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Rating Action:

MOODY'S DOWNGRADES AMERICAN REF-FUEL COMPANY (Sr. Sec. to Ba1); MSW ENERGY (Sr. Sec. to Ba3); MSW ENERGY II (Sr. Sec. to Ba3); OUTLOOK STABLE

28 Apr 2005
MOODY'S DOWNGRADES AMERICAN REF-FUEL COMPANY (Sr. Sec. to Ba1); MSW ENERGY (Sr. Sec. to Ba3); MSW ENERGY II (Sr. Sec. to Ba3); OUTLOOK STABLE

Approximately $900 Million of Debt Securities Downgraded

New York, April 28, 2005 -- Moody's Investors Service downgraded the rating of American Ref-Fuel Company LLC's (ARC) senior secured notes to Ba1 from Baa2. Moody's downgraded the senior secured notes of MSW Energy Holdings LLC and MSW Energy Finance Co., Inc.'s (co-issuers hereafter referred to as MSW Energy) to Ba3 from Ba1 and downgraded the senior secured notes of MSW Energy Holdings II LLC and MSW Energy Finance II Co., Inc.'s (co-issuers hereafter referred to as MSW Energy II) to Ba3 from Ba2. Also downgraded are $43.5 million of resource recovery bonds issued by the Connecticut Resources Recovery Authority to Ba2 from Baa2 and $172.4 million of bonds issued by the Delaware Valley Industrial Development Authority to Ba2 from Baa3, for which ARC is the underlying obligor. The rating outlook is stable for ARC, MSW Energy, and MSW Energy II.

The rating actions reflect the pending acquisition of American Ref-Fuel Holdings Corp. by Covanta Energy Corporation (Covanta) for $740 million in cash plus the assumption of debt. Covanta is financing the acquisition with a common stock rights offering by Covanta's parent, Danielson Holding Corporation, and through the issuance of $1.1 billion of new credit facilities being issued as part of an overall refinancing of Covanta's outstanding debt and letter of credit facilities. These ratings are assigned subject to the acquisition closing under terms and conditions which are in accordance with Moody's current understanding, including the sizing and terms of the financing.

The downgrade of the ratings of ARC, MSW Energy, and MSW Energy II considers their acquisition by a more leveraged parent company and the substantial difference in credit quality between these three subsidiaries and the new owner. The ratings also reflect structural subordination of the notes at ARC, MSW Energy, and MSW Energy II to approximately $865 million of debt at the subsidiary waste-to-energy (WTE) projects. In addition, a $75 million revolving credit facility in place at ARC is being replaced by a credit facility at Covanta and ARC will have to rely on Covanta's on-going access to this credit facility for its own liquidity needs going forward. The downgrade of the ratings of the Connecticut Resources Recovery Authority bonds and the Delaware Valley IDA bonds reflects their reliance on a senior unsecured guarantee from ARC.

Covanta emerged from bankruptcy just over one year ago, on March 10, 2004, and will continue to have relatively high consolidated leverage and limited financial flexibility following the acquisition, with approximately $3.4 billion of total debt, with $2.0 billion of recourse corporate debt, including $440 million of undrawn credit facilities, at both Covanta and American Ref-Fuel Holdings. There is a cash receipts and disbursements waterfall arrangement administered by a trustee, and distribution tests for the upstreaming of dividends to Covanta from ARC, MSW Energy and MSW Energy II. However, the collateral for the debt of these issuers is limited to the stock of subsidiaries as the underlying operating assets are pledged to secure project level debt. Distributions could be restricted by a number of cash traps if the financial performance of the underlying projects deteriorates, including a 1.30x debt service coverage test at the SEMASS project, a 1.75x debt service coverage test at ARC, and 2.0x consolidated interest coverage tests at both MSW Energy and MSW Energy II.

Although there are some structural features which may provide a degree of insulation between the weaker parent and its subsidiaries, Moody's does not believe ARC, MSW Energy or MSW Energy II would be completely insulated from potential financial problems at the Covanta parent company level under all circumstances. The ARC operating facilities will represent important, core strategic assets for the company and constitute a substantial portion of Covanta's operations and cash flow going forward. Moody's notes that when Covanta filed for bankruptcy protection in 2002, the company chose to also make filings for 123 of its domestic project subsidiaries.

The ratings also recognize the limited collateral available to the ARC, MSW Energy, and MSW Energy II bondholders and a high reliance on a few projects for most dividends. Cash flow upstreamed to service this debt is highly concentrated from two key WTE projects, Hempstead and SEMASS, which together generate over half of the cash flow distributable to ARC. The Hempstead contracts currently expire in 2009, six years before the maturity of the ARC notes and one year before the maturity of the MSW Energy and MSW Energy II notes.

The stable outlook on the ratings of ARC, MSW Energy, and MSW Energy II reflects Moody's expectation that: (i) the waste-to-energy projects' contracts with the respective municipalities and utilities will remain in place through their current maturities; (ii) Covanta management will continue to operate the plants at high availability levels and generate synergies with regard to administrative expenses; (iii) Covanta will de-lever over the next several years at the subsidiary project level; and (iv) Covanta will be able to utilize a significant portion of Danielson's NOLs.

Ratings downgraded include:

American Ref-Fuel Company LLC's senior secured notes, to Ba1 from Baa2;

MSW Energy Holdings LLC's senior secured notes, to Ba3 from Ba1;

MSW Energy Holdings II LLC's senior secured notes, to Ba3 from Ba2;

$30 million Connecticut Resources Recovery Authority Corporate Credit Resource Recovery Bonds (American Ref-Fuel Company of Southeastern Connecticut Project), to Ba2 from Baa2;

$13.5 million Connecticut Resources Recovery Authority Corporate Credit Resource Recovery Bonds (American Ref-Fuel Company LLC, I Series A and II Series A), to Ba2 from Baa2;

$172.4 million Delaware County Industrial Development Authority Revenue Refunding Bonds Series A 1997, to Ba2 from Baa3.

American Ref-Fuel Company LLC is an owner and operator of six waste-to-energy companies in the northeastern United States. It is jointly owned by MSW Energy Holdings LLC and MSW Energy Holdings II LLC. Covanta Energy Corporation, headquartered in Fairfield, New Jersey, is an energy company with operations in waste-to-energy, independent power production, and water. Parent company Danielson Holding Corporation, also headquartered in Fairfield, has operations in insurance services in addition to Covanta.

New York
Daniel Gates
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Michael G. Haggarty
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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