Reliant officials said the credit rating downgrade of subsidiary Reliant Resources (RRI) to junk status by Moody’s Investor Service Wednesday would not impact the proposed spin-off of RRI later this summer. The spin-off was approved Wednesday as a tax-free action by the Internal Revenue Service (IRS), but must be completed in six months. Reliant said the downgrade was inappropriate but expected given the state of the industry. Reliant shares fell 5% Wednesday to $10.06, and RRI shares tumbled 19% to $4.62.

“While we disagree with the [junk] rating [on RRI], we recognize the company and the industry are under pressure,” CEO Steve Letbetter said. “As we told investors during our earnings call last week, we have been taking the steps necessary to ensure that we can continue to run our business successfully.”

He said the downgrade of RRI debt was more a reaction to the conditions in the entire energy marketing and trading sector rather than the state of the company’s finances. It also was related to the delay of the spin-off, which now appears to be moving forward. Letbetter noted that Standard & Poor’s downgraded RRI to one notch above junk grade.

“[We have] stress-tested our business, and we have sufficient accessible liquidity to meet the financial needs brought on by the change in ratings.” Additional liquidity requirements triggered by loss of investment grade status are estimated at $650 million based on current commodity prices. The company has $1.2 billion of cash and available lines of credit to meet its needs.

“In addition, we do not anticipate that the downgrade changes our refinancing prospects with our lenders as we believe that they have also been anticipating the possibility of a downgrade of the company’s senior unsecured rating. We continue to be confident in our bank refinancing prospects,” Letbetter added.

Moody’s downgraded the credit ratings on RRI to Ba3 from Baa3 and assigned a senior implied rating of Ba3 to RRI. The RRI downgrade reflects Moody’s view that its “cash flow from operations is unpredictable relative to its debt load and its financial flexibility is limited.” The company needs to refinance $2.9 billion of bridge bank debt maturing in February 2003 and $800 million of the $1.6 billion corporate revolver which matures six months later.

Moody’s said that the near-term outlook for RRI’s wholesale business is “poor, driven by depressed wholesale prices both here and in Europe, constrained capacity markets, and poor credit conditions in the energy trading sector, all of which will pressure margins and challenge RRI’s ability to generate stable cash flow from operations. We note that RRI’s retail business lends a measure of diversity to the company’s earnings.”

Going forward, Moody’s said, the review for downgrade will focus on: 1) the timing for stabilization of cash flow in the wholesale business; 2) the company’s ability to refinance its bank debt and the terms of such refinancings; 3) the resolution of various government investigations into trading improprieties, including round trip trades; and 4) the company’s ability to execute its business plan including the implementation of cost cutting measures.

Turning to the regulated side of the business, Moody’s downgraded the senior unsecured long-term ratings of Reliant Energy and FinanceCo to Baa2 from Baa1, leaving the securities on review for potential downgrade. Moody’s placed the long-term and short-term ratings assigned to the regulated subsidiaries and the rating assigned to CenterPoint Energy on review for potential downgrade.

Moody’s said it remains concerned that Reliant and CenterPoint face potential credit issues associated with delays in executing the spin-off of RRI. The delay has constrained the company’s financial flexibility given that $4.7 billion of FinanceCo bank and bridge debt matures this October. Extension of these facilities is contingent on the spin-off. The review for potential downgrade will focus upon: 1) the timing for actualization of the RRI spin-off; 2) the impact to the CenterPoint credit profile should the spin of RRI not occur; 3) the ability of CenterPoint to refinance its bank facilities and the terms of such refinancings; and 4) a review of CenterPoint and subsidiary ratings in the context of the restructured electricity markets in Texas.

Letbetter said the company is confident the spin-off will occur later this summer. “We remain convinced that the spin-off is the right strategic step for both companies. Each is well positioned for success in its market sector and, as separate entities, both Reliant Resources and CenterPoint Energy will have better access to capital than the combined company,” he added.

In July 2000, Reliant said it intended to split into two public companies: CenterPoint Energy and Reliant Resources. Shareholders approved the plan in December 2001 (see Power Market Today, Dec. 18, 2001).

The company reiterated its earnings guidance for 2002 of a range of $1.65 to $1.85 per share and said the rating change does not affect the proposed spin-off of RRI.

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