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Rating Action:

MOODY'S ASSIGNS B2 TO SENIOR NOTES OF DYNEGY HOLDINGS INC. AND AFFIRMS OTHER RATINGS; SGL LOWERED TO SGL-3

29 Mar 2006
MOODY'S ASSIGNS B2 TO SENIOR NOTES OF DYNEGY HOLDINGS INC. AND AFFIRMS OTHER RATINGS; SGL LOWERED TO SGL-3

Approximately $5.45 Billion of Debt Securities Affected

New York, March 29, 2006 -- Moody's Investors Service assigned a B2 rating to Dynegy Holdings Inc.'s (DHI) proposed issuance of $750 million of senior unsecured notes due 2016. In addition, Moody's has affirmed the existing long term ratings on the $4.7 billon of outstanding recourse debt of DHI and its parent, Dynegy Inc., and lowered the company's Speculative Grade Liquidity rating to SGL-3 from SGL-2. The rating outlook is stable.

Ratings affirmed include:

Dynegy Holdings Inc. --

Corporate Family Rating, B1

Senior Secured Revolving Credit Facility, rated Ba3, $400 million

Second Priority Senior Secured Notes, rated B1, $1.75 billion outstanding

Senior Notes, rated B2 (unsecured), $1.37 billon outstanding

Shelf (Senior Unsecured/Subordinated/Preferred), rated (P)B2/(P)B3/(P)Caa1 respectively

NGC Corporation Capital Trust I -- Trust Securities, rated B3 (DHI subordinated debentures), $200 million outstanding

Dynegy Roseton, L.L.C. and Dynegy Danskammer, L.L.C. -- Pass-Through Certificates, rated B2 (senior unsecured guarantee of DHI), $800 million outstanding

Dynegy Inc. --

Convertible Subordinated Debentures, rated B2 (senior unsecured guarantee of DHI), $225 million outstanding

Shelf (Senior Unsecured/Subordinated/Preferred), rated (P)Caa1/(P)Caa2/(P)Caa3

Dynegy Capital Trust II -- Shelf rated (P)B3

Dynegy Capital Trust III -- Shelf rated (P)Caa1

DHI's B1 corporate family rating is constrained by the company's business concentration risk, its dependence on improving power markets, a hedging strategy that leaves it exposed to volatility in those markets, and leverage that remains high relative to earnings despite the overall debt reduction expected to result from its tender offer for all outstanding second priority notes. The rating is supported by the company's diversified electrical generation asset base that should benefit from an expected recovery in the power market, management's demonstrated discipline through several years of restructuring the company that has considered the needs of debt holders, and the increased flexibility offered by the company's expected debt structure with no near term maturities. The B2 rating on the senior unsecured bonds reflects their effective subordination to two tranches of secured debt offset by a strong likelihood of par recovery.

The lower SGL rating reflects adequate liquidity. While the company's current debt restructuring and deleveraging provide the company with a longer term benefit, in the short term its financial flexibility will be limited by the corresponding reduction in cash on hand. Following completion of the current restructuring, Dynegy should have cash on hand of approximately $350 million, which is expected to drop to $200 million by year end. Additional liquidity is provided by the $400 million revolving credit facility, which helps fulfill the company's $300 million to $350 million collateral requirements. Collateral requirements are minimized by the company's strategy of remaining unhedged. Moody's notes that a further significant reduction of liquidity could result in a downgrade of the company's long term ratings.

Dynegy intends to use the proceeds of the notes together with up to $1.2 billion of cash on hand, including the remaining proceeds from its sale of Dynegy Midstream Services, its natural gas liquids segment, to retire its $1.75 billion Second Priority Notes pursuant to a recent tender offer. Dynegy has also initiated an offer to convert its $225 million of convertible subordinated debentures to equity. In order to induce the note tender and the conversion, Dynegy is offering a combined premium of approximately $275 million. If all the holders of the Second Priority Notes and the Convertible Subordinated Debentures accept the tender offer, nearly 90% of the company's total funded recourse obligations will be senior unsecured. The net impact of the restructuring will be a $1.25 billion reduction in debt, which will lower total recourse debt to $3.5 billion, including the Roseton and Danskammer leases and the revolving credit facility, which is currently undrawn. This figure excludes the $400 million of ChevronTexaco convertible preferred stock and the $900 million non-recourse debt at Sithe Energies. Following this transaction, Dynegy will have reduced recourse debt by $3.5 billion, or nearly 60%, over three years while adjusted debt to capitalization will have declined from 77% to a projected 62%.

