-tax asset impairment charge of $204 million ($122 million after-tax) to fully impair the Bell Bend COLA costs. In September 2016, the NRC accepted Talen Energy's request to withdraw the COLA, while Talen Energy notified the DOE that it has withdrawn its application for a federal loan guarantee for Bell Bend. See Notes 8 and 13 to the Financial Statements for additional information.
• Susquehanna Nuclear Plant - In October 2016, Unit 2 of the Susquehanna nuclear plant experienced a brief maintenance outage as part of its continuing turbine blade modification and replacement project to address the causes of turbine blade cracking first identified in 2011. Susquehanna has determined the root cause of the issue and is expected to complete the final, permanent modifications on the Unit 2 turbine during the 2017 refueling outage and on the Unit 1 turbine during the 2018 refueling outage.
• Co-firing Projects - The Brunner Island co-fire project, which allows the units to use either coal or gas to generate electricity with the flexibility to seamlessly change the fuel blend during operation based on market conditions, is progressing. Unit 3 is currently in commercial operation, while Unit 2 is expected to be in commercial operation by the end of 2016 as originally planned. In order to avoid an outage during the winter demand season, Talen Energy has decided to defer completion and commercial operation of Unit 1 until the first half of 2017.

The Montour co-fire project, announced in June 2016, has an estimated capital cost of approximately $70 million. Talen Energy is currently further evaluating this project to consider the operating experience and results from the Brunner Island Unit 3 co-fire project, and at this time has no timetable for completing the Montour project. Therefore, the Montour project cost has been excluded from forecasted capital expenditures within "Liquidity and Capital Resources - Capital Expenditures." See Note 8 to the Financial Statements for additional information.

• PJM Capacity Auction Results - In May 2016, PJM completed the Base Residual Auction (BRA) for procuring capacity for the 2019/2020 planning year. Talen Energy cleared 6,994 MW (about 67%) of its total PJM capacity compared with 8,378 MW (about 81%) in the prior BRA for the 2018/2019 planning year. This result was primarily driven by lower than expected clearing prices in zones where the majority of Talen Energy's capacity is located. Based on the auction clearing prices and cleared MW in the auction, Talen Energy expects its PJM capacity revenues to be approximately $257 million for the 2019/2020 planning year. The expected capacity revenues do not include any value for capacity that did not clear either the base or Capacity Performance (CP) products. Any uncleared capacity has the capability to be bid into subsequent incremental auctions or sold to third parties in bilateral transactions. Under the CP construct, uncleared capacity also has the potential to provide additional value as portfolio insurance against unit non-performance or through participation in penalty revenues.
• Electricity and Natural Gas Prices - During 2016, average delivered prices for electricity continued to trend lower compared with 2015. Average electricity prices declined 20% to 38% for the nine month period across the regions where Talen Energy operates as natural gas prices continued to decline and the regions experienced milder winter weather compared with 2015. Average spot Henry Hub natural gas prices declined during the nine month 2016 period by about 16% compared with 2015. Spot natural gas prices in close proximity to Talen Energy's operations in the Northeastern U.S. declined by almost 50% during the nine month 2016 period compared with 2015.
• Sierra Club Settlement - In September 2016, the U.S. District Court, District of Montana, Billings Division approved the July 2016 settlement that was reached in the Sierra Club environmental litigation, which includes a commitment to retire Colstrip Units 1 and 2 no later than July 2022. As a result of this agreement, in the third quarter of 2016, Talen Energy updated the useful life of the units, and in future periods, this change is expected to increase depreciation by $6 million annually. See Note 10 to the Financial Statements for additional information.

Regulatory Matters

Maryland and New Jersey Capacity Matters

In April 2012, the Maryland Public Service Commission ordered three electric utilities in Maryland to enter into long-term contracts to support the construction of new electricity generating facilities in Maryland, the intent of which, Talen Energy believed, was to encourage the construction of new generation even when, under the FERC-approved PJM economic model, such new generation would not be economic. In April 2012, Talen Energy subsidiaries and several other companies filed a complaint in federal court in Maryland challenging the order on the grounds that it violates the Supremacy and Commerce clauses of the U.S. Constitution and requested declaratory and injunctive relief barring implementation of the order by the Maryland PSC Commissioners. Following certain lower court rulings, in April 2016, the U.S. Supreme Court issued a unanimous decision finding that Maryland's program is preempted by the Federal Power Act because it sets an interstate wholesale rate, contravening the Federal Power Act's division of authority between state and federal regulators.

Also in April 2016, the U.S. Supreme Court denied all petitions for certiorari in a similar case in New Jersey. The effect of the denial was to let stand lower court rulings finding that a similar law enacted by New Jersey was unconstitutional under the Supremacy Clause on the grounds that it infringes upon the FERC's exclusive authority to regulate the wholesale sale of electricity in interstate commerce.

See Note 10 to the Financial Statements for background information on these cases.

Ohio

There have been attempts in Ohio by certain companies to have their utilities be permitted to subsidize several uneconomic merchant generation assets owned by non-utility affiliates. Those attempts are being opposed by many generator and consumer interests both in Ohio and at the FERC. In April 2016, the FERC rescinded waivers it granted to certain Ohio companies that allowed them to purchase power from their affiliate generators. The Ohio companies must seek approval from the FERC that the contracts are consistent with the FERC's affiliate regulations before those contracts can be made effective. Additional efforts to oppose on grounds of federal preemption may also be made in Federal Court. If approved and not reversed, out-of-market subsidies could be disruptive to the market signals for competitive generation and threaten the long-term viability of PJM's markets. It is too early to predict the outcome of these efforts to subsidize uneconomic generators in Ohio.

Talen Energy cannot predict the impact that future economic and market conditions and regulatory requirements may have on its financial condition or results of operations.

