Shares of Allegheny Energy Inc. were off by more than an eye-popping 50% at one point last Tuesday after the company said that it is in technical default under its principal credit agreements and those of its subsidiaries, Allegheny Energy Supply Company LLC and Allegheny Generating Co., after it declined to post additional collateral in favor of several trading counterparties.

Those counterparties declared Allegheny Energy Supply in default under their respective trading agreements, which triggered cross-default provisions under the credit agreements and other trading agreements. These collateral calls followed the downgrading of the company’s credit rating by Moody’s Investors Service earlier this month.

On the day that Allegheny announced the news, the company’s stock finished off $3.72, or just over 49%, to close at $3.80, mirroring a broader slump that permeated much of the energy merchant sector as renewed concerns over the direction of several power companies pushed stock traders into a selling frenzy. However, by the end of the week, the stock had recovered some lost ground to just under $5.00 per share.

Moody’s cut the debt ratings of Allegheny Energy to junk levels of “Ba1” from “Baa2” (senior unsecured) and downgraded the ratings of subsidiaries Allegheny Energy Supply, Monongahela Power, Potomac Edison, West Penn Power, Allegheny Generating Co., and the rating of Allegheny Energy Supply Statutory Trust 2001.

Moody’s said the actions reflect declining cash flow and earnings, increased reliance on merchant power sales — which Moody’s expects to be depressed at least until 2004 — and poor results from energy trading which stem from unfavorable long term contracts and hedging arrangements.

Allegheny Energy said that it is in ongoing discussions with its bank lenders, with a view toward obtaining required waivers and additional funding. “Allegheny believes that its underlying businesses remain fundamentally sound, and that it will ultimately be able to obtain the necessary liquidity to resolve its current situation.”

At the same time, the company announced that it has determined not to post additional collateral with trading counterparties pending resolution of its bank discussions.

Allegheny Energy also announced that, based on preliminary results for the third quarter and continued weakness in the wholesale energy market, it expects that 2002 and 2003 earnings per share will be lower than previously expected. The company expects that it will provide revised earnings guidance no later than the time it releases third quarter earnings in early November.

On Wednesday, the company said that it filed an application with the Securities and Exchange Commission (SEC) seeking approval for Allegheny Energy Supply to provide collateral to support additional borrowings. The application seeks authorization for Allegheny Energy Supply to borrow up to $2 billion on a secured basis.

As a part of the filing, Allegheny Energy disclosed it intends to reduce its dividend to between 0% and 50% of the current dividend level through at least the fourth quarter of 2003. No determination has been made by the company’s board of directors as to the actual future dividend level within this range.

Allegheny said the SEC filing was part of its ongoing effort to obtain the liquidity necessary to cure existing default conditions and to resume posting collateral to trading counterparties. “We are engaged in active discussions with our banks regarding our position and are working to obtain additional liquidity as quickly as is possible,” said Alan J. Noia, Allegheny Energy Chairman.

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