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Rating Action:

MOODY'S DOWNGRADES UIL HOLDINGS CORPORATION (ISSUER RATING TO Baa3) AND THE UNITED ILLUMINATING COMPANY (SR. UNSEC. TO Baa2); RATING OUTLOOK STABLE FOR BOTH COMPANIES

16 Sep 2004
MOODY'S DOWNGRADES UIL HOLDINGS CORPORATION (ISSUER RATING TO Baa3) AND THE UNITED ILLUMINATING COMPANY (SR. UNSEC. TO Baa2); RATING OUTLOOK STABLE FOR BOTH COMPANIES

Approximately $420 Million of Debt Securities Affected

New York, September 16, 2004 -- Moody's Investors Service downgraded UIL Holdings Corp.'s (UIL) Issuer Rating to Baa3 from Baa2. Moody's also downgraded both the Issuer Rating and the senior unsecured debt rating of The United Illuminating Company (UI), UIL's utility subsidiary, to Baa2 from Baa1. The rating actions conclude a review for possible downgrade. The rating outlook for both companies is stable.

The downgrade of UIL's rating reflects concerns about:

1) The execution risk associated with ongoing efforts to rationalize remaining non-utility subsidiaries and further reduce risk in the company's consolidated business model following the sale of American Payment Systems (APS; a walk-in payment and financial services business);

2) The likelihood for higher than anticipated losses in 2004 at United Bridgeport Energy, Inc. (UBE; representing UIL's 33% ownership in a 520-megawatt merchant gas-fired generating facility) and persisting weak returns from other non-utility investments over the near term;

3) Expected lower funds from operations (FFO) in 2005. As a result, Moody's expects that UIL's FFO as a percentage of debt will decline despite debt reduction that results from the sale of APS;

4) UIL's small size, which limits its ability to withstand unanticipated cost pressures.

After UIL's non-utility subsidiaries collectively produced a loss for 2003, Moody's is concerned about the persistence of this trend in 2004 despite the fact that these businesses have not, in recent periods, required additional cash support from the parent compny. In particular, UBE remains challenged by the high natural gas price environment, which depresses both margins and sales for that project. Profitability has also eluded Xcelecom, a UIL subsidiary that provides general and specialty electrical and voice-data-video design, construction, systems integration and related services, although Xcelecom's backlog of projects is improved compared to last year. UIL has other passive investments in various funds, as well as a 25% investment in Cross Sound Cable Company (CSC). These investments, which are part of the United Capital Investments, Inc. subsidiary, were a drain on consolidated results in 2003 due to poor fund performance and the inability to bring the CSC project to commercial operating status. Moody's notes that a proposed settlement among regulators and other parties allowed CSC to commence commercial operating status in June 2004. As a result, better contributions from this project are expected in the near term, but returns on UIL's fund investments are not likely to improve in any material way.

As part of management's efforts to maximize the value of its non-utility investments, we expect to see continued negotiations for a new operating agreement at UBE for gas procurement and energy marketing. At the same time, the settlement agreement allowing for commercial operations at CSC improves prospects for refinancing of UIL's loan to the project with external project financing. Alternatively, UIL could exit either or both of these investments if an acceptable purchase offer is presented.

Importantly, UIL's liquidity position has substantially improved following completion of the sale of APS during the second quarter 2004. The sale of APS to CheckFree Corporation for approximately $110 million represented a significant gain for UIL. A portion of the proceeds were used to repay all of UIL's short-term debt. Meanwhile, UIL reported $91 million of cash at June 30, 2004, with $45 million at the parent level largely earmarked for tax payments and other post-closing costs associated with the APS sale. During July 2004, UIL also improved its liquidity by renewing its 364-day $100 million bank credit facility for a three-year term expiring July 28, 2007. We expect limited, if any usage under this facility for the balance of 2004. UIL has no maturities of long-term debt in 2004 and relatively modest sinking fund payments due in 2005 and 2006 related to its notes due 2011. The next material debt maturity within the family relates to approximately $74 million of utility debt due in 2007.

The downgrade of UI's ratings takes into account the following factors:

1) UI is not wholly insulated from the more risky non-utility investments of its parent, which makes a continuation of the one notch differential between the parent holding company and operating subsidiary more appropriate;

2) Concerns that the utility will remain challenged by past revenue reductions and operating cost pressures, which Moody's believes may result in FFO as a percentage of debt falling under 20% to the mid teens, and more in line with a peer group of Baa2 rated transmission and distribution utilities;

3) UI is more sensitive to interest rate risk than some other utilities due to a debt maturity profile under which all of its debt matures, reprices, or is subject to remarketing during the next 7 years. In the face of these challenges, the downgrade also factors in the likelihood that UIL will continue to rely heavily on UI to support its standalone obligations and common dividend since remaining non-utility investments are unlikely to collectively make any material contribution to consolidated profits, especially in the near term.

The stable rating outlook for UIL reflects Moody's view that the currently sub-par performance of UIL's remaining non-utility business investments is adequately captured in the Baa3 rating. The outlook also assumes that there will be gradual improvement in returns on those investments over the intermediate term to a level commensurate with their higher business risk profiles or that management may choose to exit poorly performing investments.

The stable rating outlook for UI reflects its relatively low-risk transmission and distribution utility business profile and efficient handling of provider of last resort supply responsibilities, which helps balance the riskier business profile of the parent's remaining non-utility business investments. The stable outlook also reflects the absence of any formal utility credit support to its parent or affiliated companies and Moody's expectations that UI will maintain its regulatory capital structure in accordance with the targets of 53% debt and 47% common equity set by the Connecticut Department of Regulatory Control for rate-making purposes, while UI continues to be UIL's principal source of cash flow for the foreseeable future.

Ratings downgraded:

UIL's Issuer Rating, to Baa3 from Baa2.

UI's Issuer Rating and senior unsecured debt, to Baa2 from Baa1.

UIL Holdings Corporation is a holding company, whose principal subsidiary is The United Illuminating Company, an electric transmission and distribution utility. Through its United Resources, Inc. subsidiary, UIL Holdings also has non-utility business investments, which include Xcelecom, Inc., United Capital Investments, Inc., and United Bridgeport Energy, Inc. Its headquarters is in New Haven, Connecticut.

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

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

No Related Data.
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