Other

In June 2016, the FERC issued Order 825 that is expected to improve "Price Formation" in the energy and ancillary service markets by reducing the settlement interval period and triggering shortage pricing in any interval where there is a shortage of energy or operating reserves. Implementation of these changes in PJM is expected to occur as early as February 2018.

Results of Operations

As a result of the RJS Power acquisition on June 1, 2015, results for RJS are included in Talen Energy's results for the three and nine months ended September 30, 2016 with only three and four months of comparable amounts in 2015. As a result of the MACH Gen acquisition on November 2, 2015, results for MACH Gen are included in Talen Energy's results for the three and nine months ended September 30, 2016 with no comparable amounts in 2015. When discussing Talen Energy's results of operations for 2016 compared with 2015, when significant, the results of RJS and MACH Gen are isolated for purposes of comparability.

The classification of certain prior period amounts has been changed to conform to the presentation in the September 30, 2016 financial statements, including, but not limited to, reclassifying the Sapphire plants from discontinued operations to continuing operations. See Note 1 to the Financial Statements for additional information.

Talen Energy is organized in two segments: East and West, based on geographic location. The East segment includes the generating, marketing and trading activities in PJM, NYISO and ISO-NE. The West segment includes the generating, marketing and trading activities located in ERCOT and WECC. In addition, Talen Energy has an "Other" category that primarily includes wages, benefits, services, certain insurance, rent, financing costs incurred primarily at Talen Energy, which have not been allocated or assigned to the segments and inter-company eliminations, and is presented to reconcile segment information to consolidated results.

The discussion within "Statement of Income Analysis" addresses significant changes in principal line items on the Statements of Income comparing the three and nine months ended September 30, 2016 with the same periods in 2015 on a GAAP basis. The "Margins" discussion, presented by segment, includes a reconciliation of that non-GAAP financial measure to operating income. The "EBITDA and Adjusted EBITDA" discussion, also presented by segment, includes a reconciliation of those non-GAAP financial measures to operating income and consolidated net income (loss).

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in Talen Energy's 2015 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis, Margins, EBITDA and Adjusted EBITDA

Statement of Income Analysis --

(a) Includes the impact from energy-related economic activity. See "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. "Wholesale Energy" also includes unrealized gains (losses) on trading activity of insignificant losses for the three months ended September 30, 2016 and 2015, and $(8) million and $(35) million for the nine months ended September 30, 2016 and 2015.

(b) Amounts included in "Margins" and are not discussed separately.

(c) Amounts for prior years have been reclassified to conform to the current presentation. See Note 1 to the Financial Statements for additional information.

(d) The three and nine months ended September 30, 215 include a $7 million decrease related to prior periods and the receipt of revenue under a transmission operating agreement with Talen Energy's former affiliate, PPL Electric Utilities Corporation. See Note 1 to the Financial Statements for additional information.

(e) The 2015 periods include a $41 million charge to reduce contracted coal deliveries. See Note 10 to the Financial Statements for additional information.

See below for a discussion of the components of the changes to Net Income (Loss) for the periods. The changes in Net Income (Loss) and Operating Income (Loss) from period to period were, in part, attributable to the acquisitions of RJS Power and

MACH Gen and several items that management believes are not indicative of ongoing operations. See "EBITDA and Adjusted EBITDA" discussion below for information on the items management does not believe are indicative of ongoing operations.

Energy-Related Businesses

Net contributions from energy-related businesses decreased by $8 million for the nine months ended September 30, 2016 compared with 2015, primarily due to a decrease in construction projects at the mechanical contracting and engineering subsidiaries in 2016.

Operation and Maintenance

The increase (decrease) in operation and maintenance for the periods ended September 30, 2016 compared with 2015 was due to:

(a) Amounts are not comparable for the three and nine month periods for MACH Gen as it was acquired in November 2015 and for the nine month period for RJS as it was acquired in June 2015.

(b) The decrease for the three and nine month period was primarily due to lower expenses, which were primarily a result of cost reductions.

(c) Facilities sold in 2016. See Note 8 to the Financial Statements for additional information.

(d) Costs related to the spinoff transaction, including expenses associated with the FERC-required mitigation and legal and professional fees.

(e) See Note 1 to the Financial Statements for additional information on acceleration of expense recorded in connection with the spinoff.

(f) Primarily due to charges under Talen Energy's severance benefits plan recorded in 2016. See Note 9 to the Financial Statements for additional information.

(g) The decrease for the nine month period was primarily due to lower corporate expenses, which were primarily a result of cost reductions following the spinoff from PPL.

(h) Primarily represents investment banking, legal and other professional services incurred directly by Talen Energy Corporation. See Note 7 for the Financial Statements for additional information on the Merger.

(Gain) loss on sale

(Gain) loss on sale for the nine months ended September 30, 2016 primarily represents the $421 million gain on the sale of the Holtwood and Lake Wallenpaupack hydroelectric facilities and the $148 million gain on the sale of the Ironwood plant. See Note 8 to the Financial Statements for additional information.

Impairments

Impairments for the nine months ended September 30, 2016 primarily includes a $204 million pre-tax charge to fully impair capitalized costs related to the Bell Bend COLA. Impairments for the three and nine months ended September 30, 2015 includes a $466 million goodwill impairment, a $109 million impairment of the Sapphire plants and a $13 million impairment of the C.P. Crane plant. See Notes 8, 13 and 15 to the Financial Statements for additional information.

Depreciation

The increase (decrease) in depreciation for the periods ended September 30, 2016 compared with 2015 was due to:

(a) Amounts are not comparable for the three and nine month periods for MACH Gen as it was acquired in November 2015 and for the nine month period for RJS as it was acquired in June 2015.

