Several favorable actions and events led Fitch Ratings to give Dynegy Inc. and its affiliates a “stable” outlook on Thursday, removing the energy merchant from Rating Watch Negative for the first time in nearly 20 months.

Fitch affirmed and removed Dynegy, Dynegy Holdings Inc., Illinois Power (IP) and Illinova Corp. from the negative rating outlook, where they had been placed in November 2001, when Dynegy was attempting to merge with Enron Corp.

The credit ratings agency also assigned a “B+” rating to Dynegy Holdings’ secured $1.1 billion revolving credit facility and $200 million term loan A, both maturing on Feb. 15, 2005. It assigned a “B” rating to its $360 million term loan B, which matures on Dec. 15, 2005.

“The removal of the Negative Rating Watch status reflects the lessening of near-term default risk as a result of several favorable actions and events,” said Fitch analysts, who noted that in April, Dynegy Holdings entered into its new $1.66 billion secured bank credit facility.

The facility requires no scheduled amortization of principal and should be adequate to fund ongoing collateral and operating needs through 2004. In addition, the risk of a default and resulting debt acceleration triggered by certain financial covenants contained in the prior credit facilities and Polaris lease has been eliminated.”

Fitch also cited other “favorable” recent actions, including the filing of audited financial statements for years 1999 through 2002 with “material disclosures consistent with expectations,” the sale of Dynegy’s U.S. communications business, the reporting of “stronger than anticipated” operating results for the first quarter of 2003 and the closing of an agreement with Southern Co. to terminate three wholesale tolling arrangements eliminating $1.7 billion of future capacity payments.

The new ratings, said Fitch, reflect its latest assessment of Dynegy’s overall credit profile. “The Stable Outlook status reflects the company’s satisfactory liquidity position and lessened near-term default risk,” and the ratings outlook recognizes Dynegy’s ongoing concerns., which include the execution risk associated with the restructuring/extension of $1.5 billion of preferred stock held by ChevronTexaco (CVX) that matures in November 2003; the “significant cash drain” from five remaining wholesale tolling agreements and the difficulty of terminating the agreements; the practical limits of materially reducing debt levels through cash from operations; and the negative overhang from ongoing government investigations and litigation.

On a consolidated basis, Fitch said Dynegy has about $8 billion of debt obligations not counting the $1.5 billion of ChevronTexaco preferred stock and payment obligations under its remaining tolling agreements, with a net present value of about $1.4 billion. “Furthermore, while recent efforts to eliminate third-party marketing and trading activities has helped ease collateral requirements and improve liquidity, the company must continue to provide substantial amounts of collateral to support its generation and midstream operations.”

The new bank facilities will allow Dynegy “limited flexibility to repurchase outstanding debt. However, all targeted large asset sales have been completed and equity financing is not likely. Even under improved operating conditions, cash flows from core operations remain weak relative to its high debt burden and any financial recovery should be gradual.”

As of May 12, consolidated liquidity at Dynegy was nearly $1.8 billion, said analysts. “Assuming a restructuring of the ChevronTexaco preferred stock and given a manageable maturity schedule, liquidity should be adequate for Dynegy and its affiliates through 2004 even if IP’s proposed sale of its electric transmission system does not occur.”

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