Although it “anticipates” a successful renewal and restructuring of maturing credit facilities, Fitch Ratings has lowered the debt ratings on Dynegy Inc. and Dynegy Holdings Inc. to “CCC+” from “B” and also has lowered the long-term ratings of affiliates Illinois Power and Illinova Corp. All of the ratings for the corporation and its affiliates remain on Rating Watch Negative.

According to the ratings agency, the downgrades reflect Fitch’s latest assessment of the company’s overall credit profile. Fitch expects Dynegy Holdings to renew on a secured basis $1.3 billion of maturing bank credit facilities and a separate $360 million lease financing on communications assets (Polaris). The corporation’s ratings “recognize the structural subordination of unsecured lenders to its bank lenders based upon a likely resolution to ongoing negotiations.”

However, noted analysts, “if the bank facilities are not renewed on a favorable basis, further ratings downgrades would likely be warranted. In particular, the current downgrade acknowledges the likelihood of lower recovery levels in a default scenario for the $2 billion of Dynegy Holdings-level debt which will remain unsecured following the conclusion of current bank negotiations.”

A $900 million bank credit facility matures on April 28, 2003 and a $400 million facility matures on May 27, 2003. “Timing of the bank loan restructurings is critical,” said analysts, because lenders on the $900 million facility “have provided a waiver that remains effective through March 31, 2003,” without which the company would be “unable to comply with at this time.” The Polaris lease also contains a 65% debt-to-capitalization test ” that could possibly be triggered based on year-end 2002 results,” expected by the end of March. “A default on either of these financial covenants could result in lenders accelerating the outstanding obligations under the credit facilities, as well as triggering cross default provisions for a significant portion of Dynegy’s outstanding debt.”

Based on Dynegy’s liquidity position on Jan. 28 ($1.5 billion), Fitch analysts estimate that the company should have liquidity levels above $1 billion “for the remainder of 2003,” which “will provide time for management to take certain planned actions.” However, said Fitch, “even if Dynegy is able to restructure its tolling arrangements and exit communications, future cash flows from its remaining core operations remain weak relative to its high debt burden. Any financial recovery will be gradual.”

Analysts said that Dynegy’s management had done a “good job to date in maximizing the value of the businesses it has sold,” but noted that “future financial flexibility is limited” because the company does not have a “large portfolio of remaining assets outside of core operations that it can sell to generate cash to pay down debt.” Dynegy is estimated to have about $8.4 billion of debt obligations on a consolidated basis, not counting the $1.5 billion of ChevronTexaco preferred stock and payment obligations under its tolling agreements with a net present value of about $1.3 billion.”

Dynegy’s efforts to eliminate third-party marketing and energy trading has helped ease collateral requirements and improve liquidity, said analysts, but “the company must continue to provide substantial amounts of collateral to support its generation and midstream operations.”

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