(b) Facilities sold in 2016. See Note 8 to the Financial Statements for additional information.

(c) The increase was primarily related to software additions.

Taxes, Other Than Income

The increase (decrease) in taxes, other than income for the periods ended September 30, 2016 compared with 2015 was primarily due to the acquisitions of RJS Power and MACH Gen. Periods in 2015 include three and four months of operations for RJS, acquired in June 2015, and no amounts for MACH Gen, acquired in November 2015.

Other Income (Expense) - net

Other income (expense) - net increased by $8 million and $10 million for the three and nine months ended September 30, 2016 compared with 2015, primarily due to higher earnings on NDT funds.

Interest Expense

The increase (decrease) in interest expense for the periods ended September 30, 2016 compared with 2015 was due to:

(a) The decrease for the three month period was due to debt maturities in May 2016 and October 2015. The increase for the nine months period was due to a debt issuance in May 2015 and the assumption of an RJS Power subsidiary's debt in June 2015 in connection with the RJS Power acquisition, partially offset by debt maturities in May 2016 and October 2015. The increase in expense from the RJS Power related debt was $24 million for the nine month period.

(b) There are no comparable amounts in the 2015 periods as MACH Gen was acquired in November 2015.

(c) The decrease for the nine month period was due to the write-off of fees in 2015 associated with Talen Energy Supply's $3 billion syndicated credit facility that was terminated in connection with the spinoff.

Income Taxes

The increase (decrease) in income taxes for the periods ended September 30, 2016 compared with 2015 was due to:

(a) Excludes income taxes related to RJS and MACH Gen due to timing of the acquisitions as described in (b).

(b) Amounts are not comparable for the three and nine month periods for MACH Gen as it was acquired in November 2015 and for the nine month period for RJS as it was acquired in June 2015.

(c) Includes income taxes related to plant impairments recorded during the three and nine months ended September 30, 2015.

(d) The nine months ended September 30, 2015, included a tax benefit of $17 million related to state deferred tax liabilities for changes in state apportionment and the impact on the future estimated state income tax rate as a result of the acquisition of RJS Power.

(e) In 2015, open audits for the years 2008-2011 were settled with the IRS resulting in a tax benefit of $12 million, which was recorded during the nine months ended September 30, 2015.

(f) The three and nine months ended September 30, 2015, included a tax benefit of $7 million for federal and state return adjustments.

See Note 5 for additional information.

Margins

Management utilizes "Margins," a non-GAAP financial measure, as an indicator of performance for its business.

"Margins" is defined as energy revenues offset by the cost of fuel and energy purchases. Management believes this performance measure is relevant due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs, RTOs and significant fluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy," "Retail energy" or "Fuel and energy purchases" on the Statements of Income. "Margins" excludes unrealized (gains) losses on: energy related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of the competitive generation assets, full-requirement sales contracts and retail activities; and trading activities. These derivatives are subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged or when realized. Energy related economic activity includes premium amortization associated with options. Unrealized gains and losses related to derivatives and premium amortization associated with options are deferred and included in "Margins" over the delivery period of the item that was hedged or upon realization.

This measure is not intended to replace "Operating Income (Loss)," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and report their results of operations. Management believes this measure provides additional useful criteria to make investment decisions. This performance measure is used, in conjunction with other information, by senior management to manage Talen Energy's operations and analyze actual results compared with budget.

Reconciliation of Margins

The following tables contain the components from the Statements of Income that are included in Margins and a reconciliation to "Operating Income (Loss)" for the periods ended September 30.

(a) Represents amounts excluded from Margins.

(b) As reported on the Statements of Income.

(c) Includes unrealized gains (losses) on energy-related economic activity, which is subject to fluctuations in value due to market price volatility. See "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. "Wholesale Energy" also includes unrealized gains (losses) on trading activity of insignificant losses for the three months ended September 30, 2016 and 2015, and $(8) million and $(35) million for the nine months ended September 30, 2016 and 2015. Amounts have been adjusted for option premiums of $3 million and $5 million for the three months ended September 30, 2016 and 2015, and $8 million and $14 million for the nine months ended September 30, 2016 and 2015. The 2015 periods include a $41 million charge recorded to "Fuel and energy purchases" related to reducing contracted coal deliveries. See Note 10 to the Financial Statements for additional information.

(d) Other includes all Income Statement line items that are fully excluded from Margins, including Operation and maintenance, (Gain) loss on sale, Impairments, Depreciation, Taxes, other than income and Energy-related businesses, net.

(e) Represents Merger-related transaction costs, primarily investment banking, legal and other professional services incurred directly by Talen Energy Corporation. See Note 7 for the Financial Statements for additional information on the Merger.

Changes in Margins

The following table shows Margins by segments, for the periods ended September 30 as well as the change between the periods. The factors that gave rise to the changes are described following the table. Periods in 2015 include three and four months of operations for the RJS assets, acquired in June 2015, and no amounts for the MACH Gen assets, acquired in November 2015.

East Segment

East segment Margins decreased by $112 million for the three month period due to lost energy and capacity revenues from assets sold in 2016 of $50 million, lower capacity prices of $49 million, lower realized energy prices of $29 million, lower spark spreads of $12 million, and lower gas plant availability of $6 million. Partially offsetting these amounts is an increase from the additions of Athens and Millennium of $33 million, as well as higher other portfolio margins of $6 million.

East segment Margins increased for the nine month period from the additions of Raven and Sapphire of $93 million, as well as $64 million from the additions of Athens and Millennium.

Excluding the impact of the Raven, Sapphire, Athens, and Millennium acquisitions, East segment Margins decreased by $229 million for the nine month period primarily due to lost energy and capacity revenues from assets sold in 2016 of $111 million, lower realized energy prices of $60 million, lower nuclear plant availability of $36 million, lower spark spreads of $20 million, lower capacity prices of $19 million, lower wholesale gas activity of $12 million and lower gas plant availability of $6 million. Partially offsetting these amounts is an increase in retail electric activity of $16 million and full-requirement sales contracts of $14 million.