The reduction in debt notwithstanding, Moody's estimates funds from operations (FFO) to debt to remain modest at approximately 3% and FFO to interest to be 1.4 times on a pro-forma basis based on the 2005 financial performance of Dynegy's generation segment, which will constitute the core of the business going forward. While these ratios are low for a B1 rated company with Dynegy's fundamental risk profile, with the current restructuring the company will have reduced its leverage significantly. This will leave it well positioned to capture upside potential when the markets in which Dynegy operates improve, which Moody's expects is reasonably likely in the medium term. If the company is able to achieve its projected growth of approximately $150 million in its power generation (GEN) segment earnings, pro-forma FFO to debt would improve to 9% and FFO to interest to 2.2 times. Although this represents nearly a 30% increase in net earnings, Moody's notes that it could be achieved with as little as 6.5% growth in revenues assuming the company's cost structure remains constant. Moody's notes that the ratings are also supported by Dynegy's expected capital structure with limited debt maturities until 2011, which should provide additional time for power market recovery.

Following an extensive restructuring of its business, Dynegy is now focused on merchant generation with a 12,769 MW portfolio of assets that is diversified by dispatch type, fuel source and geographic region. The company's revenues were correspondingly diversified in 2005, though its net earnings were much less so. Nearly 90% of its GEN segment EBITDA was generated by its coal-fired baseload generating units in Illinois, which represent just one quarter of its generating capacity. More than half of that capacity is provided by the Baldwin facility, leaving the company's revenues at risk in the event of an extended unscheduled outage.

Although the gas-fired peaking units are largely located in markets with substantial excess capacity and, as a result, do not currently contribute much to the company's profitability, they provide upside exposure to an expected market recovery. The company has chosen not to enter any new long-term power sales agreements or hedges in order to maximize its potential upside and to avoid collateral calls that would result if its contracts were out of the money. While Dynegy's baseload and intermediate plants are expected to continue to provide a source of consistent cash flow, Moody's notes that the company's strategy leaves it highly exposed to an overbuilt power generation market and gas price volatility, with its long term viability and recovery dependent on stronger power demand, higher electricity prices and improved spark spreads. In a liquidation scenario, Moody's conservatively estimates the value of the company's assets would comfortably exceed the amount of its debt.

Dynegy's exposure to fluctuations in gas prices was demonstrated by the recent $120 million downward revision of its earnings forecasts for 2006. Because gas prices largely determine the marginal price of power, and therefore the spread Dynegy's baseload coal units can achieve by selling into the market, the company estimates that a $1/mmBtu change in gas prices results in a $50 million shift in its bottom line. Despite the downward revision, the company's current forecast of 2006 EBITDA for its power generation business of $480 to $585 million still represents an increase of more than 60% from 2005 levels.

Excluding cash outflows related to the termination of the uneconomic Sterlington Tollone of Dynegy's last remaining uneconomic tolling agreements , the current debt restructuring, and an inflow from the pending swap of its 50% share of West Coast Power for NRG's interest in Rocky Road, Moody's estimates the company could generate sufficient cash from operations to meet ongoing capital spending requirements in 2006 if it is able to achieve its EBITDA target. While this would be a significant improvement, Dynegy needs to demonstrate it can deliver this level of operating and financial performance consistently. Moody's notes that based on current market prices the company is also positioned to command an additional $30 million to $40 million in revenues once its below-market power sales agreement with Ameren expires at the end of the year.

Moody's also notes that Dynegy reported a material weakness relating to income taxes in both its 2005 and 2004 10-K. While Moody's believes that such material weaknesses generally relate to isolated problems, the fact that these control issues were not remediated is considered a credit negative. Moody's will continue to monitor Dynegy's progress in remediating this material weakness.

The stable rating outlook reflects Moody's expectation of Dynegy's continued operating performance improvement as the power markets recover. Dynegy's ratings could improve through a combination of improving operational performance, consistent positive free cash flow, and cash flow coverage (FFO/debt) above 10%. The ratings could drop as a result of further deterioration in operating or financial performance relative to plan, a leveraging acquisition, or further reduction in liquidity.

Headquartered in Houston, Texas, Dynegy Inc. is the parent of Dynegy Holdings Inc. Dynegy's primary business is power generation.

New York
Andris G. Kalnins
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Aaron Freedman
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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