Ongoing concerns about the level of cash flow Dynegy Inc. will be able to generate with its restructuring led Moody’s Investors Service to downgrade the Houston company and its subsidiaries late Monday.

Primary operating subsidiary Dynegy Holdings Inc. (DHI) had its rating cut to “Caa2,” from “B3” (companies falling into the “C” category are considered likely candidates for bankruptcy).

Moody’s analysts said that cash flow relative to its high financial leverage “will likely result in minimal amounts of free cash flow available for further debt reduction.” Also, Moody’s raised questions about the “continuing uncertainty related to the ultimate resolution of the company’s debt obligations coming due over the next several years, including $1.6 billion of bank credit facilities in the second quarter of 2003.”

Moody’s dropped Dynegy’s senior implied rating to “B3” from “B2.” Illinois Power (IP) was dropped to “B3” from “B1.” The outlook for the company remains negative, said Moody’s, because of a “continuing lack of investor and counterparty confidence that has limited access to public debt markets and negatively impacted the company’s remaining businesses,” as well as the uncertainty of Securities and Exchange Commission and Federal Energy Regulatory Commission investigations. Moody’s also cited the “uncertainty relating to ongoing re-audits and reviews” of financial statements between 1999 and 2001.

“The ratings downgrade reflects ongoing concerns surrounding the level of future cash flow from Dynegy’s non-trading and marketing businesses relative to its total debt of $9.3 billion,” Moody’s wrote. “Despite some positive attributes associated with a portion of the cash flow expected from the company’s power generation, natural gas liquids and IP (regulated distribution) businesses, such as relatively stable cash flows supported by a combination of long-term contracts, key customer relationships in strategic locations, and regulation, the primary concern continues to be the amount of debt these businesses need to support.”

One of Dynegy’s “more significant challenges in the near- to medium-term will be achieving a permanent capital structure that is more appropriate, given the level of cash flow that can be reasonably expected from these businesses as well as the inherent risks associated with them. Furthermore, Dynegy has not yet completed its contemplated sale or shut-down of the communications business, and it remains unclear how successful the company will be in restructuring its tolling agreements, and both continue to consume cash.”

On and off-balance sheet debt totals $9.3 billion currently, consisting of $6.2 billion at DHI; $100 million at Illinova, $2.0 billion at IP (including $540 million of transition funding notes); $360 million of DGC leases, and approximately $600 million of unconsolidated subsidiary debt. “These amounts do not include $1.5 billion of [ChevronTexaco] preferred securities that are scheduled to mature in November 2003, and it remains unclear how this maturity will be dealt with. Given the insufficient level of operating cash flow and the lack of significant additional assets available for sale, debt protection measures are likely to remain very weak.”

Wrote Moody’s, “the rating downgrades also reflect a current liquidity profile that appears adequate to deal with all known financial obligations up to April/May of 2003 when DHI’s $1.3 billion in bank facilities and IP’s $300 million bank facility comes due. The most significant maturity prior to the bank credit facilities is a $200 million secured facility that matures in January 2003. None of the bank credit facilities can be extended via a term-out option. Dynegy currently has approximately $940 million of cash and $120 million of additional borrowing capacity, for total liquidity of $1.06 billion, which is insufficient to retire the bank facilities absent additional cash flow from operations.”

Currently, Dynegy is negotiating with its banks to replace its facilities with a secured loan. Moody’s noted that if Dynegy “violates” an earnings-to-interest covenant contained in the agreements, “which is possible, the lenders have the ability to accelerate the outstanding obligations under these facilities, which could also trigger cross-acceleration provisions in a significant portion of Dynegy’s other outstanding debt.”

If Dynegy were to violate the covenant, “it will seek a waiver from the lenders, however there is no assurance the company would be granted such a waiver, if needed. At present, how successful Dynegy will be in its efforts to put a new facility in place, and the key terms of that facility, are unknown.” Moody’s warned that “clearly,” the company “must successfully refinance these facilities before it can move forward with the rest of its restructuring plans. Provided the company is able to refinance its existing bank lines, another $190 million of mortgage bonds at IP matures in August and September of 2003.”

Dynegy plans to sell IP’s transmission system for $239 million, and will use the proceeds to issue new mortgage bonds there to retire the obligations. However, noted the analysts, “Dynegy’s current weak credit profile makes executing such plans extremely challenging.

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