West Segment

West segment Margins decreased for the three month period due to lower realized energy prices in Texas of $22 million and lower realized energy prices in Montana of $7 million. These amounts were partially offset by additional margins of $14 million from Harquahala acquired in 2015.

West segment Margins decreased for the nine month period as the result of a $25 million decrease in Montana due to lower realized energy prices and lower generation. This amount was partially offset by additional margins of $3 million from Harquahala and Jade.

EBITDA and Adjusted EBITDA

In addition to operating income (loss), management utilizes EBITDA and Adjusted EBITDA, which are both non-GAAP financial measures, as indicators of performance for Talen Energy's business, with Adjusted EBITDA as the primary financial performance measure used by management to evaluate its business and monitor results of operations.

EBITDA represents net income (loss) before interest expense, income taxes, depreciation and certain amortization. Adjusted EBITDA represents EBITDA further adjusted for certain non-cash and other items that management believes are not indicative of ongoing operations including, but not limited to, unrealized gains and losses on derivative contracts, stock-based compensation expense, asset retirement obligation accretion (net of gains (losses) on retirements), impairments, gains and losses on securities in the NDT funds, gains or losses on sales, dispositions or retirements of assets, debt extinguishments and transition, transaction and restructuring costs.

EBITDA and Adjusted EBITDA are not intended to represent cash flows from operations, operating income (loss) or net income (loss) as defined by GAAP as indicators of operating performance and are not necessarily comparable to similarly-titled measures reported by other companies. Management cautions investors that amounts presented in accordance with Talen Energy's definitions of EBITDA and Adjusted EBITDA may not be comparable to similar measures disclosed by other companies because not all companies calculate EBITDA and Adjusted EBITDA in the same manner. Talen Energy believes EBITDA and Adjusted EBITDA are useful to investors and other users of these financial statements in evaluating Talen

Energy's operating performance because they provide additional tools to compare business performance across companies and across periods. Talen Energy believes that EBITDA is widely used by investors to measure a company's operating performance without regard to such items as interest expense, income taxes, depreciation and amortization, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired. Additionally, Talen Energy believes that investors commonly adjust EBITDA information to eliminate the effect of restructuring and other expenses, which vary widely from company to company and impair comparability. Talen Energy adjusts for these and other items; as management believes that these items would distort their ability to efficiently view and assess the company's core operating trends. In summary, management primarily uses Adjusted EBITDA as a measure of operating performance to assist in comparing performance from period to period on a consistent basis and to readily view operating trends, as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations, as a measure of certain corporate financial goals used to determine variable compensation and in communications with the Talen Energy Corporation Board of Directors, senior management, shareholders, creditors, analysts and investors concerning Talen Energy's financial performance.

Reconciliations of EBITDA and Adjusted EBITDA

The table below provides reconciliations of EBITDA and Adjusted EBITDA to operating income (loss) on a segment basis and to net income (loss) on a consolidated basis for the periods ended September 30.

62

(a) Represents Merger-related transaction costs, primarily investment banking, legal and other professional services incurred directly by Talen Energy Corporation. See Note 7 for the Financial Statements for additional information on the Merger.

(b) Represents unrealized gains (losses) on derivatives. See "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. "Wholesale Energy" also includes unrealized gains (losses) on trading activity of insignificant losses for the three months ended September 30, 2016 and 2015, and $(8) million and $(35) million for the nine months ended September 30, 2016 and 2015. Amounts have been adjusted for option premiums of $3 million and $5 million for the three months ended September 30, 2016 and 2015, and $8 million and $14 million for the nine months ended September 30, 2016 and 2015.

(c) Represents net realized gains on certain derivative contracts that were terminated due to the spinoff transaction.

(d) Related to a prior period revenue adjustment for the receipt of revenue under a transmission operating agreement with Talen Energy Supply's former affiliate, PPL Electric Utilities Corporation. See Note 1 to the Financial Statements for additional information.

(e) To mitigate the risk of oversupply, Talen Energy incurred pre-tax charges for the three and nine months ended September 30, 2015 to reduce its contracted coal deliveries. See Note 10 to the Financial Statements for additional information.

(f) Includes OCI amortization on non-active derivative positions.

(g) For the periods prior to June 2015, represents the portion of PPL's stock-based compensation cost allocable to Talen Energy.

(h) Operations were suspended and the Corette plant was retired in March 2015.

(i) Costs related to the spinoff transaction, including expenses associated with FERC-required mitigation and legal and professional fees. Also see "(a)" above.

(j) Contingency relates to the termination of a gas supply contract. See Note 10 to the Financial Statements for additional information.

Changes in Adjusted EBITDA

The following table shows Talen Energy's Adjusted EBITDA by segment for the periods ended September 30 as well as the change between periods. The factors that gave rise to the changes are described following the table. Periods in 2015 include three and four months of operations for the RJS assets, acquired in June 2015, and no amounts for the MACH Gen assets, acquired in November 2015.

East Segment

The decrease for the three month period for the East segment was driven by lower margins, partially offset by lower operation and maintenance expenses. The decrease in margins was primarily due to lost energy and capacity revenue from plants sold in 2016, lower capacity prices, realized energy prices and spark spreads, partially offset by additional margins from the Athens and Millennium operations acquired in 2015. Operation and maintenance expenses decreased partially due to reduced non-outage costs at the Susquehanna plant and lower expenses relating to plants sold in 2016.

