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Rating Action:

MOODY'S DOWNGRADES BANK LOAN RATING OF A&P TO B2 FROM Ba3, SENIOR NOTES TO Caa1 FROM B3, AND LIQUIDITY RATING TO SGL-3 FROM SGL-2

12 Aug 2004
MOODY'S DOWNGRADES BANK LOAN RATING OF A&P TO B2 FROM Ba3, SENIOR NOTES TO Caa1 FROM B3, AND LIQUIDITY RATING TO SGL-3 FROM SGL-2

Approximately $1.0 Billion of Debt Affected.

New York, August 12, 2004 -- Moody's Investors Service downgraded all ratings of The Great Atlantic & Pacific Tea Company, Inc ("A&P"), including the bank loan to B2 from Ba3, the three senior note issues to Caa1 from B3, and the Speculative Grade Liquidity Rating to SGL-3 from SGL-2. The downgrade is prompted by A&P's high cash burn rate and the demonstrated inability to tangibly improve weak operations. Benefiting the ratings are Moody's opinion that cash balances largely will finance free cash flow deficits over the next four quarters and A&P's important positions in its core markets around New York City and Toronto. The rating outlook continues to be negative.

The following ratings were downgraded:

- $400 million revolving credit facility to B2 from Ba3,

- $220 million of 7.75% senior notes (2007) to Caa1 from B3,

- $217 million of 9.125% senior notes (2011) to Caa1 from B3,

- $200 million of 9.375% senior notes (2039) to Caa1 from B3,

- Senior unsecured shelf to (P)Caa1 from (P)B3,

- Subordinated shelf to (P)Caa2 from (P)Caa1,

- Junior subordinated shelf to (P)Caa2 from (P)Caa1,

- Preferred stock shelf to (P)Caa3 from (P)Caa2,

- Preferred trust securities issued by A&P Finance I, A&P Finance II, and A&P Finance III to (P)Caa2 from (P)Caa1,

- Speculative Grade Liquidity rating to SGL-3 from SGL-2,

- Senior implied rating to B3 from B2, and the

- Long-term issuer rating to Caa1 from B3.

The fundamental ratings consider Moody's opinion that A&P will experience substantial free cash flow deficits over the medium-term, the limited availability of alternate liquidity given the previous monetization of most owned assets, and the unknown outcome of the strategy to turn around operating performance by updating the store base. The high degree of financial leverage, the weak return on assets (which causes Moody's to conclude that further asset rationalization will prove necessary), and the uncertainty regarding the company's true economic performance because of continual one-time charges also adversely impact Moody's opinion of the challenges facing A&P. However, the sizable cash balances and revolving credit facility availability, A&P's important positions in its key markets around the New York City and Toronto metropolitan areas, and the lack of pending debt maturities support the fundamental ratings. The relatively high gross margins (resulting from high perimeter department sales) and incremental progress in working capital efficiency also benefit the company.

The significant cash balance and the availability of a significant portion of the revolving credit facility support the company's adequate short-term liquidity position. Adversely impacting the SGL rating are the limited availability of alternate liquidity given that the most easily monetizable assets (Accounts Receivable, Inventory, and Pharmacy Prescription Files) already collateralize the bank loan and Moody's expectation that the company will experience a substantial free cash flow deficit over the next four quarters. As of June 19, 2004, the company had about $279 million of balance sheet cash but Moody's notes that the company utilized about $134 million for operating purposes and franchisee cash of $24 million was consolidated with A&P's financial statements per FIN 46-R.

The negative outlook considers the possibility that ratings may decline if (1) the company cannot reduce its cash burn rate through improving operations, (2) working capital becomes a material use of cash, or (3) the operating regions outside of the New York City and Toronto metropolitan areas remain unprofitable. The company has indicated that it would consider selling any asset except for the two profitable divisions around New York City and southern Ontario, but Moody's does not regard potential divestiture of operating divisions as a reliable liquidity source. Progress up the rating scale is unlikely unless operating cash flow covers debt service and a normalized level of capital investment and store-level performance approaches industry operating norms.

The B2 rating on the secured revolving credit facility ($330 million available to The Great Atlantic and Tea Company, Inc. and $70 million available to The Great Atlantic & Pacific Company of Canada) considers that this debt enjoys guarantees from the company's operating subsidiaries and is well secured by a borrowing base comprised of inventory, liquid accounts receivable, and prescription files. Certain assets remain unpledged such as real estate in about 38 locations. As of June 19, 2004, the fixed charge coverage ratio (as defined by the bank agreement) fell below the minimum level of 1.00:1 that would have been tested if less than $50 million of availability remained on the revolving credit facility. Moody's estimates that the company had about $173 million of revolving credit availability after $128 million in Letter of Credit utilization, $49 million in borrowing base limitations, and $50 million of fixed charge coverage reduction.

The Caa1 rating on the unsecured notes considers that these three issues are issued at the holding company level and do not receive guarantees from the operating subsidiaries. These unsecured notes are effectively subordinate to significant operating company obligations including the $400 million bank facility and $478 million of trade accounts payable.

Moody's anticipates that the company will generate EBITDA of around $200 million over the next twelve months. Expected cash outflows include about $90 million of cash interest expense (pro-forma for treating capital costs of the recent sale & leaseback transaction as interest expense instead of rent expense) and capital investment of about $260 million. Given Moody's expectation that sales will not grow, we believe that permanent working capital investment will be minimal. For the twelve months ending June 19, 2004 (assumes the $60.1 million impairment charge to write-down the long-lived assets and goodwill at Farmer Jack's is added back), lease adjusted leverage was 6.6 times, fixed charge coverage (as defined by Moody's) was 0.1 times, and return on assets was slightly negative. Operating performance with one-time charges added back has declined over the past several years in spite of previous efforts to divest non-core assets and exit underperforming stores. EBITDA margin for the 12 months ending June 2004 equaled 1.8% compared to 2.5% and 4.2% in the Fiscal Years ending Feb. 2003 and Feb. 2002, respectively. In Moody's opinion, A&P must significantly invest in store remodels to remain a viable franchise because of the underinvestment during the past three years (as evidenced by depreciation substantially exceeding capital expenditures) and the low return on assets.

The Great Atlantic & Pacific Tea Company, Inc., headquartered in Montvale, New Jersey, operates 628 and franchises 66 supermarkets in 10 states, the District of Columbia, and Ontario. Revenue for the twelve months ending June 2004 was $10.9 billion. Affiliates of the German supermarket operator Tengelmann own 58% of A&P.

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
Richard Baldwin
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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