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Rating Action:

MOODY'S DOWNGRADES AVON ENERGY PARTNERS HOLDINGS TO B2 FROM Baa3 AND AQUILA NETWORKS TO Baa3, OUTLOOK NEGATIVE

23 Dec 2002
MOODY'S DOWNGRADES AVON ENERGY PARTNERS HOLDINGS TO B2 FROM Baa3 AND AQUILA NETWORKS TO Baa3, OUTLOOK NEGATIVE

London, 23 December 2002 -- Moody's Investors Service downgraded the debt ratings of Avon Energy Partners Holdings ("AEPH") to B2 from Baa3, and downgraded the issuer rating of Aquila Power Networks plc and the guaranteed debt rating of Midlands Electricity plc to Baa3 from Baa2. The outlook on all ratings is negative.

Moody's believes that, in the absence of any support from its parents Aquila Inc. (Ba2) and FirstEnergy Corp. (Baa2), cash flows from the regulated Aquila Networks business alone may not be sufficient to fully cover AEPH's financial obligations over the long-term, with remaining group cash flows emanating from significantly less stable sources such as dividends from power plant investments in Turkey and Pakistan. This concern is further heightened by the recognition that the next regulatory price review (for the period from 01 April 2005) introduces a risk that, reduced operating cash flows at Aquila Networks may also constrain the cash flow distribution capacity of Aquila Networks to AEPH.

Contributing to this is Moody's belief that, based on the obligations imposed upon the company's directors under the Aquila Network licence as well as the undertaking given by its owners as ultimate controllers, the single most important concern for management is to avoid any breach of the licence of the regulated entity. As a result, in the event that deterioration or credit concerns were to develop impacting Aquila Networks, intra-group dividend restrictions could be imposed that would impair AEPH's ability to service its debt. There also is a risk that executive orders by the UK electricity Regulator OFGEM, as part of the regulatory ring-fencing, could restrict cash distributions from Aquila Networks.

The company confirmed to the rating agency that it is AEPH that is the subject of the currently ongoing process whereby its owners Aquila Inc (79.9%) and FirstEnergy Corp. (20.1%) have solicited expressions of interest for the company. As highlighted by Moody's previously, the current group debt of around GBP 1.2billion is in excess of the regulatory asset value of the networks business of around GBP 950million. Moody's is therefore concerned that, whether or not AEPH is sold, AEPH bondholders are significantly exposed. However, the company's management was not able to provide any comfort from either its current owners, in the case that AEPH was not sold, or the prospective future owners, with respect to the AEPH debt.

Moody's points out that the counter indemnity provided by AEPH to Aquila Networks for the guarantee of the GBP 150 million 2007 Eurobond issued by Midlands Electricity plc, which was put in place upon the request of OFGEM, imposes an additional condition upon AEPH which in Moody's opinion the company would have difficulty to comply with in the absence of any external credit support. Until this is addressed or removed, this counter indemnity is regarded as a contributing factor to rating concerns at this time.

The issuer rating and the ratings of debt issued or guaranteed by Aquila Power Networks are underpinned by the protection offered by the regulatory ring-fencing provisions of its distribution licence, and the stable cash flows and comfortable debt protection measures on a stand-alone basis, including retained cash flows to debt of around 20% and positive free cash flows after CAPEX but before intra-group dividends of around GBP 40 million. Aquila Networks' main liquidity requirements are CAPEX and interest payments, and Moody's expects that the company should be able to cover almost all of its liquidity needs from operating cash flow. On a purely stand-alone basis, this company is clearly an investment grade entity, however the one notch downgrade to Baa3 reflects the reliance upon intra-group cash flows by its liquidity-constrained affiliates.

The GBP150million 2007 bond issued by Midlands Electricity plc benefits from an unconditional and irrevocable guarantee by Aquila Networks, and hence has the same rating as the regulated entity.

In Moody's opinion, the possibility of loss of licence is a big incentive for the company's management and the owners of AEPH to protect the interests of Aquila Networks. The negative outlook for the ratings of Aquila Networks and its guaranteed debt reflects the uncertainty, at this point in time, surrounding any practical steps that Aquila Network's management, and possibly the Regulator, propose to implement in order to affect the ring-fencing of this licenced entity. It also reflects the need to obtain a waiver with respect to the change of control clause contained in Aquila Networks' bank facilities in the case that AEPH was sold. Once this uncertainty is removed, it is more likely than not that Moody's will stabilise the outlook on the ratings of Aquila Networks depending on the credit profile and degree of reliance upon Aquila Networks' cash distributions in the future.

The outlook on the debt ratings of AEPH will remain negative as Moody's will seek to gain an understanding of the strategic and economic intentions of the company and its current or future owners with respect to AEPH, and its implications for bondholders of this entity.

Avon Energy Partners Holding is the parent company of Midlands Electricity plc, whose principal operating subsidiary is the fourth largest electricity distribution network in England & Wales, with total connected customers of 2.3 million. In addition to its regulated monopoly network business, AEPH has three remaining investments in independent power generation projects in the UK, Turkey and Pakistan.

London
David G. Staples
Senior Vice President
European Corporates
Moody's Investors Service Ltd.
44 20 7772 5454

London
Ralf Wimmershoff
Vice President - Senior Analyst
European Corporates
Moody's Investors Service Ltd.
44 20 7772 5454

No Related Data.
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