The decrease for the nine month period for the East segment was driven by lower margins and higher operation and maintenance expenses. The decrease in margins was primarily due to lost energy and capacity revenues from plants sold in 2016, lower realized energy prices, nuclear plant availability, spark spreads, capacity prices and wholesale gas activity, partially offset by additional margins from the Raven, Sapphire, Athens and Millennium operations acquired in 2015, and increased retail electricity sales and full-requirement sales contracts. Operation and maintenance expenses increased primarily due to the Raven, Sapphire, Athens and Millennium operations acquired in 2015, partially offset by lower expenses relating to plants sold in 2016.

West Segment

The decrease for the three month period for the West segment was driven by lower margins and higher operation and maintenance expenses. The decrease in margins was primarily due to lower realized energy prices at the Jade and Montana operations, partially offset by additional margins from the Harquahala operations acquired in 2015. Operation and maintenance expenses increased primarily from the addition of Harquahala.

The decrease for the nine month period for the West segment was driven by lower margins and higher operation and maintenance expenses. The decrease in margins was primarily due to lower realized energy prices and lower generation at Montana, partially offset by additional margins from Harquahala and Jade operations acquired in 2015. Operation and maintenance expenses increased primarily due to the additions of Jade and Harquahala.

Other

The increase for the nine month periods was primarily due to lower corporate expenses, which were primarily a result of cost reductions following the spinoff from PPL.

See "Margins" and "Statement of Income Analysis" above for a more detailed analysis of the changes.

Financial Condition

Liquidity and Capital Resources

Talen Energy had the following at:

(a) December 31, 2015 includes $108 million related to the New MACH Gen RCF, which at September 30, 2016 is classified as "Long-term debt" on the Balance Sheet based on New MACH Gen's intent to refinance on a long-term basis.

Net cash provided by (used in) operating, investing and financing activities for the nine months ended September 30, and the changes between periods were as follows.

Operating Activities

The components of the change in cash provided by (used in) operating activities for the nine months ended September 30, 2016 compared with 2015 were as follows.

The change in non-cash components primarily resulted from $595 million of net gains from generation assets sold in 2016 and $379 million related to asset impairments, partially offset by a $77 million increase in unrealized losses on hedging and other hedging activities and a $71 million increase in depreciation. The increase in cash from operations from changes in working capital was primarily due to an increase in accounts payable, accrued taxes payable and decreases in fuels, materials and supplies, partially offset by a decrease in counterparty collateral (due in part to market price movement) and increases in accounts receivable and unbilled revenues. The increase in accrued taxes payable is primarily due to higher 2016 taxable income resulting from gains on the aforementioned sales of generation assets. The change in accounts payable was related to decreases that occurred in 2015 due to lower settled values on realized gas hedges, timing of payments and the settlement of PPL affiliated accounts payable in advance of the June 1, 2015 spinoff. The decrease in inventory is related to declines in coal inventory. The increases in accounts receivable are primarily related to decreases in 2015 from the settlement of PPL affiliated accounts receivable in advance of the June 1, 2015 spinoff, while changes in unbilled revenues resulted primarily from decreases in 2015 related to expiring contracts and lower hedging activity.

Investing Activities

The $1.4 billion increase in cash provided by investing activities for the nine months ended September 30, 2016 compared with 2015 primarily reflects $1.5 billion in pre-tax cash proceeds received in 2016 from sale of the Ironwood, Holtwood, Lake Wallenpaupak and C.P. Crane power generation facilities. See Note 8 to the Financial Statements for additional information. Partially offsetting this increase was the $84 million increase in expenditures for property, plant and equipment, primarily from the Brunner Island co-fire project in 2016, from the RJS and MACH Gen plants that were acquired in June and November 2015 and from information technology system projects that are being implemented as a result of the separation from PPL, partially offset by a decrease in 2016 compared to 2015 at Susquehanna primarily due to the timing of fuel purchases.

Financing Activities

The components of the change in cash provided by (used in) financing activities for the nine months ended September 30, 2016 compared with 2015 were as follows.

(a) Includes activity under the New MACH Gen RCF which at September 30, 2016 is classified as "Long-term debt" on the Balance Sheet.

In 2015, Talen Energy made a distribution to its predecessor member prior to the June 2015 spinoff, with no such distributions occurring in 2016. In 2016, Talen Energy used a portion of the proceeds from the February 2016 sales of the Ironwood and C.P. Crane power generation facilities to repay all then outstanding $600 million of short-term borrowings under Talen Energy Supply's RCF and later used borrowings under Talen Energy's Supply's RCF to repay a May 2016 $350 million debt maturity. In 2015, Talen Energy used the proceeds from its May 2015 $600 million debt issuance to repay all then outstanding, $630 million, of short-term borrowings under Talen Energy Supply's RCF.

Talen Energy may from time to time seek to retire or repurchase outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

See Note 6 to the Financial Statements for information on 2016 short and long-term debt activity. See Note 5 in Talen Energy's 2015 Form 10-K for information on 2015 activity. See "Merger Agreement" below for information on the impact of the Merger on future debt issuances and credit facility capacity.

Revolving Credit Facilities

Talen Energy Supply and a subsidiary maintain credit facilities to enhance liquidity and provide credit support. The total committed borrowing capacity under outstanding credit facilities and the use of this borrowing capacity were:

The amounts "Borrowed" are recorded as either "Short-term debt" or "Long-term debt" on the Balance Sheets depending on the facility utilized and management's ability and intent to repay or refinance borrowings.

The Talen Energy Supply RCF provides capacity for revolving cash borrowings and up to $925 million of letters of credit, which in combination cannot exceed the capacity of the facility at any given time. The commitments at September 30, 2016 under the Talen Energy Supply RCF are provided by a diverse bank group, with no one bank or its affiliates providing an aggregate commitment of more than 8% of the total committed capacity. See "Merger Agreement" below for information on future reduction in the capacity of this facility.

The New MACH Gen RCF provides capacity for revolving cash borrowings and up to $120 million of letters of credit, which in combination cannot exceed the capacity of the facility at any given time.

Other Facilities

Talen Energy Supply is party to a $1.3 billion Amended STF Agreement whereby Talen Energy Supply will receive credit to be applied to satisfy collateral posting obligations related to Talen Energy's energy marketing and trading activities with counterparties participating in the facility.

See Note 6 to the Financial Statements for further discussion of Talen Energy Supply's credit and other agreements.

Merger Agreement

The consideration payable in the Merger with affiliates of Riverstone will be funded by Talen Energy's cash on hand and the proceeds of a new secured term loan. See Note 6 of the Financial Statements for information on merger-related financing arrangements. In accordance with a consent agreement entered into with the administrative agent and lenders under the Talen Energy Supply RCF, the Talen Energy Supply RCF will be reduced from $1.85 billion to $1.4 billion upon closing of the transaction. Consummation of the Merger is not subject to a financing condition, but is subject to a condition that Talen Energy Corporation has unrestricted cash and cash equivalents and undrawn revolver capacity equal to at least $350 million at closing, subject to certain exceptions, and after taking into account the proceeds of the new senior secured term loan discussed above. Consummation of the Merger is also subject to the condition that immediately prior to the Merger, certain specified defaults and events of default under the Talen Energy Supply RCF shall not have occurred. See Note 7 of the Financial Statements for additional information.

Long-term Debt

See Note 6 to the Financial Statements for information on Talen Energy Supply's long-term debt activity.

Rating Agencies and Credit Considerations

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The ratings issued by rating agencies are not recommendations to buy, sell or hold any debt securities of Talen Energy, and they are often based in part on information provided by Talen Energy and other sources. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. Talen Energy's credit ratings may affect its liquidity, access to capital markets and cost of borrowing.

The following table sets forth the credit ratings issued by Moody's and Standard & Poor's for outstanding debt securities or credit facilities of Talen Energy Supply at:

In June 2016, following the announcement of the Merger, Moody's placed the ratings of Talen Energy Supply, including its corporate issuer rating, senior secured rating, and the rating on a majority of its senior unsecured debt obligations under review for downgrade. Additionally, the rating of approximately $830 million of Talen Energy Supply's senior unsecured debt was placed under review for upgrade as a result of guarantees that become effective upon the closing of the Merger as described in Note 7 to the Financial Statements. In October 2016, Moody's assigned a Ba1 rating to the $600 million senior secured Term Loan B that is expected to be issued by Talen Energy Supply upon the closing of the Merger. See Note 6 for further discussion of the senior secured Term Loan B.

In June 2016, following the announcement of the Merger, S&P affirmed the ratings of Talen Energy Supply. In October 2016, S&P assigned a BB rating to the $600 million senior secured Term Loan B that is expected to be issued by Talen Energy Supply upon the closing of the Merger. See Note 6 for further discussion of the senior secured Term Loan B.

Various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage and interest rate instruments contain provisions that require the posting of additional collateral, or permit the counterparty to terminate the contract, upon a downgrade in Talen Energy Supply's credit rating. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral requirements for Talen Energy for derivative contracts in a net liability position at September 30, 2016.

Talen Energy has no credit rating triggers that, by themselves, would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.

Capital Expenditures

The table below shows Talen Energy's current capital expenditure projections for the years 2016 through 2020.

(a) Does not include the Holtwood and Lake Wallenpaupack hydroelectric projects, the Ironwood natural gas combined-cycle plant, and the C.P. Crane coal-fired power plant, which have been sold. See Note 8 to the Financial Statements for additional information on the divestitures.

(b) Includes capitalized interest, which over all years, is expected to total approximately $52 million.

Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. The above table has been revised from what was presented in the 2015 Form 10-K primarily to remove expenditures (including capitalized interest) related to the Bell Bend project. Also, the table excludes the estimated $70 million project cost of the Montour co-fire project announced in June 2016 that is currently being further evaluated. See Note 8 to the Financial Statements for additional information on the Bell Bend COLA and the Montour co-fire project.

Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about Talen Energy's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk (Non-trading)

Talen Energy's non-trading activity includes economic hedge transactions that address a specific risk. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of Talen Energy's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). See Note 14 to the Financial Statements for additional information.

To hedge the impact of market price volatility on Talen Energy's energy-related assets, liabilities and other contractual arrangements, Talen Energy subsidiaries both sell and purchase physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enter into financial exchange-traded and over-the-counter contracts. Talen Energy's non-trading commodity derivative contracts range in maturity through 2020.

The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended September 30. See Notes 13 and 14 to the Financial Statements for additional information.

(a) Represents the fair value of contracts at the end of the quarter of their inception. 2015 includes the impact of contracts acquired as part of the RJS Power acquisition.

The following table segregates the net fair value of non-trading commodity derivative contracts at September 30, 2016, based on the observability of the information used to determine the fair value.

Talen Energy subsidiaries sell electricity, capacity and related services and buy fuel on a forward basis to hedge the value of energy from Talen Energy's generation assets. If these Talen Energy subsidiaries were unable to deliver firm capacity and energy or to accept the delivery of fuel under their agreements, under certain circumstances they could be required to pay liquidated damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect Talen Energy's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although Talen Energy attempts to mitigate these risks, it cannot be assured that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.

Commodity Price Risk (Trading)

Talen Energy's trading commodity derivative contracts range in maturity through 2019. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended September 30. See Notes 13 and 14 to the Financial Statements for additional information.

(a) Represents the fair value of contracts at the end of the quarter of their inception.

The following table segregates the net fair value of trading commodity derivative contracts at September 30, 2016, based on the observability of the information used to determine the fair value.

VaR Models

A VaR model is utilized to measure commodity price risk in margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given Talen Energy's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the nine months ended September 30, 2016 was as follows.

The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at September 30, 2016.

Interest Rate Risk

Talen Energy, directly or through its subsidiaries, may issue debt to finance its operations, which would expose it to interest rate risk. Talen Energy may utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in components of current market interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management policy are designed to mitigate interest rate exposure and volatility in interest expense.

Talen Energy had no interest rate hedges outstanding at September 30, 2016.

Talen Energy is exposed to a potential increase in interest expense and to changes in the fair value of its debt portfolio. The estimated impact of a 10% adverse movement in interest rates at September 30, 2016 would cause an insignificant increase in interest expense and a $99 million increase in the fair value of debt.

NDT Funds - Securities Price Risk

In connection with certain NRC requirements, Susquehanna Nuclear maintains trust funds to fund certain costs of decommissioning the Susquehanna Nuclear plant. At September 30, 2016, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the balance sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna Nuclear's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. Talen Energy actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At September 30, 2016, a hypothetical 10% increase in interest rates and a

10% decrease in equity prices would have resulted in an estimated $78 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.

Credit Risk

See Notes 13 and 14 to the Financial Statements and "Risk Management - Credit Risk" in Talen Energy's 2015 Form 10-K for additional information.

Acquisitions, Development and Divestitures

Talen Energy from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined periodically based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the acquisitions of MACH Gen and RJS Power, the divestitures of the Ironwood, Holtwood, Lake Wallenpaupack and C.P. Crane power plants and the developments regarding the Bell Bend COLA and the Brunner Island and Montour co-firing projects.

Environmental Matters

The following is a discussion of the more significant environmental matters impacting Talen Energy's business this fiscal year. See "Item 1. Business" in Talen Energy's 2015 Form 10-K for additional information on environmental matters.

CSAPR

Annual and seasonal nitrogen oxide emission allowance trading programs, as well as annual sulfur dioxide emission allowance trading, commenced in 2015 for 28 states under the EPA's CSAPR Rule. In September 2016, the EPA finalized an update to its CSAPR Rule to address the 2008 ozone NAAQS. The "CSAPR Update Rule" establishes more stringent ozone season nitrogen oxide budgets for 22 states, including several where Talen Energy owns generation. Additional capital and/or operation and maintenance expenses (including the purchase of additional allowances), could be imposed on Talen Energy plants in Maryland, New Jersey, New York, Pennsylvania and Texas as a result of this action. At this time, Talen Energy does not expect this matter will have a material impact on Talen Energy's results of operation or financial condition.

NAAQS

The Connecticut Department of Energy & Environmental Protection and the Delaware Department of Natural Resources and Environmental Control recently petitioned the EPA to find that emissions from the Brunner Island plant are significantly contributing to the nonattainment of the 2008 and/or 2015 eight-hour NAAQS for ozone in their respective states. The EPA extended the deadline to respond to both petitions to January and March of 2017, respectively. If the EPA grants either petition, and finds that Brunner Island has significantly contributed to nonattainment or interfered with maintenance of a NAAQS in either state, Talen Energy could be required to cease operations at Brunner Island within three months of such finding or comply with EPA-imposed emission limits. Talen Energy is evaluating the above petitions and cannot predict at this time, whether either of them will be granted or denied by the EPA or the impact, if any, on Talen Energy's financial condition or operations.

Pertaining to the EPA's 2010 NAAQS for sulfur dioxide, the EPA and the Sierra Club entered into an approved consent decree in March, 2015 that establishes deadlines for remaining area designations. Several of Talen's affected plants are in undesignated areas and various actions occurred in the third quarter of 2016 to advance these characterizations including the EPA's final designation of the area around Brandon Shores and Wagner as non-attainment. Compliance with regulations or site-specific obligations, that could be developed to address the standard, could lead to increased capital and/or operation and maintenance expenses for some of Talen Energy's coal plants.

Regional Haze

The EPA's regional haze programs were developed under the Clean Air Act to eliminate man-made visibility degradation by 2064. Under the programs, states are required to make reasonable progress every decade, through the application of, among other things, Best Available Retrofit Technology on power plants commissioned between 1962 and 1977. The primary power plant emissions affecting visibility are sulfur dioxide, nitrogen oxides and particulates. While the focus of regional haze regulation has been on the western U.S., in December 2015, a final federal implementation plan for Texas was released with an emphasis on coal plants. That rule was stayed by the U.S. Courts of Appeals for the 5th Circuit in July 2016.

GHG Regulations

The EPA's final rules for new and existing power plants were published in the Federal Register in October 2015, along with a proposed federal implementation plan for those states that fail to submit an acceptable state implementation plan for the existing plant rule. The EPA's existing plant rule was stayed by the U.S. Supreme Court in the first quarter of 2016 pending the outcome of other legal challenges to the rule. The new plant rule remains in effect and challenges are also outstanding in federal court. The D.C. Circuit heard oral arguments on challenges to the merits of the EPA's rule in September 2016. Talen Energy is unable to determine if the rules will have a material adverse effect on Talen Energy's financial condition or results of operations, but increased capital and operation and maintenance costs could be imposed.

New Accounting Guidance

See Notes 2 and 19 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. Certain accounting policies are particularly important to an understanding of the reported financial condition or results of operations, and require management to make estimates or other judgments of matters that are inherently uncertain, including policies for defined benefits, income taxes, asset impairments (excluding investments), AROs, business combinations and price risk management.

See "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations," in Talen Energy's 2015 Form 10-K for a discussion of each critical accounting policy.

TALEN ENERGY CORPORATION

TALEN ENERGY SUPPLY, LLC

Reference is made to "Risk Management" in "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations."

(a) Evaluation of Disclosure Controls and Procedures.

Disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their desired control objectives. The registrants' principal executive officers and principal financial officers, based on their evaluation of the registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) have concluded for their respective companies that, as of September 30, 2016, the registrants' disclosure controls and procedures were effective, at the reasonable assurance level, to ensure that information required to be disclosed by each registrant in the reports filed by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms and that such information is accumulated and communicated to management, including the principal executive and principal financial officers, to allow for timely decisions regarding required disclosure.

(b) Change in Internal Controls over Financial Reporting.

During the third fiscal quarter of 2016, Talen Energy implemented a new enterprise resource planning system and other associated financial systems which resulted in a material change to the registrants' internal controls over financial reporting. Because of the inherent risks associated with implementing the new systems, the registrants continue to review the impact of the implementations and make changes to the internal controls over financial reporting to address these risks. The implementation of the systems is expected to strengthen overall internal controls and facilitate the transition of internal controls of RJS Power and MACH Gen to the internal control structure of the registrants. Reference is made to "Item 9A. Controls and Procedures" of Talen Energy's 2015 Form 10-K for a discussion regarding ongoing assessments of internal control over financial reporting relating to the RJS Power and MACH Gen acquisitions that occurred during 2015. Except for those items, there were no changes in the registrants' internal controls over financial reporting that occurred during the third fiscal quarter of 2016 that have materially affected, or are reasonably likely to materially affect, the registrants' internal control over financial reporting.

Talen Energy's 2015 Form 10-K and Form 10-Q for the quarters ended March 31, 2016 and June 30, 2016, including the sections titled "Risk Factors" and "Forward-Looking Information," contain detailed discussions of certain risks and uncertainties that could materially adversely affect Talen Energy's business, operating results, or financial condition.

On June 2, 2016, Talen Energy Corporation entered into an Agreement and Plan of Merger (the Merger Agreement) with RPH Parent LLC, SPH Parent LLC, CRJ Parent LLC (each, an affiliate of Riverstone, and collectively referred to as "Parent"), and RJS Merger Sub Inc. (a wholly owned subsidiary of Parent referred to as "Merger Sub"), pursuant to which Merger Sub will merge with and into Talen Energy Corporation (the Merger), with Talen Energy Corporation continuing as the surviving corporation on the terms and conditions set forth in the Merger Agreement. On October 6, 2016, the stockholders of Talen

Energy Corporation approved the Merger. Talen Energy Corporation currently expects the transaction to be completed by the end of 2016, subject to NRC approval and satisfaction of other customary closing conditions.

The following risk factors, which are related to the Merger, supplement and should be read in conjunction with the risks and uncertainties addressed in those prior filings.

Failure to complete the Merger, as a result of the failure to obtain necessary regulatory approvals or otherwise, could negatively impact Talen Energy's business and the market price of Talen Energy Corporation's common stock.

If the Merger is not completed for any reason, Talen Energy will be subject to a number of material risks, including the disruption to its business resulting from the announcement of the signing of the Merger Agreement, the diversion of management's attention from Talen Energy's day-to-day business, expenses incurred in connection with the proposed Merger and the restrictions imposed by the Merger Agreement on the operation of Talen Energy's business during the period before the completion of the Merger, which may make it difficult for Talen Energy to achieve its business goals if the Merger does not occur.

If the Merger is not completed for any reason, Talen Energy Corporation's stockholders will not receive any payment for their shares in connection with the Merger. Instead, Talen Energy Corporation will remain an independent public company, and the shares will continue to be traded on the NYSE. In addition, if the Merger is not completed, Talen Energy expects that management will operate Talen Energy's business in a manner similar to that in which it is being operated today and that Talen Energy Corporation's stockholders will continue to be subject to the same risks and opportunities to which they are currently subject, including, without limitation, risks related to the competitive power generation industry in which Talen Energy operates and adverse economic conditions.

Furthermore, if the Merger is not completed, and depending on the circumstances that would have caused the Merger not to be completed, the price of the shares of Talen Energy Corporation's common stock may decline significantly. If that were to occur, it is uncertain when, if ever, the price of the shares would return to the prices at which the shares currently trade. Accordingly, if the Merger is not completed, there can be no assurance as to the effect of these risks and opportunities on the future value of shares held by Talen Energy Corporation stockholders. If the Merger is not completed, Talen Energy Corporation's board of directors will continue to evaluate and review Talen Energy's business operations, properties and capitalization, among other things, make such changes as it deems appropriate and continue to seek to identify opportunities to enhance stockholder value. If the Merger is not completed for any reason, there can be no assurance that any other transaction acceptable to Talen Energy Corporation will be offered or that Talen Energy's business, prospects or results of operation will not be adversely impacted.

Failure to complete the Merger could trigger the payment of a termination fee.

The Merger Agreement contains certain termination rights, including the right of Talen Energy Corporation to terminate the Merger Agreement to accept a superior proposal, subject to specified limitations, and provides that, upon termination of the Merger Agreement by Talen Energy Corporation or Parent upon specified conditions, Talen Energy Corporation will be required to pay Parent a termination fee of up to $50 million, or less under specified conditions. See "Item 2. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview - Merger Agreement" for additional information.

Uncertainties associated with the Merger may cause Talen Energy to lose key customers or suppliers and make it more difficult to retain and hire key personnel.

As a result of the uncertainty surrounding the conduct of Talen Energy's business following the completion of the Merger, prior to the Merger, Talen Energy may lose key customers and suppliers. In addition, Talen Energy's employees may be uncertain about their future roles and relationships with Talen Energy following the completion of the Merger, which may adversely affect Talen Energy's ability to retain them or to hire new employees.